You have likely heard the term “structured settlement,” which refers to a system in which a plaintiff receives payments from his or her settlement over time rather than in a lump sum. This can be an appropriate settlement planning choice for plaintiffs who will require long-term medical treatment or are facing a permanent disability.
The appeal of structured settlements comes, in part, from their tax savings. But structuring a settlement is just one way a plaintiff can reap the benefits of long-term income and a tax break. A lesser known option, called a non-qualified settlement, can also provide plaintiffs with tax relief.
First, let’s revisit what a “qualified” assignment is. In a personal injury case, the plaintiff may settle for a lump sum amount in principle, and then arrange to have a portion of the settlement dedicated to an income strategy. This 0bligation becomes part of the original settlement, and in order for the tax exemption on all “earnings” to work, the obligation is assigned. The assignee is payed to assume the obligation, holds settlement funds after the defendant settles and creates a periodic payment obligation. Personal injury settlement payments are “qualified” because they are not subject to income tax. Qualified typically means that the process of setting up the structure qualifies under IRC section 130 and 104, and is either a personal injury case or a workers compensation case. Tax exemption on earning from your settlement requires some kind of bodily injury as defined by the IRS.
A non-qualified assignment (NQA) is an assignment of an obligation to pay money in the future (a structured plan) in cases that do not involve bodily injury. The assignments are designed to handle funds from settlements in non-personal injury cases. With an NQA, a plaintiff can reap the benefits of financial planning by spreading their settlement over a long period of time instead of receiving it in one lump sum (which would be taxable). Not only does it offer the opportunity to receive payments designed to spread the tax burden, but by controlling the timing of the receipt of income, taxpayers can plan each and every year around the receipt of the additional income.
Simple planning measures like contributions to 401k, SEP, or IRA’s and taking deductions can significantly reduce the amount of tax that is paid on a settlement. A lump sum settlement guarantees the highest amount of tax and the least deductions in a single tax year. There are many types of lawsuits, some of which involve whistleblowers, patents, intellectual property, sexual harassment, and discrimination, which result in a taxable settlements. We experienced firsthand hundreds of business owners who have recovered in the BP litigation, who were happy to see their claim resolve, but they cringed when they netted out their award after attorney fees and federal and state taxes. Many of these types of recoveries only see 25 percent or so actually go to the plaintiff after fees and taxes.
Most litigants haven’t thought about their taxes, much less how much money they might be getting until their lawyer recommends settlement. It is a big question to ask a client, would you like your $1 million check sent to you, or would you like a wire to your bank. Most of our clients truly appreciate the time to process, and the time to seek advice from family, friends, CPA’s, family attorneys and settlement planners. What are their options?
Settlements are by nature the end of litigation. There are oftentimes sensitive decisions associated with settlement. A non qualified assignment in your taxable case may sound attractive, but getting all of the right people in the room to give you sound advice will take time. A signature planning tool of a plaintiff settlement planning practice is the qualified settlement fund.
The main benefits of establishing a QSF include the ability to:
- Extend the amount of time available to plan for the incoming settlement money, allowing attorneys to provide thorough client counseling and make decisions about the disbursement of funds.
- Allow the defendants to make a payment into the fund in exchange for a general release from the litigation.
- Provide lawyers with their fees months sooner.
Qualified settlement funds ONLY provide planning time in certain types of cases. The treasury regulations 1.468B are specific to the types of cases. Typically all torts, or cases based on tort type rights, such as personal injury, wrongful death, breach of contract satisfy the “case type” requirement making the qualified settlement fund a very useful tool in tax-free and taxable cases.
Milestone Consulting is one of the only companies today to offer an independent, non-qualified solution. We offer non-qualified options for plaintiffs and their attorneys to evaluate the amount of the settlement or fee they choose to take in the year of settlement. Deferring portions of the settlement through non-qualified assignments can reduce the overall tax bite, and gives litigants and their attorneys investment options (pre-tax).
Like with all solutions, having a tax problem is a good problem to have, but through the use of both qualified settlement funds and non-qualified assignments, you can control the timing of your taxation. A beautiful thing in the world of litigation and taxes.
About John Bair
John Bair has guided thousands of plaintiffs through the settlement process as founder of Milestone Consulting, LLC, a broad-based settlement planning and management firm. Milestone’s approach is comprehensive and future-focused. John’s team has guided thousands of clients by taking the time to understand the complexities of each case. They assess the best outcome and find the path that enables each client to manage their many needs. Read more about Milestone Consulting at http://milestoneseventh.com/.
A West Point graduate where he served as captain and military aviator, John Bair continues his commitment to our country through his efforts within the settlement planning industry. He has represented families of victims lost in the Flight 3407 crash, offered pro bono services to the families of 9/11 victims and drafted the first consumer protection bill for plaintiffs (H.R. 3699).