Are Structured Settlements tax free? That is the question.
1. Income tax exemption: Structured settlement payments—including growth—are 100% income tax-free.
Comment: TRUE, if the payments represent damages that qualify for an exclusion from gross income set forth in IRC 104(a)(1), IRC 104(a)(2) or IRC 139F. Generally, worker’s compensation, personal physical injury or physical sickness, wrongful death and wrongful incarceration. It is not the structured settlement payments themselves that drives the tax treatment, it is what the parties agree the damages the structured settlement payments represent compensation for and how that is applied in the tax code.
2. While lump sum cash settlements are income tax-free for physical injury cases, if the money is placed in a traditional investment, then any growth is subject to income taxes.
Comment: Not exactly. The answer fails to recognize capital investments that produce capital gains.
The term capital gain refers to the increase in the value of a capital asset when it is sold from what you paid for it.
A short term gain or loss is when the asset is disposed of in one year or less. A long term capital gain or loss occurs if an asset is sold after holding for more than one year. The asset must be disposed of (sold) in order to realize a capital gain or loss. In other words, unrealized gains and losses that reflect an increase or decrease in the value of an investment are not considered a taxable capital gain.
So it would be inaccurate to say that “if the money is placed in a traditional investment, then any growth is subject to income taxes”.