When negotiating a taxable settlement, it’s crucial to consider the tax implications of the damages awarded. A fully taxable settlement significantly reduces the claimant’s net recovery compared to settlements that are tax-deferred, partially taxable, or tax-exempt. Implementing tax-efficient planning strategies—such as structured settlements—can help reduce tax liabilities, improve financial outcomes for claimants, and facilitate fair and reasonable claim resolutions.
The Benefits of Deferred Income
Deferring income to a future tax year can provide significant financial advantages. Rather than receiving a large lump sum and facing higher immediate tax rates, spreading settlement payments over time can result in a lower overall tax burden.
For example, the tax impact of a $500,000 settlement received in one year is considerably higher than if the same amount were distributed in ten equal annual installments. The concept of deferred income recognition has long been used in deferred compensation plans for high-income earners, and similar benefits apply to structured settlements.
Planning Tools to Reduce Tax Liability
Claimants and defendants involved in taxable settlements should explore available tax planning tools. Options such as specialized trusts and structured settlements provide strategic ways to manage tax obligations and optimize financial outcomes. Consulting with tax professionals early in the settlement process can ensure proper structuring and compliance.
Expert Insights from Forbes
Tax attorney and author Rob Wood recently highlighted the tax challenges associated with settlements and attorney fees in an article published in Forbes. His analysis emphasizes common tax pitfalls that claimants face when receiving taxable settlements.
While Wood’s article brings important tax concerns to light, it does not address a key solution: non-qualified structured settlements, which offer flexible, tax-efficient settlement options that can be annuity-based, market-based, or a combination of both.
Conclusion
Understanding and planning for the tax implications of a settlement can significantly impact the claimant’s financial recovery. Structured settlements and other planning tools provide opportunities to reduce tax burdens and maximize net proceeds. For those navigating taxable settlements, exploring these options with financial and legal professionals can lead to a more favorable financial outcome.
For more insights, read Rob Wood’s full article: “Unlike Trump’s $25 Million Meta Deal, Most Legal Settlements Are Taxed” (free access, no paywall).
By John McCulloch, JD/MBA, CSSC, CMSP, CMSS
Structured Settlement Consultant and Vice Chairman at Arcadia
John McCulloch specializes in structured settlements, bringing extensive experience in casualty, property, fidelity, and workers’ compensation claims. Before joining Arcadia, he served as Senior Vice President at Allstate Assignment Company. John holds an MBA from the University of Phoenix, a JD from Purdue University, and a BA from St. Martin’s University.
