Settlements in personal physical injury cases are typically paid in one of two ways. The litigant may receive a lump sum payment or agree to a structured settlement arrangement providing for periodic payments. In this context, structured settlements usually refer to situations where the defendant pays a lump sum to a financial intermediary that makes periodic payments to the plaintiff. A major tax advantage of this structure is when the lump sum is invested in an annuity on a pre-tax basis. Since section 104 makes no distinction between damages received as lump sums or as periodic payments, each payment should be 100% excludable from income. Although the additional monies attributable to time delays or earnings on investments can be viewed as interest, each payment should be tax-free. By contrast, if the recipient receives a lump sum any investment earnings would thereafter be taxable.
