Periodic Payment Settlement Act

What Is the Periodic Payment Settlement Act?

The Periodic Payment Settlement Act of 1982 revolutionized court settlements by offering the option for settlements to be paid as a stream of reliable payments over extended periods. The Act allows injured parties to conclude litigation in a way that provides them with an ongoing stream of income to support their needs.

Before the late 1960s, structured settlements didn’t exist in the United States and injured parties received their compensation as lump sums. That approach lasted until enterprising insurance executives conceptualized the idea of paying out personal injury and other lawsuit settlements over time. They theorized that since traditional lump-sum court settlements were exempt from taxation, these new structured settlements should be exempt as well.

The Internal Revenue Service agreed, issuing a decision in 1979 validating the idea. Congress got on board a few years later, and in 1982 lawmakers passed the Periodic Payment Settlement Act. The Act, spearheaded by Sen. Max Baucus from Montana, gave structured settlements the full federal stamp of approval. President Ronald Reagan signed the act into law in 1983. 

The law is still in effect today and has shaped the format and practice of structured settlements. Now, the federal law works in accordance with individual state regulations to provide protections to consumers with structured settlements.

How Incremental Payments Ensure Long-Term Security

Unlike lump-sum court settlements, structured settlements involve a series of payments that form a stream of reliable income over multiple years.

When he introduced the Periodic Payment Settlement Act, Baucus explained his rationale that using a lump-sum settlement had “proven unsatisfactory… in many cases because it assumes that injured parties will wisely manage large sums of money so as to provide for their lifetime needs.”

The reality, Baucus said, was that injured people, especially minors, often spent their lump-sum awards in just a few years and were left with no way to fund their needs in the future.

Structured settlements, Baucus said, give injured people “a steady income over a long period of time and insulate them from pressures to squander their awards.”

The Act received bipartisan support in Congress. Lawmakers across the aisle agreed with Baucus that structured settlements could protect injured people from spending lump-sum legal settlements quickly, leaving them with no means of support for the rest of their lives.

Tax Exemptions for Periodic Payments

By bestowing tax advantages on the settlement recipient and the parties making the payments, Congress encourages structured settlements as a means of restoring financial well-being to people who have been harmed, helping them avoid the need for public assistance in the future. The law also encourages the use of annuities to fund structured settlements.

The same year Reagan signed the Periodic Payment Settlement Act, Congress also passed Internal Revenue Code Section 130, which governs the tax-free treatment of most structured settlements that receive funding through annuities or Treasury securities.

Under this law, structured settlements are exempt from taxes in all cases involving injuries, sickness or wrongful death. This means that the total amount of the structured settlement annuity can grow with no taxes and then be distributed to the settlement holder, who also pays no taxes.

Conversely, the person who receives funds from a lump-sum payout may invest them, but they will owe taxes on any growth those investments accumulate.

The law not only exempts injured parties from having to pay income taxes on structured settlements, it also makes it easier for the defendants of the settlements to conclude their obligation to the plaintiffs all at once. They may do this by issuing “qualified assignments,” or paying third-party structured settlement companies to administer the settlement payments.

This special treatment applies only to cases involving injury, sickness and death. In 1995, the U.S. Supreme Court ruled that the tax code provision does not affect cases involving employment age discrimination when the claim doesn’t involve sickness or injury.

In 1997, Congress extended the protections of the Periodic Payment Settlement Act to workers’ compensation cases involving employees injured on the job. President Bill Clinton signed that legislation, known as the Taxpayer Relief Act.

Structured Settlement Protection Acts

While structured settlements are beneficial to thousands of injured people, they do have a downside: illiquidity. Owners cannot access the bulk of their settlement funds at any given time, which can be problematic if they are dealing with a financial emergency and need a cash infusion.

In response to this, factoring companies began purchasing the rights to future payments at a discount. This allows structured settlement holders to obtain large lump sums when they are needed.

The federal government imposed regulations on these purchases to prevent buyers from taking advantage of injured people. In short, federal law imposes a 40% tax on these payment purchases unless they are made in accordance with state laws known as Structured Settlement Protection Acts.

All 50 states have their own Structured Settlement Protection Acts, with the last, New Hampshire, adding theirs in 2021. These state laws work to supplement federal regulations by requiring that any factoring transaction be approved by a judge, who must conclude that the transaction is in the best interest of the settlement holder.

Read More: Selling Structured Settlement Payments

Frequently Asked Questions About The Periodic Payment Settlement Act