When a Texas medical malpractice lawsuit is resolved with a settlement, there are some important factors to consider on how it should be funded.
One of the questions we frequently get asked by our clients here at Painter Law Firm is whether a medical malpractice settlement is considered taxable income.
Before answering, I should say that individual facts and circumstances vary, so I advise consulting with a qualified tax professional.
With that said, though, 26 U.S. Code Section 104 provides that compensation for a personal injury, including medical malpractice, is generally not considered taxable income. That’s why we always make sure that our settlement agreements contain language citing the statute and explaining how the settlement payment is because of a medical malpractice personal injury.
The benefits of special needs trusts and annuities
Any time a minor (an individual under 18 years old) is a party to a lawsuit, the court has to approve the terms and distribution of the settlement. The reason for this is to make sure that the settlement is in the best interest of the minor and that a parent, other individual, or attorney isn’t treating the minor unfairly.
Once there is a settlement, the court will appoint an independent guardian ad litem, an attorney who will review the case and proposed settlement, then make recommendations to the court. Those recommendations and the ultimate approval are done at an oral hearing called a minor settlement conference.
Any funds that are to be distributed to the minor will have to be protected until the minor reaches the age of 18.
For smaller settlements, the court may order the funds to be deposited into the registry of the court. When the minor turns 18, he or she can apply and have the funds released, with a small amount of interest that the principal earned in the registry.
For larger settlements, the guardian ad litem may recommend, or the court may require, setting up a structured settlement.
In some situations, where the minor was the injured person and requires substantial future care needs, it may be appropriate to set up a special needs trust. This type of trust allows payment for certain needs of the beneficiary, yet preserves eligibility for income or means-based government programs, like Medicaid.
Regardless of whether the minor was the primary injured party or not, an annuity is an appealing option in many situations. Annuities are essentially contracts guaranteeing future periodic payments either for life or for defined pay-out dates. The benefit of an annuity versus the registry of the court is that it yields higher returns that are entirely exempt from taxes.
One important issue to keep in mind is that special needs trust, annuity, and structured settlement decisions need to be made before the settlement is actually funded. The reason for this is a legal doctrine called constructive receipt. Basically, if the plaintiff or plaintiff’s attorney receives the lump sum of the settlement, then the tax benefits of the special needs trust or annuity are off the table.
Settlement agreements and funding instructions must be carefully and competently thought out and prepared. This is another reason why it’s important to hire a top-rated experienced Houston, Texas medical malpractice lawyer to represent and advise you in your case.