Non-Qualified Structured Settlements: Tax Deferral, Uses, and Risks

A non-qualified structured settlement is a payment arrangement for legal recoveries that don’t qualify for the physical-injury tax exclusion, letting the plaintiff receive the money as periodic payments over years instead of a lump sum, and pay income tax on each payment only in the year it arrives. The money is still taxable. What changes is the timing, and with it the marginal rate that applies each year.

The contrast with a qualified structured settlement matters because the two get confused. Qualified structures cover claims for personal physical injury or physical sickness under IRC Section 104(a)(2), and their payments arrive entirely tax-free. Non-qualified structures cover everything else: employment discrimination, wrongful termination, breach of contract, defamation, punitive damages, environmental claims, and similar taxable recoveries. The 1996 Small Business Job Protection Act added the word “physical” to Section 104(a)(2) and eliminated the exclusion for punitive damages, which sharpened the line between the two categories.¹

How the Deferral Is Actually Built

The mechanism is called a non-qualified assignment. The defendant (or its insurer) agrees to settle through periodic payments rather than a lump sum, then transfers that payment obligation to a third-party assignment company. The assignment company becomes the sole entity responsible for future payments, and the defendant receives a full release.²

The assignment company funds the obligation by buying an annuity, or in newer products a funding agreement, from a life insurance company. The annuity is owned by the assignment company, not by you. You hold only an unfunded, unsecured promise to receive payments on the agreed schedule.³ That structural detail is what keeps the IRS from treating you as having received the whole settlement upfront. Payments flow from the annuity issuer through the assignment company to you, and you report each one as income only in the year it arrives.

Because non-qualified assignments fall outside IRC Section 130, the assignment company itself has a tax problem: the lump sum it receives from the defendant to buy the annuity can be treated as its own corporate income. A U.S.-based assignee would owe corporate tax on those funds and erode the arrangement’s economics.⁴ The industry has historically used assignment companies domiciled in Barbados, Ireland, or Switzerland to minimize that layer.⁵ Barbados has been the most common jurisdiction, operating under the 1984 U.S.-Barbados Income Tax Treaty.⁶ MetLife has claimed its MetLife Assignment Company, Inc. was the first domestic U.S.-based assignment company offering NQA products.²

What the Tax Savings Look Like

Take a $750,000 employment settlement as MetLife modeled it. Received as a lump sum, the immediate federal tax bill runs to roughly $191,095. If instead you take $100,000 upfront and structure the remaining $650,000 over 20 years of monthly payments, the total tax across the full period comes to about $45,686, a nominal savings of roughly $145,000.⁷ The savings come from keeping annual income lower and staying in lower marginal brackets each year.

The funds inside the annuity also grow tax-deferred until paid out. Each periodic payment consists of a return of the original purchase amount, generally not taxed again, and earnings taxed as income when received.⁸ One academic analysis compared the effect to a 401(k) or IRA without the annual contribution limits or early-withdrawal penalties those accounts impose.⁹

What Can Collapse the Deferral

Deferral is not automatic. The IRS can collapse the structure and tax the full settlement in year one if the arrangement fails common-law doctrinal tests. Four requirements do the work:

No constructive receipt. You must have no unrestricted right to demand the funds. Settlement documents must prohibit accelerating, deferring, increasing, or decreasing payments.³
No economic benefit. The funding annuity must be owned by the assignment company and remain subject to the claims of that company’s general creditors. You cannot own or control the annuity.
No cash equivalency. Your right to future payments must be non-assignable, non-transferable, and cannot be pledged or used as collateral. Agreements typically void the settlement if you attempt any of these.
Timing. All structure documentation must be finalized before the settlement agreement becomes legally binding. Once a settlement is signed or funds reach a trust account, you may be deemed to have constructively received the payment, and later deferral efforts become ineffective.¹⁰

A 2008 IRS Private Letter Ruling confirmed that when these conditions are met, the periodic payments are included in income only in the year received.¹¹ A private letter ruling cannot be cited as precedent by other taxpayers, which is part of why practitioners treat these arrangements as if every element will be scrutinized.

Which Cases Can Use a Non-Qualified Structure

Any settlement that produces taxable income to the plaintiff is a candidate. Common categories include:²

Employment disputes: wrongful termination, sexual harassment, discrimination (age, race, gender, disability), and claims for mental anguish or emotional distress.
Contract and business claims: breach of contract, legal malpractice, Directors and Officers (D&O) liability, and Errors and Omissions (E&O) claims.
Punitive damages, pre-judgment interest, and post-judgment interest.
Environmental contamination, property damage, and cleanup cost disputes.
FINRA suitability cases, fraud and conspiracy claims, whistleblower awards, and defamation.
Contingency attorney fees from any of these case types.

One important carve-out applies in employment cases. Amounts that constitute wages for payroll tax purposes, specifically back pay, front pay, and severance subject to FICA and FUTA withholding, are ineligible for NQA treatment.² Settlement allocation is therefore critical: the wage and non-wage components must be separated before the agreement is finalized, and the IRS evaluates allocations based on whether they reflect the substance of the underlying claims.¹² Vague or blended allocations can produce unfavorable treatment across the whole amount.

Designing the Payment Schedule

The payment schedule is negotiable at settlement, and the design options include:

Fixed periodic payments, monthly, quarterly, or annual, for a set term or for your lifetime.
Deferred lump sums scheduled for specific future dates, useful for anticipated expenses like college tuition or retirement.
Stepped increases that grow over time to account for inflation.
Life-contingent payments that continue for your lifetime and cease at death, unless a guaranteed period protects beneficiaries.²
Market-based options tied to an objective formula or investment index rather than a fixed annuity rate.⁵

Traditional NQA annuities must comply with IRC Section 72(u), which requires contracts owned by non-natural persons such as assignment companies to function as immediate annuities. Payments generally must begin within one year of funding and be substantially equal.⁸ Section 72(q) imposes a 10% penalty tax on distributions from deferred annuities before age 59½, with exceptions for substantially equal periodic payments and payments after death or disability.¹³ Newer funding-agreement products, such as MetLife’s NQA Flex Agreement introduced on April 6, 2026, sidestep the Section 72(u) constraints and allow deferred start dates beyond one year and lump-sum payments.¹⁴

Whichever schedule you choose must be selected and finalized before the settlement is funded. Once the annuity is established, the schedule generally cannot be changed.¹⁵

Structuring Attorney Fees

Plaintiff attorneys can structure contingency fees through the same NQA mechanism, independently of whether the client structures their own recovery. This became a significant planning tool after the Supreme Court’s 2005 decision in Commissioner v. Banks, which held that plaintiffs must include the full settlement in gross income, including the portion paid to counsel as a contingency fee.⁷

The mechanics mirror the plaintiff’s arrangement. A defendant funds an assignment company, which buys an annuity to pay the attorney over time. The attorney defers both the fees and the investment growth until each payment arrives, leveling income across years and avoiding the spike a large single-year fee would create.¹⁶ There is no statutory cap on the amount deferred and no requirement that other firm employees participate.

The legal foundation is Childs v. Commissioner, a 1994 Tax Court decision affirmed by the Eleventh Circuit. The court held that a structured fee arrangement did not trigger constructive receipt because the attorney had no unfettered demand for the money at settlement, and the promises to pay were neither funded nor secured, meaning they did not constitute property taxable under IRC Section 83.¹⁷

That precedent is now under active challenge. In December 2022, the IRS Office of Chief Counsel issued a General Legal Advice Memorandum arguing that Childs is binding only within the Tax Court, that the Eleventh Circuit’s unpublished affirmance carries limited weight, and that the original ruling failed to address the economic benefit doctrine or the requirements of IRC Section 409A governing nonqualified deferred compensation.¹⁸ Tax professionals may have difficulty supporting fee structures at a substantial-authority level, and return preparers may need to disclose such arrangements on tax returns.

Pairing With a Special Needs Trust

Non-qualified structured settlement payments can be directed into a first-party Special Needs Trust to preserve a disabled beneficiary’s eligibility for Medicaid and Supplemental Security Income. Assets held inside the SNT are not counted against those programs’ resource limits, so the trust can fund supplemental expenses like specialized therapy, personal care, and equipment without disqualifying the beneficiary.¹⁹

Drafting has to be precise. The annuity’s payee must be the SNT, not the individual. Federal law requires first-party SNTs to name the state Medicaid agency as the remainder beneficiary at the beneficiary’s death, and a commutation clause, required in 49 states (all except California), must let the remaining annuity payments be converted to a lump sum on death so the state can recover its Medicaid expenditures.²⁰

Where the Law Is Not Settled

Non-qualified structured settlements sit in a less secure legal position than qualified ones. There is no specific IRS code section authorizing or governing them, no published revenue ruling directly addressing the full scope of NQA tax treatment, and the leading judicial precedent, Childs, is under active IRS challenge after nearly 30 years of industry reliance. The 2022 General Legal Advice Memorandum signaled that the agency may pursue enforcement against fee structures, and potentially other NQA arrangements, using arguments the original Childs court never considered, including Section 409A.¹⁸

The practical takeaway is that the entire deferral benefit depends on documentation. Practitioners advise drafting non-qualified assignments with strict adherence to the constructive receipt, economic benefit, and cash equivalency safeguards, and treating the arrangement as if every element will be examined, because the absence of a clear statutory safe harbor leaves nothing else to fall back on.³ If you are considering one, get the structure agreed and papered before you sign the settlement, and work with a settlement planner and tax counsel who handle these arrangements regularly.

1
IRS. Tax Implications of Settlements and Judgments
2
MetLife. Non-Qualified Assignment
3
Wood LLP. Nonqualified Structured Settlements
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4 Structures. Non-Qualified Assignment and Structured Settlements
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Roberts & Holland LLP. U.S.-Barbados Tax Treaty Analysis
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MetLife. Structuring an Employment Settlement: A Tax-Efficient Solution
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Pacific Life. Why Structure a Nonqualified Settlement
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Boston College Law Review. Structured Settlements Tax Analysis
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IRS. PLR 200836019
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Amicus Planners. Structured Settlement Employment Cases
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Federal Bar Association. History of the Taxation of Annuity Contracts
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MetLife. MetLife Launches New Deferred Payment Option for Non-Physical Injury Claims
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CPT Institute. Structured Settlements and Special Needs Trusts: A Synergistic Approach
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Special Needs Answers. Funding a Special Needs Trust With a Structured Settlement