Taxes and Government Benefit Impacts Receiving a lump sum settlement can trigger a number of problems with taxes and government benefits such as social security. Much depends on the kind of settlement that is involved. The trigger has to do with what is considered income. Both social security and income taxes become problematic as one's income level goes up in a given tax year. Taxes increase and social security benefits decrease unless you are past a certain age. Where a lump sum settlement is paid to address an injury or a caused disability for physical harm, taxes are likely not going to apply. The reason being is that the settlement is paying to return someone to their status quo physically, or compensating for loss. A related payment as a result is not considered income per se. Mental suffering and emotional damages paid by settlement are not necessarily off the hook, however. The IRS tends to consider such payments as punitive and in effect a form of income. That makes the funds taxable. State tax agencies tend to follow the path of the IRS and duplicate their charges at the state tax level. Any settlement recipient should discuss the ramifications of receiving it with a lawyer and a tax consultant before signing on the settlement forms. On the social security side, if government benefits are taken before reaching full benefit age, then a penalty can occur if income is received when receiving social security payments. In short, the recipient can see part or all of benefits received having to be returned at tax time. Depending on the numbers, the recipient can find himself owing funds back in the form of income taxes as social security penalties are applied. How much is lost depends on how much income is earned and whether it crosses predetermined income thresholds. Much of the major tax hit can be avoided by simply not agreeing to a lump sum settlement. Using a structured settlement instead brings one's total income in a tax year down to just the periodic settlement payment as well as any other income earned that year. The total is taxed by the appropriate tax bracket. Over the life of a structured settlement, this approach can save a significant amount in tax avoidance as a lower tax bracket usually applies versus that of a lump sum. Investing When you receive a lump sum settlement, the first place the money has to go is into a bank account. While there may be a list of things to pay for, most payers transfer funds via a cashier's check or a check made out by their attorney's office. That means the recipient has to deposit the check in another account for the funds to actually move based on the check document. When money sits in a bank account or gets put in some kind of investment vehicle such as a money market account, mutual fund, stocks, or asset, it tends to grow in value (not always). The growth of the funds whether it be in the form of interest, dividends, or capital gains is taxable. Again, similar to the taxes on the initial settlement if any are owed, as the recipient of the gains you are also responsible for paying the related taxes as well. Failure to do so can quickly add up in late interest and tax penalties. Settlement & Taxes Before you grab that fast cash, learn what’s involved with Lump Sum Settlements