640 / When is a defendant who is a party to a structured settlement entitled to deduct the payments made pursuant to the agreement?
If the payor uses the accrual method of accounting, he or she can deduct any allowable expenses in the year in which: (1) all events that prove liability have occurred, (2) the amount of the liability can be determined with reasonable accuracy and (3) the economic performance requirement has been met with respect to the liability.2
In the context of a structured settlement, economic performance by the defendant will typically occur as the defendant actually makes the required payments to the plaintiff.3
For example, assume that the parties to a lawsuit enter into a structured settlement that requires the defendant to pay $150,000 per year to the plaintiff for 10 years, and the defendant immediately purchases an annuity to provide for the entire $1.5 million obligation. Economic performance occurs when each $150,000 payment is made to the plaintiff—not when the defendant purchases the annuity. Therefore, assuming all other requirements are met, the defendant is entitled to deduct $150,000 for each of the 10 years in which payment to the plaintiff is properly made under the structured settlement.
1. Treas. Reg. § 1.461-1(a)(1).