Structured Settlements Authority

Rethinking Structured Settlements

A Structured Settlement May Not Be the Right Answer

Structured Settlement Tax Rule

In order to clarify issues regarding the selling of structured settlement annuities in exchange of lump sum payments to third party finance firms, the Internal Revenue Service has created a set of rules.

The regulations first published in February 2003 and finalized later in July of that same year, impose a 40% excise tax on the sale of structured settlements unless certain conditions are met. This tax is applied as a disincentive on all transactions related to the conversion of structured settlement annuity into a lump sum unless the transaction is first approved in a state court.

There has been a significant increase on the number of structured settlement annuities sold by recipients to finance firms all around the country since the 1990s. Structured settlement are long-term, sometimes lifetime annuities that were used to pay compensation to victims who need longtime or lifelong care. However, after receiving the structure, some recipients change their mind and instead opt to sell their settlement policies in exchange for a large lump sum.

The excise tax imposed on the sale of the right to receive future structured payment rights was enacted to discourage finance firms from buying them without going through the courts. Finance firms who were into the business of buying settlement annuities on the other hand were quick to defend that the nature of their business. These factoring companies argue that they allow the structured settlement recipients the benefit of changing their mind about how they receive their settlement claims without having to go back to court. But proponents argue that such actions remove important protections from the recipients and also cause confusion on the issue of the annuities' tax status.

The reason Congress gave a tax break to incomes that came from structured settlement was to promote their use. The reason Congress did this was that in many cases, accident victims who once had the stable source of income from the structured settlement annuity and have later sold their settlement policy and frivolously spent the huge lump sum have found themselves left with no income at all. These same people then become dependents of the state and a burden to society. It is in the interest of the public to encourage the use of structure settlements and in the event that they are sold, that a review is made to verify that the sale is indeed in the best interest of the beneficiary. The regulations released by the IRS clarify the accounting on sales of such settlements as they affect insurers.

Increasing Use of Structured Settlements

The past few years have witnessed an increase in the number of compensation awards to accident victims to cover damages that they incurred due to personal injury or product liability accidents. Headlines featuring large personal injury awards due to a wide range of accidents resulting from a single personal injury case to large scale product liability cases, such as faulty tires, have become a norm nowadays. With the increasing number of personal injury awards, structured settlements are slowly gaining popularity because of the significant guarantees that they provides as well as the favorable tax benefits that are made available to claimants.

A structured settlement is a voluntary, contractual, agreement to resolve the damage compensation in a personal injury or product liability case. A structured agreement involves a series of periodic and lump sum payments as compensation for damages over a set period of time based upon the future needs of the injured party.

A structured settlement agreement takes into account immediate medical and legal obligations that the claimant might incur as well as annuity payments to provide for on going medical expenses and the loss of income. Current and existing obligations might require an immediate cash settlement payment. Future and on going payments for items such as medical, surgical, and hospital bills, home and automobile modifications, rehabilitation, homemaker and custodial services, job retraining, and equipment and service expenses are typically considered in a capital needs analysis.

Structured settlements are frequently used with a special needs trust in order to further ensure financial security and preserve government benefit eligibility for Social Security and Medicaid. Trusts involving structured settlements should, however, be carefully drafted so as to qualify and normally require the advice of an expert in that area.

The Periodic Payment Settlement Act of 1982 limited the qualified funding options for structured settlements to annuities and government bonds via IRC §130. IRC §130 reinforced and expanded §104(a). Further modifications to IRC §130 were done through the Tax Reform Act of 1986 so as to include cases of wrongful death.

Structured settlements are being widely used today even on non personal-injury cases that involves the necessity to resolve issues regarding financial needs. Examples of such cases are lottery winnings, employment severance and workers compensation cases, and divorce. It must be noted however that the tax-free benefits are not available to non personal injury cases such as those aforementioned.

Benefits of Structured Settlements

Benefits for the Defendant:

1. In many case it is actually faster to settle the claim using a structured agreement rather than litigating the case in a court of law. Legal procedures, scheduling court dates and dealing with motions to postpone or delay can take substantial amounts of time. A mutually agreed upon settlement can help eliminate or reduce these types of delays.
2. Once the structure settlement is reached and the payment annuity is assigned, the responsibility and liability of the defendant is released.
3. The combination of cash lump sums and long-term annuity payments provided by structured agreement will help the claimant and his dependents recover from the loss and get on with their life. The defendant has the opportunity to show a sign of concern regarding the welfare of the victim by providing for their needs in the structure. This is also a contribution to society by reducing the victims need to rely on charity or public assistance to recover from their loss.
4. Structured settlement agreements can also save the claimant as well as the defendant money by helping them avoid expense and risk of a jury trial.

Benefits for the Claimant:

1. The beneficiary gains a sense of security with the knowledge that will receive a guaranteed stream of future payments to provide for their loss of income and ongoing medical needs.
2. The structured settlement payments received as compensation for the loss or injury are completely free from federal and state income taxes. In addition, any interest, growth or appreciation on the initial value of the structure is also exempt from taxation.
3. Once an agreement is reached, it gives the victim the freedom to focus on their recovery and rehabilitation instead of thinking about a long legal battle or the complexity of money management that comes with cash settlements.
4. Structured settlements also help victims avoid expense and risk or a jury trial.

Evaluating a Structured Settlement Claim

During the compensation process following an accident, the likelihood that a structured settlement will be utilized to resolve the claim has increased significantly in recent years. Records have shown that on claims involving losses of $1 million or more, more than 29% were resolved with the use of a structured payment agreement as their mode of settling the claim.

Professionals who specialize on this area typically arrange structured settlements. Some structures are for minor claims the claimant, but more typically the claimant utilizing this type of settlement will require ongoing annuity payments to provide for long-term care and replacement of income.

After an agreement is made to settle the claim using structured payments, those in charge establishing the annuity payments would then determine the claimant’s realistic future needs. Future payments would have to provide for basic living and medical needs as well as planned lump-sum payments that may be required for big spending such as wheelchair replacement, a college education (for the claimant or a dependent), or a future surgery. Initial cash sums could also provide for the reimbursement of upfront legal and medical expenses.

The process of extrapolating an accident victim’s future need is a critical task. Due to the complexity, most defendants will employ an outside broker who has experience structuring payments in tort settlements. This normally will make the task easier and ensure that the future settlement payments are appropriate. The most appropriate way to settle a complex case with a fair settlement is to focus the discussion on the plaintiff’s specific needs.

When a case involves a serious injury to a victim, it is common practice is for the attorney of the victim to present a life care plan that lays out the future needs of the victim to the defense. The life care plan usually includes an estimate of future costs provided by a life care planner. In situations like this, an experienced broker can be a particularly valuable to the claimant.

After the future needs of the victim are quantified, the actual negotiations between the two parties can begin. The primary focus of the negotiation should be on how the proposed payment schedule will compensate the claimant for his or her loss

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