Structure Laws
Internal Revenue Code, Section 104
Compensation for Injuries and Sickness
This section of the Code allows claimants to exclude from their gross income monies received for physical injuries or sickness whether by suit or agreement and whether as lump sums or as periodic payments. The Periodic Payment Settlement Act of 1982 amended this section to allow the recipient to exclude from gross income all of the payments from a suit or agreement, whether paid all at once or in the future. The Small Business Job Protection Act of 1996 inserted the word “physical” into IRC § 104(a)(2) in describing injury or sickness, and removed punitive damages from the exclusion. The text of IRC § 104 is excerpted as follows:
(a) In General: Except in the case of amounts attributable (and not in excess of) deductions allowed under section 213 (relating to medical, etc., expenses) for prior taxable year, gross income does not include:
(a)(1) amounts received under workmen’s compensation acts as compensation for personal injuries or sickness;
(a)(2) the amount of any damages (other than punitive damages) received (whether by suit or agreement and whether as lump sums or as periodic payments) on account of personal physical injuries or physical sickness…For purposes of paragraph (2), emotional distress shall not be treated as a physical injury or physical sickness. The preceding sentence shall not apply to an amount of damages not in excess of the amount paid for medical care (described in subparagraph (A) or (B) of section 213(d)(1)) attributable to emotional distress.
Internal Revenue Code, Section 130
Certain Personal Injury Liability Agreements
This section of the Code, added by the Periodic Payment Settlement Act of 1982, permits the amount of money used to purchase an annuity or government obligation to fund payments of a settlement agreement for a personal injury suit to be excluded from the assignee’s gross income. The Taxpayer Relief Act (formerly called the Balanced Budget Act) of 1997 added workers’ compensation payments under IRC § 104(a)(1) to the language of IRC § 130, making them eligible for qualified assignment the same as physical injury or physical sickness tort claim payments under IRC § 104(a)(2), but applicable to claims under workmen’s compensation acts filed after the date of the enactment of the Taxpayer Relief Act (August 5, 1997).
(a) In General: Any amount received for an agreement to a qualified assignment shall not be included in gross income to the extent that such amount does not exceed the aggregate cost of any qualified funding assets.
(b) Treatment of Qualified Funding Asset: In the case of any qualified funding asset:
(1) the basis of such asset shall be reduced by the amount excluded from gross income under subsection (a) by reason of the purchase of such asset, and
(2) any gain recognized on a disposition of such asset shall be treated as ordinary income.
(c) Qualified Assignment: For the purpose of this section, the term “Qualified Assignment” means any assignment of a liability to make periodic payments as damages (whether by suit or agreement) on account of personal injury or sickness or as compensation under any workmen’s compensation act:
(1) if the assignment assumes such liability from a person who is party to the suit or agreement or the workmen’s compensation claim, and
(2) if:
(a) such payments are fixed and determinable as to amount and time of payment,
(b) such periodic payments cannot be accelerated, deferred increased or decreased by the recipient as such payments,
(c) the assignee does not provide to the recipient of such payments rights against the assignee which are greater than those of a general creditor,
(d) the assignee’s obligation on account of the personal injuries or sickness is no greater than the obligation of the person who assigned the liability, and
(e) such periodic payments are excludable from the gross income of the recipient under paragraph (1) or (2) of section 104(a).
(d) Qualified Funding Asset: For purposes of this section, the term “Qualified Funding Asset” means any annuity contract issued by a company licensed to do business as an insurance company under the laws of any State, or any obligation of the United States, if:
(1) such annuity contract or obligation is used by the assignee to fund periodic payments under any qualified assignment,
(2) the periods of the payments under the annuity contract or obligation are reasonably related to the periodic payments under the qualified assignment, and the amount of any such payment under the contract or obligation does not exceed the periodic payment to which it relates.
(3) such annuity contract or obligation is designated by the taxpayer (in such manner as the secretary shall by regulations prescribe) as being taken into account under this section with respect to such qualified assignment, and
(4) such annuity contract or obligation is purchased by the taxpayer not more than sixty days before the date of the qualified assignment and not later than sixty days after the date of such assignment.
Treasury Regulations, Section 1.451
Constructive Receipt
Constructive receipt is the doctrine that taxes income before the income is actually received.
2(a) General Rule. Income although not actually reduced to a taxpayer’s possession is constructively received by him in the taxable year during which it is credited to his account, set apart for him, or otherwise made available so that he may draw upon it at any time, or so that he could have drawn upon it during the taxable year if notice of intention to withdraw had been given. However, income is not constructively received if the taxpayer’s control of its receipt is subject to substantial limitations or restrictions.
Significant private letter ruling excerpts from the Internal Revenue Service have further defined constructive receipt as it applies to structured settlements.
(P.L.R. 83-33035) Disclosure by defendant of the existence, cost or present value of the annuity will not cause you to be in constructive receipt of the present value of the amount invested in the annuity.
(P.L.R. 90-17011) Knowledge of the existence, cost and present value of the annuity contract used to fund the settlement offer…will not cause the family to be in constructive receipt of the amount payable under the annuity contract or the amount invested in the annuity contract.
Internal Revenue Code, Section 5891
Structured Settlement Factoring Transactions
This section was added to the Code effective January 23, 2002, imposing a 40 percent tax on the “factoring discount” (a term of art defined in this statute) in any settlement payment purchase transaction not pre-approved by an “applicable state court.” The jurisdiction can be either the state in which the payee is domiciled or in the state in which either the party to the structured settlement (usually the assignee) or the person issuing the funding asset (usually an annuity) is domiciled. More than two-thirds of the states have enacted “applicable state statutes.” The state court must determine that the transfer does not contravene any federal or state statute or court order, and that it is “in the best interest of the payee, taking into account the welfare and support of the payee’s dependents.”
(a) IMPOSITION OF TAX—There is hereby imposed on any person who acquires directly or indirectly structured settlement payment rights in a structured settlement factoring transaction a tax equal to 40 percent of the factoring discount as determined under subsection (c)(4) with respect to such factoring transaction.
(c)(4) FACTORING DISCOUNT—The term “factoring discount” means an amount equal to the excess of—
(A) the aggregate undiscounted amount of structured settlement payments being acquired in the structured settlement factoring transaction, over
(B) the total amount actually paid by the acquirer to the person from whom such structured settlement payments are acquired.