| 1. WHAT IS THE PURPOSE OF IRC SECTION 104? IRC Section 104 allows compensation for injuries or sickness to flow income tax free to the recipient.
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| 2. WHAT DOES IRC SECTION 104(a) (2) PROVIDE? IRC Section 104 (a)(2) provides for the income tax-free receipt of payments on account of personal injury or sickness. |
| 3. HOW DOES IRC SECTION 104(a)(2) APPLY TO STRUCTURED SETTLEMENTS? IRC Section 104(a)(2) applies to structured settlements by allowing the recipient to exclude from gross income moneys received for personal injuries or sickness whether by suit or agreement and whether as lump sums or periodic payments |
| 4. NAME SOME EXAMPLES OR SETTLEMENTS THAT WOULD FALL UNDER SECTION 104 (a)(2).
- Auto bodily injury dog bites
- Wrongful death boating accidents
- Medical malpractice slips and falls
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| 5. NAME SOME EXAMPLES OF PERSONAL INJURIES OR SICKNESS THAT DO NOT FALL UNDER SECTION 104 (a)(2). Breach of contract - Worker's compensation claims prior to August, 1997.
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| 6. WHAT DOES IRC SECTION 104(a)(1) PROVIDE? IRC Section 104 (a)(1) provides for the income tax free receipt of payments received under workers compensation acts as compensation for personal injuries or sickness. |
| 7. WHY IS IT IMPORTANT TO DISCOVER THE ORIGINATION OF THE PHYSICAL INJURY? Discovering the origin of the claim is important because you must determine if IRC Section 104 (a) (1) or Section 104 (a)(2) apply to the personal injury or sickness.
For example: an employee was injured on the job, however, due to an error on the part of the insurance agent there was no worker's compensation insurance. The actual claim was filed under the agent's errors and omissions policy. Although the claim was handled under a liability policy, the origination of the injury was worker's compensation, therefore, it would most likely fall under 104(a)(1) and not 104(a)(2). |
| 8. WHAT IS REVENUE RULING 79-220?
It is the foundation of the structured settlement industry. In Revenue Ruling 79-220 the IRS held that in order for periodic payments to qualify in full for an income tax exemption under Section 104(a)(2), the recipient must have no ownership rights (actual or constructive) in the annuity contract purchased by the defendant to fund its periodic payments obligation. Any payments made to the estate after the recipient’s death are fully excludable for income tax purposes. |
| 9. WHAT IS CONSTRUCTIVE RECEIPT? Constructive receipt is an income tax principle which provides that income not actually received by a party but credited to his account, set apart for him, or otherwise made available so that he may draw upon or could have drawn upon it will be considered currently taxable income. |
| 10. WHAT IS IRC SECTION 72? IRC Section 72 is the code section which provides general rules for the taxation of annuity contracts. |
11. WHAT IS 72 (U)?
IRC Section 72(U) addressed the tax treatment of annuity contracts owned by non-natural persons (i.e. corporations, partnerships, certain trusts, etc.). In case of such a contract, the income on the contract for any taxable year is treated as ordinary income received or accrued by the owner in that year.
Therefore, if a non-natural person, i.e. XYZ Casualty Co or XYZ Taxable Self- Insured, owns:
(1) a deferred annuity (i.e. an annuity wherein the payments do not begin within one year of the date of deposit) or
(2) an immediate annuity which does not have substantially equal payments, the owner of the annuity would be taxed on the inside build-up of the annuity during the deferral period.
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12. WHAT ARE THE EXCEPTIONS TO THIS RULE THAT ARE IMPORTANT TO THE STRUCTURED SETTLEMENT INDUSTRY?
(A) An annuity is exempt from tax on the inside build-up if the contract meets the requirements for a qualified funding asset as described in IRC Section 130(d) even though there may not be a qualified assignment. (This allows defendants to purchase annuities to fund 104 (a)(2) physical injury settlements and escape annual income taxation on the annual increase in value of the annuity contract.)
(B) An annuity is also exempt if it is an immediate annuity and is purchased with a single premium, provided the payments begin no later than one year from the date of deposit and provides for a series of substantially equal payments with the payment intervals not greater than one year. NOTE: The Code does not define "substantially equal", thereby leaving this open to interpretation.
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13. WHAT TYPE OF CASES SHOULD COMPLY WITH 72(U)?
Worker’s compensation cases, and personal injury cases which do not involve physical injury or sickness. Note: Prior to quoting these types of cases, it is recommended that you contact the life insurance companies for clarification of their interpretation of 72(u). |
| 14. WHAT IS THE PURPOSE OF IRC SECTION 130?
IRC Section 130 permits the money used to purchase annuity or government obligation to fund the periodic payments of a settlement agreement to be excluded from Assignee’s gross income. |
| 15. WHAT DOES IRC SECTION 130 APPLY TO? IRC Section 130 applies to personal physical injury or sickness liability assignments. |
| 16. WHY IS SECTION 130 IMPORTANT TO OUR BUSINESS? IRC Section 130 allows for qualified assignments. |
| 17. WHAT IS IRC SECTION 130 (C)? IRC Section 130 (C) defines the term "qualified assignment". According to the definition, a qualified assignment is an assignment of a liability to make periodic payments as damages (whether by suit or agreement) on account of personal injury or sickness ( in a case involving physical injury or sickness). |
| 18. WHY IS SECTION 130 (C) IMPORTANT TO OUR BUSINESS? IRC Section 130 (C) allows the property/casualty carrier or self insured to transfer its liability to make periodic payments to a third party assignment company, possibly obtaining a full release. |
19. WHAT ARE THE ELEMENTS OF IRC SECTION 130?
a) The assignor must be a party to suit or agreement.
b) A personal injury must involve a physical injury or physical sickness which falls under 104(a)(2). Periodic payments must be excludable from the gross income of the recipient under IRC section 104(c)(2).
c) A qualified funding asset must be purchased.
d) Payments must be fixed and determinable and cannot be accelerated, deferred, increased, or altered in any way by the recipient of such payments.
e) The obligation assigned can be no greater than the obligation of the assignors.
f) The qualified funding asset must be purchased within sixty (60) days of assignment.
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20. GIVE SOME EXAMPLES OF CASES WHICH DO NOT QUALIFY UNDER IRC SECTION 130(C).
A) Workers compensation cases filed prior to 8/5/97. Cases filed after that date qualify for assignment under Section 130.
B) Claimant has receipt of the funds and wants to purchase an annuity.
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21. GIVE AN EXAMPLE OF A TYPE OF CASE WHICH WOULD FALL UNDER IRC SECTION 104 (a)(2), BUT MAY NOT QUALIFY UNDER IRC SECTION 130(C).
An example would be a Reversionary Trust. IRC Section 130 (c) requires that payments be received by the recipient income tax free under 104 (a)(2). Upon the death of the recipient, the funds in the trust and future periodic payments revert back to the insurer. Because the insurer does not have a physical injury which falls under IRC section 104(c)(2), it probably doesn’t qualify for assignment. (Please note, you should contact the life company writing the case for their interpretation.) |
22. GIVE AN EXAMPLE OF AN IRC SECTION 104(a)(2) VIOLATION.
The claimant having constructive receipt. |
23. WHAT IS IRC SECTION 130(D)?
IRC Section 130(d) is the section of the Internal Revenue Code that defines a "Qualified Funding Asset." |
24. WHAT TYPES OF FUNDING VEHICLES ARE ALLOWED UNDER SECTION 130 (D)?
A qualified funding asset can be either an annuity contract or an obligation of the US Government. |
25. IS IT CONSIDERED CONSTRUCTIVE RECEIPT IF THE CLAIMANT KNOWS THE COST OF THE QUALIFIED FUNDING ASSET (ANNUITY OR US GOVERNMENT OBLIGATION)?
Generally, a knowledge of cost is not a problem (see PLR 8333035). However, there can be a problem with the cost being revealed depending upon how cost is revealed. This would apply when negotiating a case strictly on a cash basis, and once an agreed price is obtained , the claimant then decides he wants a structured settlement. It is important that the cost not be the consideration. If it is, it could be considered as constructive receipt which could jeopardize the tax treatment of the future periodic payments under the settlement. |
26. WHAT ARE THE REPERCUSSIONS OF VIOLATING THE 60 DAY RULE?
(A) To the Assignee:
The assignee may be taxed on the entire premium upon receipt. This results in, at the very least, a major mismatching of income and deductions.
(B) To the insurer/self insured:
The assignee has the right to terminate the Qualified Assignment, thereby keeping the insurer/self-insured liable for future periodic payments. The self- insured defendant would lose its up-front deduction.
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| 27. WHAT IS IRC SECTION 468B? 468B allows a company pursuant to a court order, to create a qualified settlement fund to resolve and satisfy certain types of liabilities, even if those liabilities relate to future loss exposure. |
| 28. WHAT ADVANTAGES OCCUR BY USING A QUALIFIED SETTLEMENT FUND?
A 468B fund can provide a current income tax deduction where one might otherwise be unavailable.
For example; a self insured may know that it has to pay $10 million in an asbestos case, but does not yet know who all of the plaintiffs are, or what proportion of the judgment each will be entitled to. Without the benefit of 468B, the company might create a reserve for the liability for book purposes, but would only be entitled to income tax deductions as payments are made to the various plaintiffs. These payments could be made over many years, thus delaying the income tax deduction for a long time. If, however, the company can meet the requirements of 468B, it can establish a qualified settlement fund, transfer money or property to the fund, and can take a current income tax deduction for the $10 million.
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| 29. ARE THE EARNINGS OF A QUALIFIED SETTLEMENT FUND TAXABLE? Yes, while money or property transferred to a qualified settlement fund are received by the fund free of income tax, the fund pays a federal income tax of 39.6% on the earnings of the funds assets. State income taxes may also apply. |
30. WHAT ARE THE REQUIREMENTS OF IRC SECTION 468B?
A) It must be established pursuant to an order of, or be approved by, a governmental authority (including a court of law) and must be subject to the continued jurisdiction of that authority.
B) The fund must be established to resolve or satisfy one or more claims that result from an event, or series of events, that has occurred and that gives rise to liabilities under the Comprehensive Environmental Response, Compensation and Liability Act of 1980 (CERCLA); out of a tort, breach of contract, or violation of the law, or as the IRS later designates. Note that a fund cannot be used to satisfy liabilities arising under the workers compensation act or a self-insured health plan.
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| 31. CAN PROPERTY AND CASUALTY COMPANIES USE 468B FUNDS? Yes, however, they are not taxed in the same manner as ordinary companies, and do not need to establish a qualified settlement fund to get a current income tax deduction. They may still use a qualified settlement fund to settle certain types of liabilities and segregate the assets for long term exposures. |
| 32. CAN 468B FUNDS MAKE QUALIFIED ASSIGNMENTS UNDER IRC SECTION 130? Yes, qualified settlement funds may make qualified assignments in cases involving physical personal injuries (see Revenue Proc. 93-94). |
33. WHY IS IRC SECTION 468B IMPORTANT TO THE STRUCTURED SETTLEMENT INDUSTRY?
A) Money or property can be transferred to a qualified settlement fund. Property may include annuity contracts and funding agreements.
B) A qualified settlement fund that is funded with cash may purchase an annuity contract or funding agreement as a fund investment.
C) The fund itself can make qualified assignments.
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Overview