Congress enacted law to provide special tax breaks for payments received by tort victims in structured settlements, and for the companies that funded them. The payments were tax free, whereas if the tort victim had been given a lump sum and invested it themselves, the payments from those investments would be taxable.
Companies liked structured settlements because it allowed them to avoid taxes to a certain extent, and plaintiffs liked them because it allowed them to receive tax-free payments of what became, over time, a much larger amount of money than the original amount paid out by the settling party. Such settlements were also considered an especially good idea for minors, as they held the money safe for adulthood and ensured that youth would not find the money wasted or ill-spent. “Despite the best intentions of plaintiffs, lump sum settlement awards are often quickly dissipated because of excessive spending, poor financial management, or a combination of both. Statistics showed that twenty-five to thirty percent of all cash awards are exhausted within two months, and ninety percent are exhausted within five years.” Andrada, “Structured Settlements – The Assignability Problem,” 9 S. Cal. Interdis. L.J. 465, 468 (Spring 2000).
An explanation of IRS Code section 130 was given during discussions of possible taxation of companies that bought future payments under those structured settlements. “By enacting the PPSA, Congress expressed its support of structured settlements, and sought to shield victims and their families from pressures to prematurely dissipate their recoveries.” 145 Cong. Rec. S52281-01 (daily ed. May 13, 1999) (statement of Sen. Chaffee).
Congress was willing to afford such tax advantages based on the belief that the loss in income taxes would be more than made up by lower expenditures on public assistance programs for those who suffered significant injuries. A strict requirement for a structured settlement to qualify for this tax break was that the tort victim was barred from accessing their periodic payments before they came due. It was for this reason that the annuity had to be owned by another who had control over it. The tort victim could not be seen to have “constructive receipt” of the annuity funds prior to their periodic payments. If the tort victim could cash in the annuity at any time, it was possible that the IRS might find constructive receipt.
“Congress conditioned the favorable rules on a requirement that the periodic payments cannot be accelerated, deferred, increased or decreased by the injured person. Both the House Ways and Means and Senate Finance Committee Reports stated that the periodic payments as personal injury damages are still excludable fro income only if the recipient is not in constructive receipt of or does not have the current economic benefit of the sum required to produce the periodic payments.”
Testimony of Tax Legislative Counsel Joseph M. Mikrut to the Subcommittee on Oversight of the Committee of Ways and Means, March 18, 1999. “These factoring transactions directly undermine the policy objective underlying the structured settlement tax regime, that of protecting the long term financial needs of injuries persons . . . “ (Id.)
Mr. Mikrut was testifying in favor of imposing a punitive tax on factoring companies that engaged in pursuit of structured settlement payments. Despite the use of non-assignment clauses in annuity contracts to secure the tax advantages for tort victims. companies cropped up that tried to advantage of these individuals in ”factoring” transactions, purchasing their periodic payments in return for a deeply discounted lump sump payment. Congress felt that factoring company purchases of structured settlement payments “so directly subvert the Congressional policy underlying structured settlements and raise such serious concerns for the injured victims,” that bills were proposed in both the Senate and the House to penalize companies which engage in such transactions. (Id.)
Before the enactment of IRC 5891, which became effective on July 1, 2002, some states regulated the transfer of structured settlement payment rights, while others did not. Most states that regulated transfers at this time followed a general pattern, substantially similar to the present day process which is mandated in IRC 5891 (see below for more details of the post-2002 process). However, the majority of the transfers processed from 1988 to 2002 were not court ordered.[9] After negotiating the terms of the transaction (including the payments to be sold and the price to be paid for those payments), a formal purchase contract was executed, effecting an assignment of the subject payments upon closing. Part of this assignment process also included the grant of a security interest in the structured settlement payments, to secure performance of the seller’s obligations. Filing a public lien based on that security agreement created notice of this assignment and interest. The insurance company issuing the structured settlement annuity checks was typically not given actual notice of the transfer, due to antagonism by the insurance industry against factoring and transfer companies. Many annuity issuers were concerned that factoring transactions, which were not contemplated when Congress enacted IRC 130, might upset the tax treatment of qualified assignments. HR 2884 (discussed below) resolved this question for annuity issuers.
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