Statement of Thomas W. Little, President
Little, Meyers, Garretson & Associates, Cincinnati, Ohio, and
Past President, National Structured Settlements Trade Association
Testimony Before the Subcommittee on Oversight,
of the House Committee on Ways and Means
Hearing on the Tax Treatment of Structured Settlements
March 18, 1999
Mr. Chairman, my name is Thomas W. Little. I am President of Little, Meyers, Garretson & Associates, a structured settlement broker firm headquartered in Cincinnati, Ohio. I am testifying today as Past President of the National Structured Settlements Trade Association.
I. Background and Policy of the Structured Settlement Tax Rules
The National Structured Settlements Trade Association (NSSTA) is an organization composed of more than 500 members which negotiate and fund structured settlements of tort and worker's compensation claims involving persons with serious, long-term physical injuries. Structured settlements provide the injured victim with the financial security of an assured payout over time. Founded in 1986, NSSTA's mission is to advance the use of structured settlements as a means of resolving physical injury claims.
A. Background
Structured settlements are used to compensate seriously-injured, often profoundly disabled, victims of torts and workplace accidents. A lump sum recovery used to be the standard in personal injury cases. The injured victim then faced the daunting challenge of managing a large lump sum to cover substantial ongoing medical and living expenses for decades, even for a life-time. All too often, this lump sum swiftly eroded away. When the money was gone, the victim was left still disabled and still unable to work. In such cases, responsibility to care for this disabled person fell to the State Medicaid system and public assistance system.
Structured settlements provide a better approach. A voluntary agreement is reached between the parties generally through their counsel under which the injured victim receives damages in the form of a stream of periodic payments tailored to the future medical expenses and basic living needs of the victim and his or her family from a well-capitalized, financially-secure institution. This process may be overseen by a court, particularly in minor's cases. Often this payment stream is for the rest of the victim's life to make sure that future medical expenses and the family's basic living needs will be met, and that the victim will not outlive his or her compensation.
These are voluntary arrangements. The injured victim has a choice whether or not to take a structured settlement, and generally about a third of the injured victims who are offered a structured settlement take it. The other two-thirds take the cash lump sum.
A recent study underscores the fact that structured settlements typically are used in the case of major physical injuries "when the loss payments are very large." ("Closed Claim Survey for Commercial General Liability: Survey Results, 1997", p. 22, prepared by ISO DATA, Inc., a nonprofit arm of the Insurance Services Office, Inc., which conducted the survey under the auspices of the National Association of Insurance Commissioners (NAIC), the national group of the State insurance regulators).
The ISO study found that of the 215 claims involving structured settlements in the survey sample, 67% arose from "major injuries" ("permanent significant", "permanent major", "permanent grave", death and "temporary major"), with an average total payment of $408,000. The remaining 33% of claims involving structured settlements had an average total payment of $210,000. "Total payment" for this purpose means in effect the total present value of the settlement, and consists of (i) the lump sum of cash paid at settlement, plus (ii) the present value of the future structured payments. The ISO study found that about half of the present value of the case was paid in an upfront lump sum to meet the victim's cash needs (e.g., retrofitting the house for wheelchair access), and the remaining half represented the present value of the structured future payments. (ISO Study, at p. 22). Overall, the ISO study found that the average total present value (including the upfront cash and the present value of the future payments) of a case resolved by structured settlement was $343,000. (ISO Study, at p. 21).
Structured settlements have the strong support of the plaintiff's bar, the defense bar, judges, and mediators.
Congress has adopted a series of special rules in sections 130, 104, 461(h), and 72 of the Internal Revenue Code to govern the use of structured settlements by providing that the full amount of the periodic payments constitutes tax-free damages to the victim and that the liability to make the periodic payments to the victim may be assigned to a structured settlement assignment company that will use a financially-secure annuity to fund the damage payments.
In the Taxpayer Relief Act of 1997, in a provision co-sponsored by a majority of the House Ways and Means Committee, Congress recently extended the structured settlement tax rules to worker's compensation to cover physical injuries suffered in the workplace.
B. Structured Settlement Tax Rules Were Adopted by Congress to Protect Victims from Pressure to Dissipate Their Recoveries
In introducing the 1981 legislation that originally enacted the structured settlement tax rules, Sen. Max Baucus (D-Mont.) pointed to the concern over squandering of a lump sum recovery by injured tort victims or their families:
"In the past, these awards have typically been paid by defendants to successful plaintiffs in the form of a single payment settlement. This approach has proven unsatisfactory, however, in many cases because it assumes that injured parties will wisely manage large sums of money so as to provide for their lifetime needs. In fact, many of these successful litigants, particularly minors, have dissipated their awards in a few years and are then without means of support."
[Congressional Record (daily ed.) 12/10/81, at S15005.]
By contrast, Sen. Baucus noted: "Periodic payments settlements, on the other hand, provide plaintiffs with a steady income over a long period of time and insulate them from pressures to squander their awards." (Id.)
In introducing legislation last year to protect structured settlements and injured victims from the practice of factoring, Sen. Baucus reiterated this original legislative intent:
"Thus, our focus in enacting these tax rules in sections 104(a)(2) and 130 of the Internal Revenue Code was to encourage and govern the use of structured settlements in order to provide long-term financial security to seriously injured victims and their families and to insulate them from pressures to squander their awards."
[Congressional Record (daily ed.) 10/5/98, at S11499.]
Therefore, the federal tax rules adopted by Congress to govern structured settlements reflect a policy of insulating injured victims and their families from pressures to dissipate their awards.
In addition, Congress was concerned that the injured victim not have the ability to exercise such control over the periodic payments that he or she would be deemed to have received a lump sum recovery that was then invested on his or her behalf, destroying the fully tax-free nature of the periodic payments to the injured victim. The House Ways and Means and Senate Finance Committee Reports adopting the structured settlement tax rules both state: "Thus, the periodic payments as personal injury damages are still excludable from income only if the recipient taxpayer is not in constructive receipt of or does not have the current economic benefit of the sum required to produce the periodic payments." (H.R. Rep. No. 97-832, 97th Cong., 2d Sess. (1982), 4; Sen. Rep. No. 97-646, 97th Cong., 2d Sess. (1982), 4.)
Reflecting this Congressional policy of protecting injured victims from pressure to squander their recoveries and the need to avoid any risk of constructive receipt of a lump sum by the victim, the structured settlement tax rules prohibit the victim from being able to accelerate, defer, increase, or decrease the periodic payments. (I.R.C. § 130(c)(2)(B)). In addition, the periodic payments must constitute tax-free damages in the hands of the recipient. (I.R.C. § 130(c)(2)(D)).
In compliance with these Congressional requirements and consistent with State insurance and exemption statutes, including "spendthrift" statutes that restrict alienation of rights to payments under annuities and under various types of claims (e.g., worker's compensation and wrongful death claims), structured settlement agreements customarily provide that the periodic payments to be rendered to the injured victim may not be accelerated, deferred, increased or decreased, anticipated, sold, assigned, pledged, or encumbered by the victim.
As the Treasury Department has noted, "Consistent with the condition that the injured person not be able to accelerate, defer, increase or decrease the periodic payments, [structured settlement] agreements with injured persons uniformly contain anti-assignment clauses." (U.S. Department of the Treasury, General Explanations of the Administration's Revenue Proposals (Feb. 1999), at p. 192).
Sen. John Chafee (R-R.I.), in introducing along with Sen. Baucus recent legislation to protect structured settlements and injured victims from the practice of factoring observed: "Structured settlement payments are nonassignable. This is consistent with worker's compensation payments and various types of Federal disability payments which also are nonassignable under applicable law. In each case, this is done to preserve the injured person's long-term financial security." (Congressional Record (daily ed.), 10/2/98, at S11340).
II. Purchases of Future Structured Settlement Payments by Factoring Companies Directly Undermine the Important Public Policies Served by Structured Settlements
A. Background
Over the past two years, there has been dramatic growth in a transaction, generally known as a "factoring" transaction, that effectively takes the structure out of structured settlements.
In such a factoring transaction, the injured victim who is receiving periodic payments of damages for physical injuries under a structured settlement sells his or her rights to future periodic payments to a factoring company. In exchange, the injured victim receives from the factoring company a sharply discounted lump sum payment.
This is a transaction that the injured victim enters into with a third party, completely outside of the structured settlement and generally without even the knowledge of the other parties to the structured settlement. The factoring company is not in the structured settlement business, and the structured settlement company is not in the factoring business.
In an effort to avoid the anti-assignment provisions in the structured settlement agreements, the factoring companies typically have the injured victim simply present the structured settlement company with a change of address to a post office box, or change of direct deposit to a bank account, under the control of the factoring company to accomplish the redirection of payments to the factoring company. Thus, the structured settlement company obligated to make the periodic payment damages under the structured settlement is not a party to the factoring transaction and often has no notice of it at all.
At the time the structured settlement is created, the victim has multiple layers of protection by means of State insurance licensing and regulatory requirements and oversight, the Federal tax law requirements for the terms of a structured settlement, legal counsel, and in many cases court oversight. By contrast, the factoring companies and their transactions are completely unregulated.
B. Rapid Growth in Factoring Company Purchases of Structured Settlement Payments
Factoring companies use extensive advertising and telemarketing, as well as direct appeals to plaintiffs' lawyers coupled with a finder's fee, to solicit new business. For example, one major factoring company, J.G. Wentworth, stated in a 1997 Securities and Exchange Commission filing that during the first 9 months of 1997 alone, it ran 56,000 television commercials. Wentworth's SEC filing states that it runs a telemarketing call center with 200 telemarketing stations operating 24 hours a day, 6 days a week.
The factoring companies direct considerable advertising at the plaintiffs' bar, promising the injured victim's lawyer a second fee on the same case -- this time by unwinding the structured settlement. For example, an ad by Stone Street Capital, a factoring company, placed in a prominent trial lawyer publication, states:
"You helped your clients once by winning them a structured settlement. Now you can help them again by showing them how to convert all or a portion of their settlement to a lump-sum payment.
"For each of your clients who exercise this exciting new option, your firm will be compensated for legal fees by facilitating the standardized processing of an annuity purchase agreement. On average, these fees amount to about $2,000 per conversion. [Emphasis in original]."
The factoring company business is a rapidly growing one. J.G. Wentworth recently announced that it has undertaken approximately 7,700 structured settlement purchase transactions with a total value of $370 million. According to SEC filings, during the first 9 months of 1997, J.G. Wentworth undertook 3,759 structured settlement purchase transactions. These purchased structured settlement payments had a total undiscounted maturity value of $163.6 million and were purchased for $74.4 million. Blocks of purchased structured settlement payments are now being "securitized" by the factoring companies and marketed on Wall Street.
C. Public Policy Concerns Created by Factoring Company Transactions
Factoring company purchases of structured settlement payments create serious problems affecting all participants in structured settlements and directly thwart the clear Congressional policy that underlies the structured settlement tax rules.
As Sen. Baucus observed "All of the careful planning and long-term financial security for the injured victim and his or her family can be unraveled in an instant by a factoring company offering quick cash at a steep discount." (Congressional Record (daily ed.) 10/5/98, at S 11500).
Just as lump sum tort recoveries are frequently dissipated, all too often this lump sum from the factoring company is as quickly dissipated, and the injured person finds himself or herself in the very predicament which the structured settlement was intended to avoid.
Having factored away their only assured source of future financial support and then dissipating the cash received, these injured victims are likely to face an uncertain financial future and may face the prospect of taxpayer-financed assistance programs to cover their future medical expenses and basic living needs.
As Rep. Clay Shaw (R-Fla.) stated in introducing the "Structured Settlement Protection Act" (H.R. 263) along with Rep. Pete Stark (D-Ca.) and a broad bipartisan group totaling some 17 Members of the Ways and Means Committee: "As long-time supporters of structured settlements and the congressional policy underlying such settlements, we have grave concerns that these factoring transactions directly undermine the policy of the structured settlement tax rules." (Congressional Record (daily ed.) 2/10/99, at E192).
On the Senate side, as Sen. Baucus observed in introducing the same legislation:
"I speak today as the original Senate sponsor of the structured settlement tax rules that Congress enacted in 1982. I rise because of my very grave concern that the recent emergence of structured settlement factoring transactions -- in which factoring companies buy up the structured settlement payments from injured victims in return for a deeply-discounted lump sum -- completely undermines what Congress intended when we enacted these structured settlement tax rules."
[Congressional Record, (daily ed.), 10/5/98, at S11499.]
Sen. Baucus then went on to say:
"As a long-time supporter of structured settlements and an architect of the Congressional policy embodied in the structured settlement tax rules, I cannot stand by as this structured settlement factoring problem continues to mushroom across the country, leaving injured victims without financial means for the future and forcing the injured victims onto the social safety net -- precisely the result we were seeking to avoid when we enacted the structured settlement tax rules."
[Id., at S11500.]
Sen. Chafee, lead Republican co-sponsor of the legislation, echoed Sen. Baucus's concerns: "These factoring company purchases directly contravene the intent and policy of Congress in enacting the special structured settlement tax rules." (Congressional Record (daily ed.) 10/2/98, at S11340.)
NSSTA's members are on the front lines. We see the human costs when factoring companies unravel the structured settlements to injured victims. Court records from across the country tell the story -- there's the quadriplegic in Oklahoma, the quadriplegic in California, the paraplegic in Texas, the victim of Connecticut with traumatic brain injures dating from childhood, and the injured worker receiving worker's compensation benefits in Mississippi -- all selling their future payments to the factoring companies. The human costs in factoring cases such as these were recently chronicled in a U.S. News & World Report entitled "Settling for Less -- Should accident victims sell their monthly payments?" (January 25, 1999), pp. 62-66.
In many cases the injured victim's dissipation risks are magnified because the lump sum payment that the injured victim receives in the factoring transaction is so sharply discounted. While factoring transactions apparently reflect a range of discounts, it is not uncommon for an injured victim to receive a lump sum payment of half or even less of the present value of the structured settlement payments being sold.
In one recent case, a 20-year-old structured settlement recipient who was receiving monthly payments from a tort action when she was a child was persuaded to sell a series of her future payments for approximately 36 percent of their discounted present value. A few months later, she was persuaded to sell additional future payments for approximately 15 percent of their discounted present value.
Based on this case and many similar examples from court records, it is clear that in factoring company transactions structured settlement recipients often are persuaded to sell future payments for far less than the payments are worth.
The structured settlement tax rules require that the periodic payments constitute tax-free damages on account of personal physical injuries in the hands of the recipient of those payments. (I.R.C. §§ 130(c)(2)(D); 104(a)(2)). Following the factoring away by the injured victim, the periodic payments are received by the factoring company and its investors and do not constitute tax-free damages in their hands. One of the requirements for a qualified assignment no longer is met. This creates serious Federal income tax uncertainties under the structured settlement tax rules for both the victim and the company funding the structured settlement.
Injured victim
- The injured victim not only loses the benefit of the future tax-free damage payments, but also runs a risk of being taxed on the lump sum received from the factoring company if such payment is treated as received on account of the sale of the victim's future payment rights and not on account of the original injury.
- If the structured settlement payments were freely assignable by the injured victim and a ready market of financial institutions was available to acquire such payments, the victim might be deemed in constructive receipt of the present value of the future payments just as if the payments could be accelerated. In that case, from the outset of the settlement a portion of each periodic payment would be treated as taxable earnings, rather than tax-free damages.
Company funding the structured settlement
Under the structured settlement tax rules, the settling defendant (or its liability insurer) assigns its periodic payment liability to a structured settlement company in exchange for a payment which is excluded from the structured settlement company's income if the structured settlement tax rules under I.R.C. § 130 are satisfied and such payment is reinvested in either an annuity or U.S. Treasury obligations precisely matched in amount and timing to the periodic payment obligation to the injured victim. The structured settlement company's income from the payments under the annuity or Treasuries is matched by an offsetting deduction for the damage payment to the victim.
- Once the factoring company buys the injured victim's payments, those payments no longer constitute tax-free personal physical injury damages under Code section 104 in the hands of the recipient, and hence one of the requirements for a qualified assignment under Code section 130(c)(2)(D) no longer is satisfied. The critical question then becomes whether the Code section 130 requirements for a qualified assignment apply only at the time the structured settlement is established or constitute continuing requirements for the structured settlement. On that question, there is no clear-cut answer, and considerable tax uncertainty results.
- The factoring transaction raises the concern that the structured settlement tax rules no longer may be satisfied and the risk that the structured settlement company may be required to recognize and pay tax on amounts previously excluded from its income or to pay tax on the "inside build-up" under the annuity, for which there is no cash distribution to pay the tax. This is a tax risk that the structured settlement company had sought to avoid through use of the anti-assignment provisions in the structured settlement agreement and is not in a position to absorb.
- The structured settlement company may face an obligation to report the payments made to the factoring company as taxable income even though in many cases the identity of the purchaser or even the existence of the factoring transaction itself is unknown.
While factoring transactions normally involve only the injured victim and the factoring company, the underlying structured settlements typically involve multiple parties such as family members, defendants, liability insurers, and state workers' compensation authorities in workers' compensation cases. Because structured settlement agreements prohibit transfers of payments, if the structured settlement company makes the payments -- even unwittingly -- to the factoring company, the structured settlement company may become subject to later claims that it paid the wrong party and could still be required to make the payments as originally required under the settlement. This has happened in several recent cases.
In many cases this risk of double liability is magnified by state statutes that (i) in more than 20 states give statutory effect to contract provisions prohibiting transfers of annuity benefits, and (ii) in nearly all States directly restrict or prohibit transfers of recoveries in various types of cases (e.g., worker's compensation, wrongful death, medical malpractice).
These tax risks and double liability risks raised by the factoring transaction are risks that the structured settlement company specifically sought to avoid through the anti-assignment provisions in the structured settlement agreement and is not in a financial position to absorb, years after the original structured settlement transaction was entered into.
These uncertainties and unforeseen risks could jeopardize the continued ability of structured settlement companies to fund settlements in the future. The structured settlement company's participation is necessary to enable structured settlements to be undertaken in the first instance by satisfying the objectives of both sides to the claim: the injured victim needs the long-term financial protection that the structured settlement company's funding arrangement provides, and the settling defendant wishes to close its books on the liability rather than bearing an ongoing payment obligation decades into the future.
III. A Stringent Penalty Tax on Factoring Company Purchasers, Subject to a Limited Exception for Genuine, Court-Approved Hardship, Protects Structured Settlements, the Injured Recipients, and the Underlying Congressional Policy
A. Gravity of Problem Requires Strong Action by Congress
In acting to address the concerns over factoring companies that purchase structured settlement payments from injured victims the Treasury Department noted that: "Congress enacted favorable tax rules intended to encourage the use of structured settlements -- and conditioned such tax treatment on the injured person's inability to accelerate, defer, increase or decrease the periodic payments -- because recipients of structured settlements are less likely than recipients of lump sum awards to consume their awards too quickly and require public assistance." (U.S. Department of the Treasury, General Explanations of the Administration's Revenue Proposals (Feb. 1999), p. 192).
Treasury then observed that by enticing injured victims to sell off their future structured settlement payments in exchange for a heavily discounted lump sum that may then be dissipated: "These 'factoring' transactions directly undermine the Congressional objective to create an incentive for injured persons to receive periodic payments as settlements of personal injury claims." (Id., at p. 192 [emphasis added].)
The Joint Tax Committee's analysis of the issue last year echoes these concerns: "Transfer of the payment stream under a structured settlement arrangement arguably subverts the purpose of the structured settlement provisions of the Code to promote periodic payments for injured persons. (Joint Committee on Taxation, Description of Revenue Provisions Contained in the President's Fiscal Year 2000 Budget Proposal (JCS-1-99), (February 22, 1999), p. 329).
A natural question is why use the tax system to solve this problem? Isn't consumer protection best left to the States? We believe there are compelling reasons for the Ways and Means Committee to act. The problem is nationwide and mushrooming. A State-by-State approach could take years. Moreover, while noting that the States traditionally have been the province of consumer protection, the Joint Committee's analysis reasons that there is a clear role for the Federal tax law to address the policy concerns raised by sales of structured settlement payments: "On the other hand, the tax law already provides an incentive for structured settlement arrangements, and if practices have evolved that are inconsistent with its purpose, addressing them should be viewed as proper." (Joint Committee Description, supra, at p. 330).
Indeed, as Rep. Shaw observed in introducing H.R. 263 which addresses the structured settlement problem by means of a penalty tax on the factoring company: "Because the purchase of structured settlement payments by factoring companies directly thwarts the congressional policy underlying the structured settlement tax rules and raises such serious concerns for structured settlements and injured victims, it is appropriate to deal with these concerns in the tax context." (Congressional Record (daily ed.) 2/10/99, at E192).
Similarly, as Sen. Chafee observed last year in introducing the same legislation on the Senate side: "It is appropriate to address this problem through the federal tax system because these purchases directly contravene the Congressional policy reflected in the structured settlement tax rules and jeopardize the long-term financial security that Congress intended to provide for the injured victim. The problem is nationwide, and it is growing rapidly." (Congressional Record (daily ed.), 10/2/98, at S11340).
House Ways and Means Chairman Archer has indicated informally that, "If there are abuses out there, we'll look for them, we'll ferret them out, and we will do away with them." (BNA Daily Tax Reporter, 12/5/99, GG-1), and in later remarks pointed to transactions that make "an end run around the Code." Clearly, factoring company purchases of structured settlement payments from injured victims fall into the category of abusive transactions to which Chairman Archer refers.
A Federal tax approach also is necessary in order to address the tax uncertainties that the factoring transaction creates for the parties to the original structured settlement.
There is broad bipartisan support among Members of the House Ways and Means Committee, the Senate Finance Committee, and from Treasury for addressing the structured settlement factoring problem by means of a stringent penalty on the factoring company to discourage the transaction, except in cases of genuine, court-approved hardship of the injured victim.
B. Treasury Proposal
The Treasury Department in the Administration's FY 2000 Budget has proposed a 40-percent excise tax on factoring companies that purchase structured settlement payments from injured victims.
Under the Treasury proposal, "any person purchasing (or otherwise acquiring for consideration) a structured settlement payment stream would be subject to a 40 percent excise tax on the difference between the amount paid by the purchaser to the injured person and the undiscounted value of the purchased income stream, unless such purchase is pursuant to a court order finding that the extraordinary and unanticipated needs of the original recipient render such a transaction desirable." (Treasury General Explanations (Feb. 1999), at p. 192). The proposal would apply to transfers of structured settlement payments made after date of enactment.
The Treasury proposal represents a strong and appropriate response to the structured settlement factoring problem.
C. Bipartisan Congressional Proposal
1. Stringent penalty on factoring company that purchases structured settlement payments from injured victims
Reps. Clay Shaw (R-Fl.) and Pete Stark (D-Ca.), two senior Members of the Ways and Means Committee, have introduced H.R. 263 (the "Structured Settlement Protection Act") which adopts a similar approach by imposing a 50 percent excise tax on the difference between the amount paid by the purchaser to the injured victim and the undiscounted value of the purchased payment stream. H.R. 263 is co-sponsored by a broad bipartisan group totaling 17 Members of the Ways and Means Committee. It is endorsed by the National Spinal Cord Injury Association and the National Organization on Disability. It is supported by Treasury.
Sens. John Chafee (R-R.I.) and Max Baucus (D-Mt.) introduced companion legislation last year with similar broad bipartisan support among Finance Committee Members.
As Sen. Baucus noted, the excise tax approach is a penalty, not a tax increase or a new tax: "I would stress that this is a penalty, not a tax increase -- the factoring company only pays the penalty if it undertakes the transaction that Congress is seeking to discourage because the transaction thwarts a clear Congressional policy." (Congressional Record (daily ed.), 10/5/98, at S11500).
2. Exception for limited cases of genuine, court-approved hardship
This stringent excise tax would be coupled with a limited exception for genuine, court-approved financial hardship situations. The excise tax would apply to factoring companies in all structured settlement purchase transactions except in the case of a transaction that is pursuant to a court order finding that "the extraordinary, imminent, and unanticipated needs of the structured settlement recipient or his or her dependents render such a transaction appropriate."
This exception is intended to apply only to a limited number of cases in which a genuinely "extraordinary, imminent, and unanticipated" hardship actually has arisen (e.g., serious medical emergency for a family member) and which has been demonstrated to the satisfaction of a court, as well as a showing that transferring away such payments will not leave the injured victim and his or her family exposed to undue financial hardship in the future when the structured settlement payments no longer are available.
3. Need to protect the tax treatment of the original structured settlement
In the limited instances of extraordinary and unanticipated hardship determined by court order to warrant relief, adverse tax consequences should not be visited upon the claimant or the other parties to the original structured settlement. Accordingly, the bipartisan Congressional proposal would clarify in the statute or the legislative history that in those limited instances in which the extraordinary, imminent, and unanticipated hardship standard is found to be met by a court, the original tax treatment of the structured settlement under I.R.C. §§ 104, 130, 72, and 461(h) would be left undisturbed.
That is, the periodic payments already received by the claimant prior to any factoring transaction would remain tax-free damages under Code section 104. The assignee's exclusion of income under Code section 130 arising from satisfaction of all of the section 130 qualified assignment rules at the time the structured settlement was entered into years earlier would not be challenged. Similarly, the settling defendant's deduction under Code section 461(h) of the amount paid to the assignee to assume the liability would not be challenged. Finally, the status under Code section 72 of the annuity being used to fund the periodic payments would remain undisturbed.
Despite the anti-assignment provisions included in the structured settlement agreements and the applicability of a stringent excise tax on the factoring company, there may be a limited number of non-hardship factoring transactions that still go forward. If the structured settlement tax rules under I.R.C. §§ 130, 72, and 461(h) had been satisfied at the time of the structured settlement and the applicable structured settlement agreements included an anti-assignment provision, the original tax treatment of the other parties to the settlement -- i.e., the settling defendant and the Code section 130 assignee -- should not be jeopardized by a third party transaction that occurs years later and likely unbeknownst to these other parties to the original settlement.
Accordingly, the bipartisan Congressional proposal also would clarify in the case of a non-hardship factoring transaction, that if the structured settlement tax rules under I.R.C. §§ 130, 72, and 461(h) had been satisfied at the time of the structured settlement and the applicable structured settlement agreements included an anti-assignment provision, the section 130 exclusion of the assignee, the section 461(h) deduction of the settling defendant, and the Code section 72 status of the annuity being used to fund the periodic payments would remain undisturbed.
Finally, the bipartisan Congressional proposal would clarify the tax reporting obligations of the annuity issuer and section 130 assignee in the event of a factoring transaction. In the case of a factoring transaction, either on a court-approved hardship basis or a non-hardship basis, of which the annuity issuer has actual notice and knowledge, assuming that a tax reporting obligation otherwise would be applicable, the annuity issuer would be obligated to file an information report with the I.R.S. noting the fact of the transfer, the identity of the original payee, and the identity where known of the new recipient of the factored payments. No reporting obligation would exist where the annuity issuer (or section 130 assignee) had no knowledge of the factoring transaction.
Conclusion
H.R. 263 fully protects structured settlements, the injured victims, and the Congressional policy underlying structured settlements.
H.R. 263 has broad bipartisan support among Members of the Ways and Means Committee. It is endorsed by the National Spinal Cord Injury Association and the National Organization on Disability. It is supported by Treasury.
This bipartisan Congressional proposal should be included as part of the tax legislation considered by Congress this year.