Can You Structure Pre Death Pain & Suffering and Claims of Decedent?

by John Darer® CLU ChFC MSSC CeFT® RSP CLTC

Can you structure damages paid for pre-death pain and suffering or other elements of damages originating PRIOR to the decedent's death? 

Can a decedent's heirs avoid these elements of damages by simply allocating 100% to wrongful death when the facts of the case show that litigation was commenced many years before a decedent's death and in which the decedent's pain and suffering was extensively pleaded in the years leading up to the decedent's death, day in the life videos were produced and used to support the case, mediation briefs documented the suffering, there were projections of loss of earnings etc.

Consider the following:

1. Auto accident case
2. Litigation commenced 5+ years before decedent died
   
3. Plaintiff was in excruciating pain for 5+ years before he died,
   
4. Plaintiff left 2 minor children
   
5. Litigation commenced shortly after the accident occurred and stretched an additional 2 years after his death. The case caption was amended to the "Estate of" after the decedent died.

Discussion

A.  Decedent's pre-death pain & suffering must pass through his/her estate.

 
"Proceeds from causes of action originating before the decedent's death, such as pain & suffering, become part of the decedent's gross estate"  Death and Damages Can Be Taxing-Jeremy Babener NYU Law, Trusts and Estates Journal (Penton Media) April 2011 citing Rev Rul 69-8 1969-1 CB 219 and IRS Technical Advisory Memo 98-11-006 (November 24, 1997) (award to plaintiff's trust included in plaintiff's estate upon his death; and  Estate of Jeanne M. Houston v Commissioner of Internal Revenue Service  TCM 182-362 (June 28, 1982) (claim of wrongful death of husband included in widow's estate upon her subsequent death)

 

B. All the property that a person owns is part of his or her estate. An estate can include clothes, jewelry, tools, cars, musical instruments, a house, land the house is built on, cash, bank accounts, retirement accounts, stocks, bonds, annuities and other items. The aforesaid damages are an additur to the taxable estate of the decedent. Applicable Estate and/or inheritance taxes (after any applicable estate tax deductions) and executor fees (administrator costs, if dies intestate) must be paid BEFORE the remainder is divided among survivors and closing of the Estate. 

C. Personal physical injury damages and physical sickness damages are excludable from gross income subject to the terms oi IRC §104(a)(2)

D. Money received as an inheritance is excludable from income under IRC §102(a)

E. IRC §130 governs qualified assignments. IRC 130 is a work around the taxation of income from annuities owned by non natural persons (see IRC 72(u)). Without the work around the cost of structured settlement would likely increase as there would be no tax exclusion to the assignee. The tax exclusion is critical in the majority of structured settlements where Defendants and their insurers have no interest in owning the annuities, or having a contingent liability. on their books.  We can easily point to non qualified assignment companies to prove our point. If the IRC 130 exclusion was not an issue for non natural persons then there would be no need for offshore domiciles such as Barbados and Ireland for non qualified assignment companies.

F. IRC  §130(c) (2)(D) makes no provision for payments received as an inheritance under IRC §102(a). To wit

 

(A) such periodic 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 of such payments,

(C) 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

(D) such periodic payments are excludable from the gross income of the recipient under paragraph (1) or (2) of section 104 (a).

G. The legislative history of the 1996 amendment to Section 104(a)(2) provides explicitly:  If an action has its origin in a physical injury or physical sickness, then all damages (other than punitive damages) that flow therefrom are treated as damages received on account of personal physical injuries or physical sickness whether or not the recipient of the damages is the injured party. For example, damages (other than punitive damages) received by an individual on account of a claim of loss of consortium due to the physical injury or physical sickness of such individual's spouse are excludable from gross income.  H.R. Conf. Rep. No. 104-737, at 300 (1996), reprinted in 1996 U.S.C.C.A.N. 1474, 1793. 

H.  Private Letter Ruling 200121031, 5/29/2001, IRC Sec(s). 104..."Because there exists a direct link between the physical injury suffered and the damages recovered, Taxpayer may exclude from gross income any economic damages compensating for such injury..." Source: Little Meyers & Associates

*****

On May 4, 2011  I posed the following question to several recognized tax authorities on structured settlements:

"Can the portion of settlement allocation reflecting the pre-death pain & suffering damages be structured to heirs? My understanding is that IRC 102(a) covers inheritances, any damages flowing from PI are not income taxable, IRC 130(c) only provides for assignment of IRC 104(a)(1) and IRC 104(a)(2)  What is bugging me is the severity and duration of the P&S being major part of the negotiation and prosecution of the case.

Your initial thoughts on whether or not this could be structured" 

 

The responses...

  

A. David Higgins The Settlement Law Group

"John:

 

I think you are the only broker or life company in the business that pays attention to this issue.  Damages suffered by the decedent before his death belong to the decedent and pass through his estate.  Those are excluded from the heir’s income as inheritances, not damages for personal injury".

David M. Higgins

THE SETTLEMENT LAW GROUP
11355 West Olympic Boulevard, Suite 200
Los Angeles California 90064
Tel: 213-833-0202
Fax: 213-291-8300
Cell: 310-415-3344

B. After this clarification from me

"...apologies for not being more clear in the question, I am aware of the Estate tax issue, my question is whether or not the damages that must pass through the estate can be structured? Clearly an allocation to wrongful death is a solution. However the unusual aspect of this case is the degree and duration of P&S, which seems to make an allocation to all Wrongful death more difficult. The Surrogates Court must approve the allocation. My client is an insurer. The provisions in a standard QA that permit an unwind (of the assignment) if IRC 130 (c) (isn't satisfied) brings into focus where my concerns lie here".

To which the answer was...

"...If the damages must pass through the estate, that would mean the damages to the estate are free of income tax, but then the beneficiaries of the estate are receiving money from the estate.  That may mean they are no longer  (IRC Sec) 104 damages.  (emphasis ours) This is a new and interesting issue, but I'd have to have someone hire me to be able to render an opinion." 

Issues

1. While some may try to justify structuring such elements of damage under the "origin of claim" principle, there appear to be sufficient questions about whether structuring elements of damages that must pass through a decedent's estate is possible.

2. Defendants, their insurers and counsel should carefully review settlement allocations in cases with this peculiarity to assure that the allocation is reasonable given the facts of the case, raise the issue with opposing counsel in timely fashion and avoid participating in a structured settlements where the math on the damages doesn't work out. Remember there are unwind provisions in every qualified assignment if IRC 130(c) is not satisfied. The provision is there solely to protect the qualified assignment company in case some sneaky "S.O.B." tries to slip through a case in that does not qualify. You said you wanted a CLOSED file right?                                                 NOT THIS!

3. Plaintiff attorneys, be aware that defendants and insurers are under no obligation to pre-fund structured settlements. At their option, many do so as a convenience. Sometimes that works in your client's favor. If you have such a case it may be a good idea to propose a reasonable allocation that the defendants or insurers can live with and only structure the direct survivors actions.

4. Are you being advised to use a single claimant 48B QSF and think a single claimant 468B QSF will solve your problem because the QSF trustee doesn't care about an unwind of the qualified assignment? Think again!  If the unwind provisions are set in motion after an audit several years down the road,  who is going to own the annuity and the obligation of the QSF, if the QSF no longer exists? Who is going to pay the attorney fees of your client to sort out the morass that you counseled them to accept? 

5. Surrogate and Probate Judges should perform an extra careful review of submissions to make sure that an allocation is reasonable.

6. Should a fix to IRC 130 be sought that includes inheritances of this fashion under IRC 102(a)?

7. Lest anyone misinterpret me, I am not saying don't do structures on wrongful death cases.

8.. Some have suggested using a non qualified assignment but the idea needs further fleshing out.

Comments welcome!