by John Darer CLU ChFC MSSC CeFT RSP CLTC
When a structured settlement is part of the settlement package for your client's legal case, then the consideration MUST be cash and future periodic payments (with the schedule expressly described). Language in a settlement agreement and release which does not create an obligation to pay future periodic payments is to be avoided. Without consideration being properly expressed the structured settlement could fail, with financial consequences to all parties, Defendant, Plaintiff and Insurers.
We sometimes see proposed settlement agreement language which says "Defendant or its Insurer will arrange for the purchase of an annuity". This is a potentially fatal mistake. But why is it a fatal mistake?
For starters, a properly formed structured settlement is not simply "buying an annuity".
There is unfavorable taxation on corporate owners of annuities, for which IRC 130 provides an express exclusion, if the requirements of IRC 130 are met. Most Defendants or Insurers do not want to retain the contingent liability of a long tail periodic payment obligation on their books and this is one of the reasons most structured settlements are created using qualified assignments. Lastly, the plaintiff or payee may not want to be tied emotionally or financially to the Defendant who harmed, them, or whose product or servce harmed them and the qualified assignment helps to accomplish this. .
A qualified assignment is defined in the United States Internal Revenue Code of 1986, as amended in Section 130.
The term “qualified assignment” means any assignment of a liability to make periodic payments as damages (whether by suit or agreement), or as compensation under any workmen’s compensation act, on account of personal injury or sickness (in a case involving physical injury or physical sickness)—
(1) if the assignee assumes such liability from a person who is a party to the suit or agreement, or the workmen’s compensation claim, and
(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). [emphasis added]
So if you want to use the "arrange for the purchase of an annuity" language, you're "batting 0 for 1 " out of the gate, violating IRC 130(c)(1).
Look at any qualified assignment agreement and you will see the following:
A recital that includes: "...under which the Assignor has liability to make certain periodic payments to or for the benefit of the Claimant" and (2) that the Assignor and Assignee wish to effect a "qualified assignment within the meaning of Section 130(c) of the Internal Revenue Code of 1986, as amended" and THEN
the first decretal paragraph which is usually titled Assignment and Assumption and states "Assignor hereby assigns to the Assignee, and Assignee hereby accepts and assumes, all of the Assignor's liability to make the Periodic Payments"
What are the consequences of violating IRC 130(c)
There is always a paragraph labeled "Failure to Satisfy Section 130(c)" in a qualified assignment agreement. I sometimes refer to it as the "sneaky S.O.B. clause". The paragraph is designed to provide relief to the assignment company in the event it has booked an obligation that does not qualify for the tax exclusion that IRC 130 gives the assignment company.
If there is a IRC 130(c) failure the unwind provisions in every assignment agreement provide for the qualified funding asset or annuity to be placed in the hands of the Assignor. There is unfavorable taxation on corporate owners of annuities, for which IRC 130 provides an exclusion. In trhe eveent of a qualifie assignment unwind for failure to satuisfy IRC 130, the Defendant or Insurer which has taken a write off for a novated claim in a prior year will likely have to recognize the value of the asset as income and there will be an asset liability mismatch after taxes have been taken into consideration.
For the plaintiff who has executed a qualified assignment release and pledge in the hope of getting secured creditor status, they can kiss that goodbye in the event of a IRC 130(c) failure. They become a general creditor of the defendant or insurer in the event of IRC 130(c) failure, or worse, if the qualified funding asset is placed in their hands following the unwind they have an asset which may now potentially produce some taxable income, with respect to interest.
The requirements of IRC 130 are not difficult to satisfy, so try not to get cute with settlement documents by inserting "arrange for purchase" language. Stick to what the tax code says. This is fundamental Structured Settlements 101.
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