by John Darer CLU ChFC MSSC CeFT RSP CLTC
The failure to satisfy IRC 130 could have crushing financial consequences to a qualified assignment company or Payee in certain circumstances. IRC 130
provides a tax exemption to the qualified assignment company subject to certain conditions. Without the tax exemption the qualified assignment company must declare income that it receives (the money intended for the annuity premium or cost of treasury obligations plus the qualified assignment fee).
It's not hard to satisfy IRC 130, But...over stretching could cause you to "split your plans" with the IRS
In the typical qualified assignment, there is substitution of obligors for periodic payment obligations to plaintiffs who have suffered personal physical injury, physical sickness, are wrongful death survivors, or settling a worker's compensation claim.
(a) In general
Any amount received for agreeing to a qualified assignment shall not be included in gross income to the extent that such amount does not exceed the aggregate cost of any qualified funding assets.
(b)Treatment of qualified funding asset In the case of any qualified funding asset—
(1) the basis of such asset shall be reduced by the amount excluded from gross income under subsection (a) by reason of the purchase of such asset, and
(2) any gain recognized on a disposition of such asset shall be treated as ordinary income.
(c) Qualified assignment For purposes of this section (i.e. Section 130 in its entirety) , 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 (2)if—
(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).
The determination for purposes of this chapter of when the recipient is treated as having received any payment with respect to which there has been a qualified assignment shall be made without regard to any provision of such assignment which grants the recipient rights as a creditor greater than those of a general creditor.
Important Pro Tip: IRC 130(c) is a definition of what a qualified assignment is, in the context of what a qualified assignment does from a tax standpoint. The terms of IRC 130(c) and the other parts of IRC 130 are not mutually exclusive. This is recognized in so many words by Rev. Proc. 93-34, at Section 3 "Scope", wherein it expressly states "an assignment by a designated or qualified settlement fund of a liability to make periodic payments must also satisfy all the other requirements of section 130 to be a qualified assignment. ..." A Revenue Procedure is an official statement of a procedure published in the Internal Revenue Bulletin that either affects the rights or duties of taxpayers or other members of the public under the Internal Revenue Code and related statutes, treaties, and regulations or, although not necessarily affecting the rights and duties of the public, should be a matter of public knowledge. – Rev. Proc. 89-14, 1989-8 I.R.B. 20
(d) Qualified funding asset For purposes of this section, the term “qualified funding asset” means any annuity contract issued by a company licensed to do business as an insurance company under the laws of any State, or any obligation of the United States, if—
(1)such annuity contract or obligation is used by the assignee to fund periodic payments under any qualified assignment,
(2)the periods of the payments under the annuity contract or obligation are reasonably related to the periodic payments under the qualified assignment, and the amount of any such payment under the contract or obligation does not exceed the periodic payment to which it relates,
(3)such annuity contract or obligation is designated by the taxpayer (in such manner as the Secretary shall by regulations prescribe) as being taken into account under this section with respect to such qualified assignment, and
(4)such annuity contract or obligation is purchased by the taxpayer not more than 60 days before the date of the qualified assignment and not later than 60 days after the date of such assignment.
Despite being easy to satisfy, most qualified assignments have an out clause for the qualified assignment company
Here's how the Model Qualified Assignment and Release reads
Failure to Satisfy Section 130(c). If at any time prior to completion of the Periodic Payments, the Settlement Agreement is declared terminated in a final, non-appealable order of a court of competent jurisdiction (or in the case of a workers’ compensation settlement, a final order of the applicable workers’ compensation authority) or if it is determined in any such final order that the requirements of Section 130(c) of the Code have not been satisfied in connection with this Agreement: (i) the assignment by Assignor to Assignee of the liability to make the Periodic Payments, Assignee’s acceptance of such assignment and the release by Claimant(s) of Assignor’s liability shall be of no force or effect; (ii) Assignee shall be conclusively deemed to be acting as the agent of Assignor; (iii) the Annuity shall be owned by Assignor, which shall retain the liability to make the Periodic Payments; (iv) Assignee shall have no liability to make any Periodic Payments; and (v) the parties hereto agree to cooperate in taking such actions as may be necessary or appropriate to implement the foregoing.
Under the typical qualified assignment, provided no constructive receipt has occurred, the Settlement Agreeement and Release establishes a future periodic payment obligation as consideration for the type of damages that fall within the meaning of IRC 130(c) and where the assignment company is affiliated with annuity issuer, there really is no chance that the assignment company is going to fail the IRC 130(d) qualified funding asset statutory requirement, because the qualified funding asset is an annuity.
But what of the independent qualified assignment companies? Independent qualified assignment companies have been used to inject other investments into the mix, including factored structured settlement payment streams, which are not annuities. What would happen under the unwind clause in the qualified assignment document of one such company.
A settlement planning firm which attempts to use other investments including factored structured settlement payment streams it calls "secondary market annuities", which are not annuities, raises concerns on many levels.
Have you seen this in a qualified assignment agreement that you've signed for an attorney fee deferral funded with factored structured settlement payment streams or other investments? 9. " In the event the Settlement Agreement is terminated by a court of law or in the event that Section 130(c) of the Code has not been satisfied, this contract shall terminate. _______Assignment Company shall then assign ownership of any "qualified funding asset(s)" purchased hereunder to Claimant and/or Payee, and Assignee's liability for the Periodic Payments shall terminate"
If a factored structured settlement payment stream, or any other investment, that does not fall squarely within IRC 130(d), were mischaracterized, or misrepresented, as a "qualified funding asset", if it was not a qualified funding asset, the qualified assignment company could lose its tax exemption on the transaction and have a significant taxable event. And if that happens, where is money to pay the IRS going to come from?
Under the above Paragraph 9 "out clause", the settlement planner's qualified assignment company could assign ownership of the asset to the Claimant and/or a Payee who happens to be a trial lawyer who believed they had structured and deferred their fees. Any attorney payees could face a potentially monster tax hit as a result. If the Payee is the former Plaintiff then the Plaintiff has a tax hit on the interest on the funding asset that he/she or his or her trust would now own. One way or another it has the potential to be a huge mess. This would be compounded if this was created in connection with a Qualified Settlement Fund controlled by the settlement planner's firm or an affiliate, which would potentially invalidate the assignment for not meeting the terms of Rev. Proc. 93-34.
I have lingering doubts following a webinar on QSF's delivered by Milestone CEO John T. Bair last week which misrepresented Rev. Proc. 93-34* as "black and white" permission to use investments other than annuities (and obligations of the United States) as "qualified funding assets. His assertion was not supported from the plain reading of either Rev. Proc. 93-34, or IRC 130(d).
*According to the transcript Bair said at
"I've talked to lawyers and they assume
that if they're gonna do a fee deferral
then it has to be an annuity and that is
not the case it can be backed by
investments we have a revenue procedure
ruling from 2003 that says that you know
if you create a proper periodic payment
then it can be backed by investments so
that it's black and white"