Structured Settlements 4Real® Blog: Structured Settlements | Settlement Planning News and Commentary, Now in 16th Year!

Special Needs Trust With Structured Settlement Yes or No?

by John Darer® CLU ChFC MSSC RSP CLTC

A structured settlement whose payments represent damages on account of personal physical injury, physical sickness, workers compensation or wrongful death, provides income that is tax free to the recipient of the structured settlement payments. [see IRC 104(a)(1) amd IRC 104(a)(2) as applicable].

Structured settlements may be an appropriate vehicle to be used in conjunction with a Special Needs trust (generally referred to as  a Supplemental Needs Trust in New York) to provide investment stablity and reduced expenses of the recovery.

On its website, one of my industry colleagues also purports that using a structured settlement will be useful in "preventing the taxation of interest income within the SNT".  This is untrue.

A structured settlement has absolutely no bearing on the taxation of interest income within the Special Needs Trust. Absent an investment in tax exempt investments, once structured settlement payments are deposited in to the SNT,  the interest subsequently earned on the structured settlement payments is taxable. 

The use of a structured settlement created outside a Special Needs Trust with payments feeding into the SNT,  may be helpful when comparing the potential outcome of the  investment of a comparable amount to the cost of the structured settlement by the trustee of the SNT in a permissible taxable investment.

 

What is a Lifetime Annuity? Help With Annuities

by John Darer® CLU ChFC MSSC RSP CLTC

A lifetime annuity

• Turns part of your settlement recovery, or savings,  into guaranteed income you can’t outlive. The mortality risk is shifted to a life insurance company whose business it is to assess mortality and who possesses the economy of scale to spread that risk out over all of its policyholders and annuitants.
• Can lock in an immediate or deferred income stream for life  (immediate annuity or deferred income annuity)
  
• Means you can receive stable ,secure, guaranteed* payments regardless of market conditions
• Payments may cease upon the death of the measuring life, OR can include guarantees that provide an alternative way to address the possibility that the measuring life will die prematurely.

Taxation of Lifetime income Annuities

Generally, with respect to income taxes,

• Where a structured settlement annuity is paid for a lifetime, the payments are free of income taxes, if the payments represent damages on account of personal physical injury or physical sickness or are payments from a workers compensation claim. [for more information see Internal Revenue Code Sections 104(a)(1) and 104(a)(2)]
• If the lifetime annuity is purchased by you from your after-tax savings ("non qualified" annuity ), some of the income is not subject to tax. To figure out how much income is excluded you must first calculate the exclusion ratio. The exclusion ratio is your net investment in the annuity (amount you paid for the annuity) divided by your expected return from the plan. The expected return is the total amount of annuity payments that you'll receive. Generally, an annuity provides for lifetime payments, so the total amount of annuity payments depends on your life expectancy at the annuity starting date. For example, if your net investment is $100,000 and the expected return through your life expectancy is $250,000 then the exclusion ratio is .40 (100,000 divided by 250,000). [ for more information see 26 CFR 1.72-4 - Exclusion ratio]
• If a lifetime income annuity is purchased as part of the settlement of litigation where the damages are taxable (for example an employment related settlement), or as a distribution from a qualified pension plan, then each annuity payment is fully taxable. There is no exclusion ratio.
  

 * subject to the financial strength and claims paying ability of the annuity issuer.

 

Settlement Planning Issues 2013 | "Largest Tax Hikes in the History of the U.S."

by John Darer CLU ChFC MSSC RSP CLTC

The Federal tax increases, or effective tax increases, arriving in 2013 have both settlement planning and financial planning implications and may have a positive effect on the utility of structured settlements, structured attorney fees and other financial solutions involving structured periodic payments.

A. Increase in personal income tax rates

Now             2013

10%              15%

25%              28%

28%              31%

33%              36%

35%              39.6%

Settlement Planning Implications Of 2013 Federal Income Tax Hikes

The increase in taxes increases the taxable equivalent yield of a structured settlement. Structured settlements become more attractive settlement planning option even with low interest rates. Structured settlement payments, if they represent payment of damages for physical injury, physical sickness, wrongful death, or payment of claims for workers compensation are excludable from gross income, subject to the terms IRC 104(a).

Non qualified structured settlements become even more attractive for taxable damages (employment, property, punitive damages, spousal support/alimony on divorce cases,  structured oil and gas lease bonus payments and structured celebrity endorsement fees) as the leverage of tax deferral is increased. Where applicable,  and where underwriting permits, periodic payment reinsurance  becomes more attractive as a solution as a method to pay taxable damages.

Any applicable state and/or local income tax increases will only enhance the value of structured settlements.

Annuitants already receiving structured settlement payments , but having no pressing need to raise cash will have even more of a reason to carefully consider their options before selling structured settlement payment rights. 

 B. Other 2013 Federal Tax Hikes Affecting Families

• Marriage Penalty will return for the first dollar of income
• Child tax credit drops from $1,000 to $500 per child
• Standard deduction is no longer doubles for married couples.

Settlement Planning Implications

Effect on budgeting must be considered.

Taken together with the tax bracket increases, structured settlements become more attractive, particularly on larger cases, structured attorney fees and other non qualified structured settlements. 

C. Federal Estate Tax increase as exemptions expire. 

Current

35% with $5 million exemption ($10 million for married couples)

2013

Top rate is 55% with $1 million exemption

Settlement Planning Implications

• Massive impact on large settlements.
• The $4million reduction in the Federal estate tax exemption brings a larger universe of legal recoveries into the estate taxation zone, with or without structured settlements.
• Need  for greater awareness and use of commutation riders on structured settlements. Premature death during the certain period, and/or with due guaranteed future lump sum payments brings the present value of such structured settlement payments into the estate. Without proper planning, illiquid assets would need to be sold to pay for estate taxes. Estate taxes are due within 9 months of death.
• Increased use of life insurance to " discount" the estate obligation, if plaintiff is insurable. 
• Product arbitrage on attorney fee deferral structured settlements  for attorneys aged 50 plus. If the attorney is insurable at preferred rates, consideration should be given to having little to no certain period on the annuity and provide for the contingency of premature death with life insurance held in trust outside of the attorney's estate. An added bonus is that the attorney may end up with more benefit from the structure while his/her family will receive a lump sum in lieu of remaining payments made periodically at death.  Life insurance proceeds are generally income tax free under current law.
• Increased need for estate planning expertise.

D. Capital Gains Tax hike

Current  15%

2013        23.8%

Financial Planning Implications

Greater opportunities for the use of structured installment sales ("structured sales" ) as an exit strategy for business owners and property owners where there is a high value and low cost basis. Structured sales are an imrovement on an installment sale which puts the financial muscle of a major regulated American life insurance company behind the promise to make the installment payments.

E. Dividends Tax Hike

Current   15%

2013       43.4% (includes 3.8% Obamacare investment surtax)

Settlement Planning Implications

Some alternative investment options to structured settlements are somewhat less competitive than they were before the tax increase.

To be continued... 

 

 

 

Is the Interest You Earn on a Structured Settlement Tax Free?

by John Darer® CLU ChFC MSSC RSP CLTC

One of the benefits of a structured settlement is that if you qualify the structured settlement payments are income tax-free. That's free of Federal, State and City income taxes if you are a New York state resident and Federal and State income tax free for Connecticut residents.

How Do You Qualify for a Tax Free Structured Settlement?

To qualify for the federal income tax exclusion, the periodic payments must represent damages being paid to you on account of a physical injury or physical sickness, wrongful death or payments from a claim for workers compensation [See Internal Revenue Code Section 104(a)(1) for workers compensation and 104(a)(2) for the physical injury and sickness]. Since most structured settlements today involve a qualified assignment, the requirements of IRC 130(c) also must be complied with.

An annuity payment includes both principal and interest. So the interest is built into the payment.

AN IMPORTANT DISTINCTION 

Some may also refer to the following as structured settlements but payments are not income tax free:

A. The non-qualified structured settlement, which is a financial planning solution for taxable damage cases such as employment, punitive damages, property settlements and wrongful birth (in states that don't recognize an infant's cause of action for wrongful life). Spreading out the payment through a non qualified assignment or periodic payment reinsurance may provide some tax relief. 

B. Structured settlement payment rights acquired by a buyer in the secondary market, whether directly from the seller or by assignment. It is commonly assumed that payments the acquired rights will be taxed like a regular income annuity (a portion return of principal and a portion interest), although it has not been codified. At least one financial adviser has opined that the acquistion of such rights by an individual's Roth IRA and held for 5 years may provide some tax relief.

 

 

 

 

 

Explosion in Dividend Tax Rate Will Benefit Structured Settlements

by John Darer® CLU ChFC MSSC RSP CLTC

The changing tax structure is an important consideration when comparing structured settlements to alternative investment choices on large settlements or for settlement involving those with high incomes or sizable assets.

Dividends are only as valuable to investors as the portion left after taxes. The current 15% rate cap comes from a 2003 series of temporary rate reductions that were extended through 2012. On Jan. 1, 2013, the rate cap expires, unless Congress acts in the interim.

Say you in invest in dividend paying stocks (e.g. GE, a blue chip that currently yields about 3.5%) The current federal tax rate on qualifying dividends is 15%. For 2013, however, that rate explodes to about 44.8% after factoring in the end of various tax cuts, the phasing out of deductions and exemptions, and the addition of a 3.8% tax from the health care legislation.

The higher rate would apply to single individuals who earn more than $200,000 and to married couples earning more than $250,000.

Structured settlements which are for payment of damages for wrongful death, physical injury, physical sicknesss are income tax free pursuant to IRC 104(a)(2)

 

Taxable Equivalent Yield and Structured Settlements

by John Darer CLU ChFC MSSC CeFT RSP CLTC

 

Structured settlement payments received on account of physical injury, physical sickness, workers compensation, and/or wrongful death, are income tax free to extent the payments represent damages within the meaning of IRC 140(a)(1) or 104(a)(2). How valuable is the tax exclusion? Perhaps more than you think points out a well-intentioned industry colleague who writes that the value is even higher when one takes into account the state and local taxes.

 

He says "Local income taxes appear under a variety of designations: wage taxes, income taxes, payroll taxes, local services taxes, and occupational privilege taxes. Some are imposed as a percentage of salaries or wages, while others are stated as a percentage of federal or state tax, and still others are flat amounts charged to all. For example, residents of Yonkers, New York pay 15% of their state tax as a “piggyback” local tax. In Maryland and New York City, residents pay their local income tax when they file their state income tax".  (emphasis ours)

 

John McCulloch writes that "there are a total of 4,943 local jurisdictions that impose taxes. The states that have local taxes are as follows: Alabama (4); California (1); Colorado (3); Delaware (1); Indiana (91); Iowa (297); Kansas (535); Kentucky (218); Maryland (24); Michigan (22); Missouri (2); New Jersey (1); New York (4); Ohio (774); Oregon (2); Pennsylvania (2961); and West Virginia (3) Most local income tax rates are low (1% to 3%), they generally have been ignored when computing the taxable equivalent yield of a structured settlement and as such the structured settlement may be undervalued. Taxable equivalent yields are the return that is required on a taxable investment to make it equal to the return on a tax-exempt investment, such as a municipal bond. "

 

McCulloch's analysis is notable however, it should be supplemented by noting that it would not be accurate to assume that state and local taxes are a straight add on. Consider that some tax payers who pay state and local taxes, take itemized deductions  (Schedule A), The value of the "add on tax" (in an effort to determine the highest possible taxable equivalent yield when comparing to a taxable investment) would have to take into account the effect of the deductions. This will vary state by state. Then of course you have variables  such as some smaller structures  involving people in low tax brackets who don't itemize and people who in very high tax brackets who lose many itemized deductions. If you have someone with exceptionally high un-reimbursed medical expenses, the nominal  value of the tax benefit may be offset by the tax deductions for medical expenses (again "the itemized deduction thing"). Are you comparing payments to an individual,  or to a trust? It's not a simple add on.

 

 

Check out 4structures.com LLC's Taxable Equivalent Yield chart

 

Structured Settlements for CT Residents More Valuable Due to CT Income Tax Increase

by John Darer® CLU ChFC MSSC RSP  CLTC

Connecticut Budget bill (S.B. 1239), signed May 4, 2011  by Connecticut Governor Dan Malloy, will increase CT personal income tax rates retroactive to January 1, 2011.

The new marginal income tax rates apply for those with taxable incomes of more than $100,000 for joint filers; $50,000 for single filers and married filing separately; and $80,000 for heads of households.  A legislative analysis of the budget, states S.B. 1239 does so by: 

• increasing the number of tax brackets from three to six;
• splitting the existing 5 percent bracket into four brackets and adding three higher marginal tax rates to that taxable income;
• increasing the top marginal income tax rate to 6.7 percent from 6.5 percent;
• and reducing the taxable income for the 6.7 percent rate bracket by half

The measure also phases out the lowest (3 percent) income tax bracket starting with Connecticut adjusted gross incomes of more than $100,500 for joint filers; $56,500 for singles; $78,500 for heads of household; and $50,250 for married couples filing separately.  The legislative analysis said it does so by subjecting increasingly less taxable income to the 3 percent income tax rate as Connecticut adjusted gross income increases and moving the phased-out taxable income to the 5 percent bracket.

Marginal increases in state income taxes increase the intrinsic value of a structured settlement, structured attorney fee or non qualified assignment  (taxable damage structured settlements) for Connecticut plaintiffs, claimants and plaintiff lawyers. Under current Federal tax law structured settlement payments that are for payment of damages for physical injury or physical sickness, or workers compensation,  are excluded from gross income under Section 104(a) of the Internal Revenue Code*.  There is also no state income tax for such payments. Structured attorney fees, employment structured settlements and other forms of non qualified structured settlements and assignments,  offer tax deferral options. 

For more details, contact  Connecticut settlement planning expert John Darer CLU ChFC MSSC  CeFT RSP at 203-325-8640

 

* Since 2016, Damages for wrongful imprisonment are also income tax free per IRC Section 139F. Wrongful imprisonment damages can be structured

Comparing Take Home Pay in Different Countries

Rumors of future tax increases continue, but at least from a taxation standpoint. for now, things are not as bad in the United States as other developed  countries, according to the findings of a UHY International tax study published June 10, 2011.

Country	Net Amount of a $25,000 salary kept after taxes and social security contribution.
Germany	72.6%
France	75.0%
Italy	75.2%
U. K.	83.2%
Canada	84.8%
Russia	87.0%
U. S.	90.6%
Japan	90.8%

 

Country	Net Amount of a $200,000 salary kept after taxes and social security contribution.
Italy	54.1%
Germany	56.0%
France	58.8%
U. K.	60.9%
Canada	64.7%
U. S.	69.9%
Japan	72.0%
Russia	87.0%

But things could change. UHY reports that "many governments are facing tough choices as they grapple with record deficits. Achieving a sustainable fiscal position will be difficult without raising taxes, which is a major political issue for many countries as they seek to strike a balance between fiscal responsibility and economic growth."

Increased taxes will make new structured settlements more attractive, even if interest rate stay low.  It will also make structured attorney fees, structured celebrity endorsement fees and non qualified structured settlements of taxable damages more attractive. The intrinsic value of existing structured settlements will also improve by virtsue of a higher tax rate.

Taxable Equivalent Yield Chart for Structured Settlements

Tax Benefits For For Disabled Tax Payers: Tax Tip 2011-24

Taxpayers with disabilities and parents of children with disabilities may qualify for a number of IRS tax credits and benefits. Listed below are seven tax credits and other benefits which are available if you or someone else listed on your federal tax return is disabled.

IRS TaxTips 2011-24 issued February 3, 2011 highlights the following for disabled tax payers:

1. Standard Deduction Taxpayers who are legally blind may be entitled to a higher standard deduction on their tax return.
   
   
2. Gross Income Certain disability-related payments, Veterans Administration disability benefits, and Supplemental Security Income are excluded from gross income.
   
   
3. Impairment-Related Work Expenses Employees who have a physical or mental disability limiting their employment may be able to claim business expenses in connection with their workplace. The expenses must be necessary for the taxpayer to work.
   
   
4. Credit for the Elderly or Disabled This credit is generally available to certain taxpayers who are 65 and older as well as to certain disabled taxpayers who are younger than 65 and are retired on permanent and total disability.
   
   
5. Medical Expenses If you itemize your deductions using Form 1040, Schedule A, you may be able to deduct medical expenses.See IRS Publication 502, Medical and Dental Expenses.
   
   
6. Earned Income Tax Credit EITC is available to disabled taxpayers as well as to the parents of a child with a disability.If you retired on disability, taxable benefits you receive under your employer’s disability retirement plan are considered earned income until you reach minimum retirement age. The EITC is a tax credit that not only reduces a taxpayer’s tax liability but may also result in a refund. Many working individuals with a disability who have no qualifying children, but are older than 25 and younger than 65 do -- in fact -- qualify for EITC. Additionally, if the taxpayer’s child is disabled, the age limitation for the EITC is waived. The EITC has no effect on certain public benefits. Any refund you receive because of the EITC will not be considered income when determining whether you are eligible for benefit programs such as Supplemental Security Income and Medicaid.
   
   
7. Child or Dependent Care Credit Taxpayers who pay someone to care for their dependent or spouse so they can work or look for work may be entitled to claim this credit.There is no age limit if the taxpayer’s spouse or dependent is unable to care for themselves.

And let us not forget the structured settlement, which as the result of IRC Sections 104 (and 130), affords income tax exempt periodic payments for damages paid on account of personal physical injury or physical sickness to those who are disabled, and parents and children of the disabled (to the extent that they have direct legal claims or claims derived from the injury to a loved one), and injured workers for workers compensation claims. Under IRC 5891 there is also a tax break for those who seek liquidity from their structured settlements due to unforeseen circumstances.

Helpful Links:

• IRS Publication 3966, Living and Working with Disabilities
  
  
• IRS Publication 907, Tax Highlights for Persons with Disabilities

Take New York CPLR 50B Judgment or Take Settlement Offer?

by John Darer ® CLU ChFC MSSC CeFT RSP CLTC

It Doesn't Always Make Sense to Take a Settlement on a NY CPLR 50B Judgment

Would you put 20% of your money away in an investment that is guaranteed to lose money and 80% of your money in an investment with less than 1% rate of return over less than a decade? HELL NO!

Such a conundrum was a factor in what was proffered as part of a proposed structured judgment that I was asked to review.

There is some confusion over the significance of the 4% statutory increases built into Article 50B of the New York CPLR (or in any structured annuity for that matter). It simply represents the statutory percentage that the monthly benefit payment in a structured judgment (or structured settlement annuity funding the structured judgment) changes year to year. It does not represent a rate of return. In the aforementioned scenario, a payment stream that cost over $1 million that paid out over 7 years with a 4% compound increase carried an underwhelming 0.97% internal rate of return.  Other payment streams had negative rates of return. To think that some refer to the 4% as  a " kicker" just reminds me of the "Kick me" sign affixed to the back of George McFly in the movie "Back to The Future".  "Okay...Okay you guys very funny"

 
                                                 The 4% "Kicker"?

New York personal injury lawyers should bring in a credentialed financial settlement expert, such as a registered settlement planner, as early as possible to help them and their clients analyze their options, document their file and make the best decisions. 

When does it make sense to settle a NY CPLR 50A or CPLR 50B structured judgment?

Notwithstanding that you should rely on your attorney for legal advice, it may make sense to take a small haircut for any or all of the following reasons:

• Gain greater customization than the NY CPLR 50A or CPLR 50B statutes provide
• Achieve diversification
• Income spreading by structuring taxable elements of damages when cases are settled post trial, to help mitigate what would otherwise all be taxed in year one.  Read about structuring taxable damages by way of a non qualified assignment and  reinsurance structured settlements
  
• Mitigate mortality risk with New York structured judgments that would result in a windfall to the structured judgment annuity issuer in the event of premature death, which would come at the expense of the plaintiff's survivors if the plaintiff is uninsurable for life insurance. Read Life Insurance in Structured Judgments  and Personal Injury Settlement Planning, at 5 (c)

Updated August 16, 2021