Where is this law?

This law is 26 U.S.C. § 5891, which is the citation for Title 26, Subtitle E, Chapter 55, Section 5891 of the United States Code (2008). Title 26 is the Internal Revenue Code (tax code). Subtitle E covers alcohol, tobacco, and certain other excise taxes. Chapter 55 covers structured settlement factoring transactions.

What does the law do?

This law imposes a 40% tax on purchasers of structured settlements if they don’t adhere to certain conditions such as getting court approval of the transaction, obtaining a court declaration that the transaction is in the seller’s best interest, and following state law.

What specifically does the law say?

Here is the exact language of the law:

(a) Imposition of tax
      There is hereby imposed on any person who acquires directly or
    indirectly structured settlement payment rights in a structured
    settlement factoring transaction a tax equal to 40 percent of the
    factoring discount as determined under subsection (c)(4) with
    respect to such factoring transaction.
    (b) Exception for certain approved transactions
      (1) In general
        The tax under subsection (a) shall not apply in the case of a
      structured settlement factoring transaction in which the transfer
      of structured settlement payment rights is approved in advance in
      a qualified order.
      (2) Qualified order
        For purposes of this section, the term "qualified order" means
      a final order, judgment, or decree which -
          (A) finds that the transfer described in paragraph (1) -
            (i) does not contravene any Federal or State statute or the
          order of any court or responsible administrative authority,
          and
            (ii) is in the best interest of the payee, taking into
          account the welfare and support of the payee's dependents,
          and

          (B) is issued -
            (i) under the authority of an applicable State statute by
          an applicable State court, or
            (ii) by the responsible administrative authority (if any)
          which has exclusive jurisdiction over the underlying action
          or proceeding which was resolved by means of the structured
          settlement.
      (3) Applicable State statute
        For purposes of this section, the term "applicable State
      statute" means a statute providing for the entry of an order,
      judgment, or decree described in paragraph (2)(A) which is
      enacted by -
          (A) the State in which the payee of the structured settlement
        is domiciled, or
          (B) if there is no statute described in subparagraph (A), the
        State in which either the party to the structured settlement
        (including an assignee under a qualified assignment under
        section 130) or the person issuing the funding asset for the
        structured settlement is domiciled or has its principal place
        of business.
      (4) Applicable State court
        For purposes of this section -
        (A) In general
          The term "applicable State court" means, with respect to any
        applicable State statute, a court of the State which enacted
        such statute.
        (B) Special rule
          In the case of an applicable State statute described in
        paragraph (3)(B), such term also includes a court of the State
        in which the payee of the structured settlement is domiciled.
      (5) Qualified order dispositive
        A qualified order shall be treated as dispositive for purposes
      of the exception under this subsection.
    (c) Definitions
      For purposes of this section -
      (1) Structured settlement
        The term "structured settlement" means an arrangement -
          (A) which is established by -
            (i) suit or agreement for the periodic payment of damages
          excludable from the gross income of the recipient under
          section 104(a)(2), or
            (ii) agreement for the periodic payment of compensation
          under any workers' compensation law excludable from the gross
          income of the recipient under section 104(a)(1), and

          (B) under which the periodic payments are -
            (i) of the character described in subparagraphs (A) and (B)
          of section 130(c)(2), and
            (ii) payable by a person who is a party to the suit or
          agreement or to the workers' compensation claim or by a
          person who has assumed the liability for such periodic
          payments under a qualified assignment in accordance with
          section 130.
      (2) Structured settlement payment rights
        The term "structured settlement payment rights" means rights to
      receive payments under a structured settlement.
      (3) Structured settlement factoring transaction
        (A) In general
          The term "structured settlement factoring transaction" means
        a transfer of structured settlement payment rights (including
        portions of structured settlement payments) made for
        consideration by means of sale, assignment, pledge, or other
        form of encumbrance or alienation for consideration.
        (B) Exception
          Such term shall not include -
            (i) the creation or perfection of a security interest in
          structured settlement payment rights under a blanket security
          agreement entered into with an insured depository institution
          in the absence of any action to redirect the structured
          settlement payments to such institution (or agent or
          successor thereof) or otherwise to enforce such blanket
          security interest as against the structured settlement
          payment rights, or
            (ii) a subsequent transfer of structured settlement payment
          rights acquired in a structured settlement factoring
          transaction.
      (4) Factoring discount
        The term "factoring discount" means an amount equal to the
      excess of -
          (A) the aggregate undiscounted amount of structured
        settlement payments being acquired in the structured settlement
        factoring transaction, over
          (B) the total amount actually paid by the acquirer to the
        person from whom such structured settlement payments are
        acquired.
      (5) Responsible administrative authority
        The term "responsible administrative authority" means the
      administrative authority which had jurisdiction over the
      underlying action or proceeding which was resolved by means of
      the structured settlement.
      (6) State
        The term "State" includes the Commonwealth of Puerto Rico and
      any possession of the United States.
    (d) Coordination with other provisions
      (1) In general
        If the applicable requirements of sections 72, 104(a)(1),
      104(a)(2), 130, and 461(h) were satisfied at the time the
      structured settlement involving structured settlement payment
      rights was entered into, the subsequent occurrence of a
      structured settlement factoring transaction shall not affect the
      application of the provisions of such sections to the parties to
      the structured settlement (including an assignee under a
      qualified assignment under section 130) in any taxable year.
      (2) No withholding of tax
        The provisions of section 3405 regarding withholding of tax
      shall not apply to the person making the payments in the event of
      a structured settlement factoring transaction.

-SOURCE-
    (Added Pub. L. 107-134, title I, Sec. 115(a), Jan. 23, 2002, 115
    Stat. 2436.)

Structured settlements were first utilized in Canada and the United States during the 1970s as an alternative to lump sum settlements. Structured settlements are now part of the statutory tort law of several common law countries including Australia, Canada, England and the United States.

Although some uniformity exists, each of these countries has its own definitions, rules and standards for structured settlements. Structured settlements may include income tax and spendthrift requirements as well as benefits. Structured settlement payments are sometimes called “periodic payments.” A structured settlement incorporated into a trial judgment is called a “periodic payment judgment.”

Structured Settlements in the United States

The United States has enacted structured settlement laws and regulations at both the federal and state levels. Federal structured settlement laws include sections of the (federal) Internal Revenue Code. State structured settlement laws include structured settlement protection statutes and periodic payment of judgment statutes.

Medicaid and Medicare laws and regulations affect structured settlements. To preserve a claimant’s Medicare and Medicaid benefits, structured settlement payments may be incorporated into “Medicare Set Aside Arrangements” “Special Needs Trusts.”

Structured settlements have been endorsed by many of the nation’s largest disability rights organizations, including the American Association of People with Disabilities and the National Organization on Disability.

In April 2009, financial writer Suze Orman wrote in a column that structured settlements “provide ongoing income and reduce the risk of blowing a lump sum through poor financial choices.” In response to a reader’s question, she added that financial security can be improved “if you use the structured payouts wisely.”

Definitions

The United States definition of “structured settlement” for federal income taxation purposes, found in Internal Revenue Code Section 5891(c)(1) (26 U.S.C. § 5891(c)(1)), is an “arrangement” that meets the following requirements:

• A structured settlement must be established by:
  • A suit or agreement for periodic payment of damages excludable from gross income under Internal Revenue Code Section 104(a)(2) (26 U.S.C. § 104(a)(2)); or
  • An agreement for the periodic payment of compensation under any workers’ compensation law excludable under Internal Revenue Code Section 104(a)(1) (26 U.S.C. § 104(a)(1)); and
• The periodic payments must be of the character described in subparagraphs (A) and (B) of Internal Revenue Code Section 130(c)(2) (26 U.S.C. § 130(c)(2))) and must be payable by a person who:
  • Is a party to the suit or agreement or to a workers’ compensation claim; or
  • By a person who has assumed the liability for such periodic payments under a qualified assignment in accordance with Internal Revenue Code Section 130 (26 U.S.C. § 130).

Legal Structure

The typical structured settlement arises and is structured as follows: An injured party (the claimant) settles a tort suit with the defendant (or its insurance carrier) pursuant to a settlement agreement that provides that, in exchange for the claimant’s securing the dismissal of the lawsuit, the defendant (or, more commonly, its insurer) agrees to make a series of periodic payments over time.

The insurer, a property/casualty insurance company, thus finds itself with a long-term payment obligation to the claimant. To fund this obligation, the property/casualty insurer generally takes one of two typical approaches: It either purchases an annuity from a life insurance company (an arrangement called a “buy and hold” case) or it assigns (or, more properly, delegates) its periodic payment obligation to a third party which in turn purchases an annuity (which arrangement is called an “assigned case”).

In an unassigned case, the property/casualty insurer retains the periodic payment obligation and funds it by purchasing an annuity from a life insurance company, thereby offsetting its obligation with a matching asset. The payment stream purchased under the annuity matches exactly, in timing and amounts, the periodic payments agreed to in the settlement agreement. The property/casualty company owns the annuity and names the claimant as the payee under the annuity, thereby directing the annuity issuer to send payments directly to the claimant. If any of the periodic payments are life-contingent (i.e., the obligation to make a payment is contingent on someone continuing to be alive), then the claimant (or whoever is determined to be the measuring life) is named as the annuitant or measuring life under the annuity.

In an assigned case, the property/casualty company does not wish to retain the long-term periodic payment obligation on its books. Accordingly, the property/casualty insurer transfers the obligation, through a legal device called a qualified assignment, to a third party. The third party, called an assignment company, will require the property/casualty company to pay it an amount sufficient to enable it to buy an annuity that will fund its newly accepted periodic payment obligation. If the claimant consents to the transfer of the periodic payment obligation (either in the settlement agreement or, failing that, in a special form of qualified assignment known as a qualified assignment and release), the defendant and/or its property/casualty company has no further liability to make the periodic payments.

This method of substituting the obligor is desirable for property/casualty companies that do not want to retain the periodic payment obligation on their books. Typically, an assignment company is an affiliate of the life insurance company from which the annuity is purchased.

An assignment is said to be “qualified” if it satisfies the criteria set forth in Internal Revenue Code Section 130. Qualification of the assignment is important to assignment companies because without it the amount they receive to induce them to accept periodic payment obligations would be considered income for federal income tax purposes. If an assignment qualifies under Section 130, however, the amount received is excluded from the income of the assignment company. Section 130 was enacted to encourage assigned cases; without it, assignment companies would owe federal income taxes but would typically have no source from which to make the payments.

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