What is a tax free structured settlement?
A tax free structured settlement is an alternative to a lump sum settlement
in a suit for damages for physical injury, physical sickness, and wrongful death.
The defendant, or its casualty company, agrees to pay the plaintiff payments
over a period of time. The future obligation is funded by the purchase of a
settlement annuity from a life insurance company or United States Government
Bonds. Both Annuities and Treasury Bonds are the only permissible "Qualified
Funding Assets" in structured settlement cases pursuant to I.R.C. Section
130(d).
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Are structured settlements limited to cases involving physical
injury or physical sickness?
No. Creative Capital (CCI) has handled many non-physical injury structured settlement
cases over the years including: employment cases, property damage, wrongful
mortgage foreclosure, punitive damages, disability claims, workers' compensation
and Long Shore Harbor Workers' Act (LSHWA) claims, lottery prizes, business
disputes, law firm break-ups, attorneys' fees, and more.
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Do structured settlements provide benefits in taxable settlements?
Yes. In many cases the need to structure a taxable settlement is more compelling
than in a tax-free settlement. The Alternative Minimum Tax rules (AMT), when
triggered often prevent the recipient from deducting attorney's fees and expenses
from the gross taxable settlement. For example:
 |
Gross settlement |
$ 2,000,000
|
| |
Fees & expenses |
- 900,000
|
|
|
|
| |
Net recovery |
$ 1,100,000
|
| |
Federal, state & local |
|
| |
taxes on gross
($2M) |
- 1,000,000
|
| |
Net to plaintiff after tax |
$ 100,000
|
By structuring the payout over a number of years, we are able to bring the
recipient below the AMT threshold in every year. In addition, since receipt
does not take place in a single year, the recipient earns tax-deferred interest
on money that would otherwise have been paid in taxes in year one. In fact,
the recipient earns triple tax deferred interest on 1) the principal; 2) the
interest; 3) the taxes deferred from year one.
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Why were structured settlements created?
The need for an alternative settlement in lieu of the lump sum approach that
would be advantageous to both the plaintiff and defendant gave rise to the periodic
payment approach, better known as structured settlements.
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What is the advantage to the plaintiff in choosing a structured
settlement instead of a lump sum settlement?
The biggest advantage is the tax savings. Under IRC Section 104(a)(2), all payments
made to the plaintiff in bodily injury cases are excluded from taxation. Payments
made to the estate after the plaintiff's death are also excludable (Revenue
Ruling 79-220). Had the plaintiff received a lump sum (tax free) and invested
it, the interest would be subject to taxation. In a structured settlement, both
the principal used to purchase the "Qualified Funding Asset" (T-Bonds
or annuities) and the interest earned are received by the plaintiff tax free.
Other benefits include absence of investment risk, management-free income, flexibility
in structuring payments to fit individual needs, and protection of funds against
fraud and greed.
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Is it true that casualty insurers favor structured settlements
because it enables them to save money?
Yes and no. Structured settlements, if properly negotiated, should provide a
financial incentive to both plaintiff and defendant. Over the years, CCI has
handled numerous cases where we helped the parties share the government tax
break given to structured settlement under I.R.C. section 104(a)(2). For example:
if both sides recognize that a case is worth $1M, wouldn't it be a great settlement
if the defense can spend $925,000 and provide the plaintiff with a structured
settlement benefit plan that the plaintiff would need $1.1M in cash to replicate?
In this type of a settlement the plaintiff receives more than he or she would
otherwise have accepted in cash, and the defendant pays less to settle the case
than it would have had to pay in a cash settlement.
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How is CCI able to provide the win-win situation described
in the last answer?
Simple. A window of opportunity exists at the moment of settlement. If the plaintiff
took cash and left, he or she could purchase an annuity or make an investment
that would provide a monthly cash flow. However, some or all of that cash flow
would be taxable. Since the entire cash flow from a structure is tax free, the
plaintiff would have to invest a greater amount to achieve a greater gross monthly
cash flow in order to have a net after tax amount equal to the amount we can
provide as part of a structured settlement. In the preceding answer, the plaintiff
would need $1.1M to achieve a net after tax amount equal to what the defendant
can provide for $925,000. If the case was worth $1M, both plaintiff and defendant
are better off with the structure than with cash. That's called "splitting
the subsidy".
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Who is involved in the negotiation of a structured settlement?
The defendant or casualty insurer's attorney (or claims examiner), the plaintiff
attorney, and the CCI structured settlement consultant work together to facilitate
a settlement. The Creative Capital representative will attend settlement conferences
to help settle the case to everyone's satisfaction.
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At what point is the structured settlement negotiated?
Negotiations can be conducted before a case goes to trial, during trial, after
trial or during an appeal. The early identification and settlement of cases
can often result in the greatest savings to the defense and greatest utility
to the plaintiff.
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Is it ever too late to do a structured settlement?
Yes. Once the plaintiff has the unqualified right to receive the amount proposed
for the structure it is too late to negotiate a tax free structured settlement.
For example, when a defendant's appeal from a lump sum judgment has been denied
and no further appeals are possible, the plaintiff has the absolute right to
receive the lump sum awarded. At this point a structured settlement cannot be
achieved.
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How do structured settlements compare with lump sum payouts
in terms of yield and safety?
A lump sum payment invested in any non-speculative tax free or taxable instrument
cannot match the yield of structured settlements. The tax free government subsidized
protection of structured payouts, together with the high yield of annuities
provided by financially secure life insurance companies make the periodic payment
approach a superior settlement vehicle.
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What are the components of a typical structured settlement?
There is a wide range of benefits, depending on the circumstances of the case.
Each case is individual and each settlement is different. However, options frequently
considered include:
- Up-front cash
- Level payments made monthly or at other appropriate intervals
- Payments that increase over a period of time
- Payments with increases in level amounts or percentage increases
- Payments guaranteed for life, or for a fixed period of years or both
- Level payments supplemented by periodic payments of lump sums
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Can structured settlements take inflation into consideration?
Yes. When negotiating a structured settlement, inflation is a key factor in
determining the payout plan and can be covered via an annually compounded inflation
factor in structures funded with annuities.
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What is a "substandard" case and what is its impact
on the cost/benefit of the structured settlement package?
A substandard case refers to a catastrophic injury and a shortened life expectancy
for the claimant. Fewer years of life annuity payments (because of the reduced
life expectancy) translates into savings of premium for the defendant while
providing additional benefits for the plaintiff. Should the plaintiff live longer
than anticipated, payments will continue for life.
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Who is responsible for the safety of the structured settlement?
When annuities are utilized, Creative Capital will only use those life companies
rated A+ or A++ by AM Best Company, an independent insurance appraisal firm.
Creative Capital prefers the larger life companies with the top ratings from
Moody's, Standard & Poor's or Fitch. When U.S. Treasury Bonds are employed
as a component of the settlement, the full faith and credit of the United States
stands behind the bond portion of the settlement.
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Will CCI accept a company with an "A" rating from
AM Best?
As stated above, CCI will always recommend the A+ or A++ AM Best rated life
companies (which also have high ratings from the other services). However, when
a specific life company is requested by the parties, CCI will provide a written
recitation of that company's ratings to be sure that full disclosure has been
made. CCI will also provide comparative quotes from A+ or A++ rated life companies.
If the parties insist on an A rated company, CCI will place the annuity with
that company. CCI will not place annuities with any company rated less than
A.
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Who must own the funding asset?
The defendant or the defendant's insurer must own the annuity or bonds in accordance
with IRC Section 104(a)(2) and Revenue Ruling 79-220 unless a "Qualified
Assignment" is made. The purpose served by this ownership is to protect
the plaintiff from the claim that he/she has constructive ownership of the assets,
which produce the settlement payments. A finding of constructive ownership in
the plaintiff would likely cause a portion of the settlement payments to be
taxable to the plaintiff.
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What is a Qualified Assignment?
Under Section 130 of the IRC the defendant or casualty company can assign ownership
of the funding assets (as well as the liability to make future payments) to
a "Qualified Assignee". Once this is done the defendant and casualty
company are out of the case with the same result as in a cash lump sum settlement.
This is legally called a "novation".
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Can the plaintiff be a secured creditor and have a lien
on the Qualified Funding Asset?
Yes, but only if a qualified assignment pursuant to IRC Section 130(c) is made.
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What is a Non-Qualified Assignment?
A Non-Qualified Assignment is a legal novation transferring the future periodic
payment obligation from the defendant or its carriers to a third-party non-qualified
assignee. Once that assignee accepts the assignment and assumes the future payment
obligation of the defendant, the defendant (and carrier) are fully and completely
released from the future periodic payment obligation in exactly the same way
as in a physical injury/sickness (qualified) case.
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Why was the Non-Qualified Assignment developed?
It was developed to allow the parties to obtain closure in the same way as in
physical injury cases. The defendant is able to: write off the cost of settlement;
close its file; not have to act as guarantor of a life company; cut all ties
with plaintiff. Plaintiff is able to: defer taxable compensation and legally
avoid taking a huge tax hit in a single year; sever all ties with defendant;
substitute a highly rated financial giant (Fortune 50 company) for the defendant;
obtain a negotiated benefit stream which is almost infinitely flexible and settle
more easily at a cost more likely to be acceptable to the defense because of
the tax advantages to the plaintiff.
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Should the plaintiff name specific individuals as beneficiaries
and reserve the right to change the beneficiaries?
The safest and most conservative approach is one where the plaintiff does not
retain any right to name or to change any beneficiary. It might suggest constructive
ownership. Although the life companies permit this to be done, Creative Capital
prefers to follow Revenue Ruling 79-220 to the letter. This ruling provides
that no adverse tax consequences will result when the plaintiff's estate is
the beneficiary. A Private Letter Ruling (PLR No. 8426078) allows a plaintiff
to name a natural person as beneficiary without adverse tax consequences. However,
only the Revenue Ruling is binding on the I.R.S. The Private Letter Ruling is
not. Therefore, the safer and more conservative approach is to name the plaintiff's
estate as beneficiary. Notwithstanding the foregoing, once advised of the above,
the plaintiff is free to make his/her own decision.
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How has "Tort Reform" affected the periodic payment
approach to resolving liability cases?
In approximately thirty states legislation has been passed which mandates a
structured (periodic) payout in certain "threshold" cases - even if
the case does not settle and goes to trial, verdict and judgment. In these cases
the plaintiff cannot win a cash lump sum verdict at trial. Proper identification
of these cases is crucial to the parties' proper evaluation of the claim.
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Can the casualty insurer receive part of the commission
back from the structured settlement broker?
No, this is called a rebate. Only California permits rebating on commissions.
It is illegal elsewhere. See Certificate of Reliability
and Assurances for additional details.
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What is a CORA Certificate or CORA Affidavit?
A CORA Certificate or Affidavit is a series of affirmative representations and
warranties demonstrating that no party to the settlement is being taken advantage
of. See Certificate of Reliability and Assurances
for additional details.
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How can I obtain the protection of a CORA Certificate/Affidavit?
CCI is the only structured settlement firm offering a CORA Certificate/Affidavit.
If CCI is not the broker in your case you cannot expect to receive our CORA.
However, we encourage you to go to our CORA
page, or follow the links provided here to download the Certificate
or Affidavit and print
out a copy. Insist that the broker sign it, under oath, with all the applicable
penalties for perjury. If the broker refuses to sign, you should refuse the
structure.
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Is CORA important for defendants as well as for plaintiffs?
Yes. Click here to download
CCI's "Special message from Creative Capital's General Counsel".
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What should I do when I have a case?
Contact the Creative Capital office in your region or whichever office you prefer
to work with. Click
here for our office directory.
Do you have a question not listed here?
or call 800-327-9224 for more information on how we can help
you
