IRC Section 104(a) (2)
IRC Section 130(c)
PLR 8333035
Revenue Ruling 79-220
This historic ruling provided the impetuous for the beginning of the Structured Settlement industry in the United States. Its importance cannot be overemphasized, since the IRS had definitely ruled that annuities could be used, providing certain criteria were followed, to provide tax free future payments in settlement of a personal injury law suit.
Issue
Does the exclusion from gross income provided by section 104(a) (2) of the Internal Revenue Code of 1954 apply to the full amount of monthly payments received in settlement of a damage suit or only to the discounted present value of such payment?
Facts
A, an individual sue B for damages for personal injuries. B is insured by M, an insurance company. Before the trial, A accepted M’s offer to settle the suit for a lump-sum payment of $8,000 and M’s agreement to provide A with monthly payments of $250 for A’s lifetime or 20 years, whichever is longer, the payment to be made to A’s estate after A’s death if A should die before the end of 20 years. A had no right to the discounted present value of the monthly income (the present value of which, at date of settlement, was less than the total monthly payments to be provided) or to control the investment of that amount.
To provide the monthly payments for A., M purchased a single premium annuity contract from O, another insurance company. M advised O to make payments directly to A. However, M is the owner of the annuity contract and has all rights of ownership including the right to change the beneficiary. A can rely on only the general credit of M for collection of monthly payments.
Law and Analysis
Section 61(a) of the Code and the Income Tax regulations thereunder provide that, except as otherwise provided by law, gross income means all income from whatever source derived.
Section 104(a) 2 of the Code provides that except in the case of amounts attributable to (and not in excess of) deductions allowed under Section 213 (relating to medical and dental expenses) for any prior taxable year, gross income does not include the amount of any damages received (whether by suit or agreement) on account of personal injuries or sickness.
Section 1.104-1 © of the regulations provides, in part, that the term “damages received (whether by suit or agreement)” means an amount received (other and workmen’s compensation) through prosection of a legal suit or action based upon tort or tort type rights, or through a settlement agreement entered into in lieu of such prosection.
However, if a lump-sum damage payment is invested for the benefit of a claimant who has actual or constructive receipt or the economic benefit of the lump-sum payment, only the lump-sum payment is received as damages within the meaning of Section 104 (a) (2) of the Code, and none of the income from the investment of such payment is excludable under Section 104. See Rev. Rul., 65-29, 1965-1 C.B. 59, relating to damages awarded a claimant for tortuous injuries in a lump-sum payment of 416X dollars over which claimant had unfettered control. The 416X dollars represented the discounted value of 520X dollars, which was found to be the reasonable cost of care, medicine and medical attention for the injured person over a 10-year period. Rev. Rul. 65-29 holds that only the lump-sum payment, 416X dollars, is received as damages within the meaning of Section 104(a) (2). See also Rev. Rul 76-133m 1876-1 C.B. 34, which reaches a similar conclusion with regard to a court approved settlement awarded a minor and transmitted by the clerk of the court, in the name of the minor, to a savings and loan association for deposit in certificates of deposit.
In the instant case, there is a continuing obligation by M to pay $250 per month to A for this agreed period. M’s purchase of a single premium annuity contract from the other insurance company was merely an investment by M to provide a source of funds for M to satisfy its obligation to A. See Rev. Rul. 72-25, 1972-1 C.B. 127, which relates to a similar arrangement made by an employer to provide for payment of deferred compensation to an employee. In Rev. Rul. 72-25 as here, the arrangement was merely a matter of convenience to the obligor and did not give the recipient any right in the annuity itself.
Holdings
The exclusion from gross income provided by Section 104 (a) (2) of the Code applies to the full amount of the monthly payments received by A in settlement of the damage suit because A had a right to receive only the monthly payments and did not have the actual or constructive receipt or the economic benefit of the lump-sum amount that was invested to yield that monthly payment. If A should die before the end of 20 years, the payments made to A’s estate under the settlement agreement are also excludable from income under Section 104.
TITLE 26 > Subtitle A > CHAPTER 1 > Subchapter B > PART III > SECTION 104
This is one of two sections of the IRS Code which pertain most directly to Structured Settlements.
SECTION 104. Compensation for injuries or sickness
(a) In General
Except in the case of amounts attributable to (and not in excess of) deductions allowed under section 213 (relating to medical, etc., expenses) for any prior taxable year, gross income does not include –
(1) Amounts received under workmen’s compensation acts as compensation for personal injuries or sickness;
(2) The amount of any damages (other than punitive damages) received (whether by suit or agreement and whether as lump sums or as periodic payments) on account of personal physical injuries or physical sickness.
TITLE 26 > Subtitle A > CHAPTER 1 > Subchapter B > PART III > SECTION 130
This section provides that a defendant and/or their insurer could assign their obligation to guarantee the future periodic payments to the insurance company assignee through a “qualified assignment’ and receive favorable tax treatment and a full release from all liability.
SECTION 130. Certain personal injury liability assignments
- (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, 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 physical injuries or sickness is no greater than the obligation of the person who assigned The liability, an
(D) Such periodic payments are excludable from the gross income of the recipient under paragraph (1) or (2) of Section 104 (a).
Of the determination or 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.
(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 payment 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.
Both Federal Tax Rules are consolidated under P.L. 97- 473, the Periodic Payment Settlement Act of 1982.
PRIVATE RULING 8333035 – Refers to Private Ruling 8325054
This ruling clarifies that knowledge of the annuity cost by the defendant has no impact on the tax free aspects of a Structured Settlement; rather the unqualified availability is decisive.
“This document may not be used or cited as precedent. Section 6110(J) (3) of the Internal Revenue Code.”
SECTION 0451
General Rule for Taxable Year of Inclusion (Year Received V. NOT Year Received) ---Constructive Receipt
DATE: May 16, 1983
REFER REPLY TO: CC: IND: I: 3:3:
Dear * * *
This is in reply to a letter of April 5, 1983, submitted on your behalf by your authorized representative, requesting a supplemental ruling that disclosure by defendant of the cost or present value of an annuity to be purchased to fund its monthly settlement obligation will not cause you to be in constructive receipt of the present value of the amount invested in the annuity.
On March 21, 1983, the Internal Revenue Service issued a ruling that you will have neither actual nor constructive receipt, nor the economic benefit of the present value of the amount invested in the annuity, and the periodic payments will be excludable from your gross income under section 104(a) (2) of the Internal Revenue Code. In that ruling we cited rev. Rul. 79-313, 1979-2 C.B. 74; for the proposition that a corporation will be considered the owner of an annuity if the annuity is subject to the general creditors of the corporation, the corporation can change the beneficiary of the policy and the beneficiary does not have the right to accelerate any payment or increase or decrease the amount of the annual payments specified.
You have asked for a clarification of the above ruling because of your concern that your knowledge of the existence or cost of the annuity might cause you to be in constructive receipt of that annuity.
Section 1.451-2(a) of the Income Tax Regulations provides that income although not actually reduced to a taxpayer’s possession is constructively received by him in the taxable year in which it is credited to his account, set apart for him or otherwise made available so that he may draw upon it at any time, or so that he could have drawn upon it during the taxable year if notice of intention to withdraw had been given.
Based on the language in section 1.451-2(a) of the regulations, the Service has consistently taken the position that knowledge is not determinative in deciding a question of constructive receipt, but that unqualified availability is decisive. Rev. Rul. 68-126, 1968-1 C.B. 194; Rev. Rul. 73-99, 1973-1 C.B. 412; Rev. Rul. 74-37, 1974-1`
Private Ruling 8333035 (continued)
C.B. 112; and Rev. Rul. 76-3, 1976-1 C.B. 114; all set forth conclusions consistent with this position.
Re. Rul. 74-37 takes the position that interest accruing in a Uniformed Services savings account subsequent to the time principal and interest on deposit exceeds $10,000 (at which time such interest may be withdrawn at request) is constructively received at that time since it is available within the meaning of section 1.451-2(a) of the regulations. There is no exception to this rule in the case of POW’s or MIA’s who would not be in a position to know of the triggering event.
Based on the information submitted in the original ruling request, we conclude that disclosure by defendant of the existence, cost, or present value of the annuity will not cause you to be in constructive receipt of the present value of the amount invested in the annuity.
This ruling is directed only to the taxpayer who requested it. Section 6110(j) (3) of the Code provides that it may not be used or cited as precedent.
A copy of this ruling should be attached to you tax return for the first taxable year in which those payment are received. We are enclosing a copy for this purpose.
In accordance with the power of attorney on file with us, a copy of this letter has been sent to your authorized representative.
Sincerely yours,
Anthony Manzanares, Jr.
Chief, Individual Income Tax Branch
Enclosures 2
Copy of this letter
Copy of section 6110 purposes
