Source: http://www.legalexaminer.com/miscellaneous/part-3-ethical-issues-at-settlement-protecting-the-injury-victim-client/
Timestamp: 2017-08-22 11:12:28
Document Index: 748565598

Matched Legal Cases: ['art 3', '§ 104', '§ 222', '§5891', '§ 4007', '§5891']

Part 3: Ethical Issues at Settlement – Protecting the Injury Victim Client | Legal Examiner Voices
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Section 104(a)(2) of the Internal Revenue Code
When any physical injury victim recovers money either by settlement or by verdict, the question of the tax treatment of that recovery arises. As long as it is compensation for personal physical injuries it is tax-free under Section 104(a)(2) of the Internal Revenue Code.[1] Section 104(a)(2) of the Internal Revenue Code states that “gross income does not include . . . the amount of any damages received (whether by suit or agreement and whether as lump sums or as periodic payments) on account of personal injuries or sickness.”[2] Section 104(a)(2) gives the personal injury victim two different financial options for their recovery, lump sum or periodic payments.[3]
The first option is to take all of the personal injury recovery in a single lump sum. If this option is selected, the lump sum is not taxable, but once invested, the gains become taxable and the receipt of the money will impact his or her ability to receive public assistance.[4] A lump sum recovery does not provide any spendthrift protection and leaves the recovery at risk for creditor claims, judgments and wasting.[5] The personal injury victim has the burden of managing the money to provide for their future needs be it wage loss or future medical. The second option is receiving “periodic payments” known as a structured settlement[6] instead of a single lump sum payment. A structured settlement’s investment gains are never taxed[7], it offers spendthrift protection[8] and the money has enhanced protection against creditor claims as well as judgments. [9] A structured settlement recipient can avoid disqualification from public assistance when a structure settlement is used in conjunction with the appropriate trust.
Creditor and Judgment Protection of Annuities
Oftentimes the protection that structured settlement annuities are afforded under the law in terms of judgments and creditor claims is overlooked when analyzing whether to implement one for a personal injury recovery. However, this feature is very important for injury victims who need to protect their recovery. Injury victims only get one opportunity to recover for their injuries. If someone who recovers for their injuries is subsequently involved in an accident where they injure someone else or someone is injured on their property, bank accounts and most investments are exposed to claims. In addition, if an injury victim gets into debt and has creditors making claims, their settlement related assets could be exposed to these claims.
However, many states have either common law or statutes that protect annuities from legal process. For example, in my home state of Florida there is a statute[10] that completely exempts annuities from creditors and judgments. This statute gives injury victims nearly complete protection of their settlement proceeds from judgments or creditor claims by entering into a structured settlement annuity as part of their settlement. That statute has been interpreted by Florida courts[11] to defeat judgment creditor claims against structured settlement annuities including bankruptcy creditors.
In addition, structured settlements offer enhanced protection in case of divorce or bankruptcy. Structured settlements are not owned by the injury victim. Instead, the injury victim is the payee and the life insurance company’s assignment company owns the annuity. When a structured settlement is created as part of a settlement an assignment is done. The assignment is done to transfer ownership of the annuity from the purchaser, the defendant, to the life company assignment corporation. The assignment corporation takes on the obligation to make the future periodic payments and purchases an annuity from the annuity issuer. Because of this legal arrangement, structured settlement annuities are not an asset owned by an injury victim. Consequently, it is not an asset that can generally be divided in the case of divorce.[12] The income that it produces can be considered in determining alimony, but the asset itself usually is not divided.[13] Similarly, a structured settlement annuity is not an asset generally reachable in cases of bankruptcy.[14]
State Structured Settlement Protection Acts & Section 5891 of the IRC
After the advent of the “factoring” industry in the early 1990s, nearly every state has passed a structured settlement protection act. The acts protect structured settlement recipients from unscrupulous companies that purchase structured settlements. “Factoring” companies, the name commonly used for companies that purchase structured settlements, buy injury victim’s payment streams in return for a lump sum payment to the injury victim. The lump sum payment to the injury victim for their future periodic structured settlement annuity payments is typically at a sharp discount with some discount rates being patently unfair.[15] Given the unsophisticated population selling structured settlements, the amount of advertising by factoring companies and past abuses by factoring companies, many states have enacted Structured Settlement Protection Acts and the Federal government decided to enact protective legislation in the form of Section 5891[16] of the Internal Revenue Code.
Section 5891 of the Internal Revenue Code requires that all structured settlement factoring transactions be approved by a state court, in accordance with a qualified state statute. Qualified state statutes must make certain baseline findings, including that the transfer is in the best interest of the seller, taking into account the welfare and support of any dependents. Failure to comply with these procedures results in the factoring company paying a punitive excise tax of 40% on the difference between the value of the future payments sold and the amount paid to the person who wanted to sell.
State legislatures began enacting protective legislation, called Structured Settlement Protection Acts, for structured settlements in 1997[17]. While the state Structured Settlement Protection Acts vary, they are based on a model act and most contain similar provisions. All of the acts mandate court approval of any proposed sale with a best interests finding, most impose numerous procedural requirements and call for full disclosure of the terms of the transaction. A New York case denied a petition for approval of a “factoring” transaction under the state’s structured settlement protection act because of the unfair nature of the deal, lack of a plan for the lump sum to be received and it did not serve the payee’s best interests.[18] Judge Alice Schlesinger explained, in denying the approval of the sale, that “[t]he Act, similar to others nationwide, was designed ‘to protect the recipients of long-term structured settlements from being victimized by companies aggressively seeking the acquisition of their rights’.”
Other courts that have interpreted the various state acts have found that they are “designed to protect beneficiaries of structured settlements from being taken advantage of by others.”[19] The best interests’ standard was described by a Pennsylvania court as admitting “the reality that a person’s judgment is often clouded by the lure of quick cash; and insures that the public policy considerations involving structured settlements are not usurped by organizations that lure people into assigning future payments for far less than their actual value.”[20] Similarly, cases have held the structured settlement payment acts prevent garnishment of a structured settlement annuity. In a Pennsylvania case, the court held that a creditor’s alleged security interest and garnishment of a structured settlement annuity violated the state’s Structured Settlement Protection Act.[21] In interpreting the Pennsylvania Structured Settlement Protection Act, the court determined that garnishment was encompassed by the broad meaning of the word “transfer” in the act.
Another important note is anti-assignment provisions found in many structured settlement agreements. Most settlement releases of tort claims where a structured settlement will be implemented contain an anti-assignment provision. This provision typically states that “the periodic payments cannot be accelerated, deferred, increased or decreased by claimant or any payee; nor shall claimant or any payee have the power to sell, mortgage, encumber, or anticipate the periodic payments, or any part thereof, by assignment or otherwise.” Most state courts have held that the common law and contract rights relating to these provisions are not superseded by enactment of Structured Settlement Protection Acts.[22] Accordingly, courts have blocked the sale of structured settlements even though they complied with the state act because it would be barred by the anti-assignment clause found in the settlement documents.[23] There is model language that can be inserted into a settlement agreement that would allow for factoring, if desired, but requiring it comply with IRC 5891 and relevant state Structured Settlement Protection Acts.[24]
Most states impose fines and provide civil remedies for failure to comply with the state Structured Settlement Protection Act. Some deem a violation of the statute as a violation of the Unfair Trade Practices and Consumer Protection Law.[25] In addition, there is the 40% excise tax imposed by IRC 5891 for failure to comply with the state Structured Settlement Protection Act.[26] The Structured Settlement Protection Acts provide significant protections for structured settlement recipients against factoring transactions and have in some instances prevented the sale of a structured settlement completely. These laws are a further protection of structured settlement recipients and illustrate the government’s recognition of their value to injury victims.
[5] Unlike a structured settlement, simply receiving a lump sum does not provide any spendthrift protection as the money can be dissipated rapidly. Similarly, there is no protection from creditor claims like a structured settlement enjoys.
[6] A structured settlement is a single premium fixed annuity used to provide future periodic payments to personal physical injury victims. The interest earned is not taxable under Section 104(a)(2) and a series of revenue rulings that provide the basis for structured settlements.
[7] See I.R.C. § 104(a)(2) (2007). See also Rev. Rul. 79-220 (1979) (holding recipient may exclude the full amount of the single premium annuity payments received as part of a personal injury settlement from gross income under section 104(a)(2) of the code).
[8] Structured settlements can’t be accelerated, deferred, anticipated or encumbered. The payments are made pursuant to the terms of the contract with the life insurance company. Thus a personal injury victim is protected from spending the money too quickly. However, there are “factoring” companies that will purchase structured settlement annuities and provide a lump sum payment. These transactions are now regulated by IRC 5891 and many states have enacted provisions to protect structured settlement recipients from unfair transactions. IRC 5891 requires a finding that the sale is in the best interest of the annuitant and requires judicial approval. IRC 5891
[9] Many states offer protection by statute for annuities. For example, in Florida, the Florida Statutes provide annuities immunity from legal process as long as they are not set up to defraud creditors. See generally § 222.14 Fla. Stat.
[10] Florida Statute 222.14 – Exemption of cash surrender value of life insurance policies and annuity contracts from legal process: The cash surrender values of life insurance policies issued upon the lives of citizens or residents of the state and the proceeds of annuity contracts issued to citizens or residents of the state, upon whatever form, shall not in any case be liable to attachment, garnishment or legal process in favor of any creditor of the person whose life is so insured or of any creditor of the person who is the beneficiary of such annuity contract, unless the insurance policy or annuity contract was effected for the benefit of such creditor.
[11] See Windsor-Thomas Group Inc. v. Parker, 782 So.2d 478 (Fla. 2d DCA 2001). Judgment creditor brought action to garnish annuity that funded structured settlement of tort case in favor of the judgment debtor. The issuer moved to quash the writ based on the statutory prohibition that annuity contracts are not liable to attachment, garnishment, or legal process in favor of any creditor. The Circuit Court dissolved the writ. Creditor appealed. The District Court of Appeal held that the issuer had standing to raise the statutory prohibition against garnishment.
[12] See generally Krebs v. Krebs, 435 N.W.2d 240 (Wis. 1989)
[13] See generally Ihlenfeldt v. Ihlenfeldt, 549 N.W.2d 791 (Wis. App. 1996)
[14] See In re McCollam, 612 So.2d 572 (Fla. 1993). Annuity was exempt under Florida Statute 222.14 from creditor claims in bankruptcy action. See also In re Orso, 283 F.3d 686 (5th Cir. 2002) (holding structured settlement “annuity contracts under which payments were owed came within scope of Louisiana statute exempting such contracts from the claims of creditors”); In re Belue, 238 B.R. 218 (S.D. Fla. 1999) (holding “debtor who was named, as payee and intended beneficiary, under annuity purchased by insurance company to fund its obligations under structured settlement agreement was entitled to claim annuity payments as exempt under special Florida exemption for proceeds of any annuity contracts issued to citizens or residents of state . . . .”); In re Alexander, 227 B.R. 658 (N.D. TX 1998) (holding structured settlement annuity paid to debtors following the death of their children in automobile accident was entitled to exemption as an annuity under Texas law).
[15] See J.G. Wentworth S.S.C. v. Jones, Jefferson Cty., S.W.3d 309, 315 (Ky. Ct. App. 2000) (“[i]n the four cases here the rate of return to Wentworth varied between 36 and 68 percent per year”); Windsor-Thomas Group Inc. v. Parker, 782 So.2d 478 (Fla. 2d DCA 2001) (finding that from “a functional viewpoint, this agreement is a secured promissory note with an annual interest rate of approximately 100 percent.”).
[16] 26 U.S.C. §5891
[17] Illinois was the first state to enact a structured settlement protection act. Hindert & Ulman, Transfers of Structured Settlement Payment Rights: What Judges Should Know About Structured Settlement Protection Acts, 44 NO. 2 Judges’ J. 19 (2005).
[18] Petition of 321 Henderson Receivables, L.P. V. Martinez, 816 N.Y.S.2d 298 (2006) (holding “proposed sale of payee’s structured settlement payments was not fair and reasonable and did not serve best interest of payee, and thus could not be approved pursuant to Structured Settlement Protection Act”).
[19] In re Benninger, 357 B.R. 337 (Bankr. WD. Pa. 2006).
[20] In re Hilton, No. 2005-2721, 2005 WL 4171289, 2005 Pa. Dist. & Cnty. Dec. LEXIS 392 (2005).
[21] In re Benninger, 357 B.R. 337 (Bankr. WD. Pa. 2006).
[22] See generally Rapid Settlements, Ltd. v. Dickerson, 941 So.2d 1275 (Fla 4th DCA 2006) (holding assignment of payments was prohibited under settlement agreement); Bobbitt v. Safeco Assigned Benefits Service Co., 25 Conn. L. Rptr. 324, 41 U.C.C. Rep. Serv. 2d 942 (Conn. Super. Ct. 1999) (holding Structured Settlement Protection Act did not abrogate the anti-assignment provision in the release and enforcing anti-assignment provision); In re Foreman, 365 Ill. App. 3d 608, 302 Ill. Dec. 950, 850 N.E.2d 387 (2d Dist. 2006) (rejecting a petition by factoring company under the Illinois Structured Settlement Protection Act for court approval of factoring transaction and holding anti-assignment provision in release prohibited transaction).
[24] Suggested model language is as follows: “None of the Periodic Payments and no rights to or interest in any of the Periodic Payments (all of the foregoing being hereinafter collectively referred to as “Payment Rights”) can be accelerated, deferred, increased or decreased by any recipient of any of the Periodic Payments; or sold, assigned, pledged, hypothecated or otherwise transferred or encumbered, either directly or indirectly, unless such sale, assignment, pledge, hypothecation or other transfer or encumbrance (any such transaction being hereinafter referred to as a “Transfer”) has been approved in advance in a “Qualified Order” as defined in Section 5891(b)(2) of the Code (a “Qualified Order”) and otherwise complies with applicable state law, including without limitation any applicable state structured settlement protection statute. No Claimant or Successor Payee shall have the power to effect any Transfer of Payment Rights except as provided in sub-paragraph (ii) above, and any other purported Transfer of Payment Rights shall be wholly void. If Payment Rights under this Agreement become the subject of a Transfer approved in accordance with sub-paragraph (ii) above the rights of any direct or indirect transferee of such Transfer shall be subject to the terms of this Agreement and any defense or claim in recoupment arising hereunder.”
[25] See 40 P.S. § 4007 (P.A. 2000)
[26] 26 U.S.C. §5891