Beyond Structured Settlements

Robert Wood and 468B Funds - 2

Robert W. Wood has written a new legal treatise titled "Qualified Settlement Funds and Section 468B" published as a tax portfolio by Tax Management Inc., a subsidiary of The Bureau of National Affairs, Inc. (BNA). Although Wood's new publication is part of Tax Management's U.S. Income portfolio library, copies of Wood's 468B portfolio can be purchased individually for $400.

Wood's new 468B treatise bears the same title and addresses the same subject matter as the 2009 legal textbook he wrote for the Tax Institute. S2KM reviewed Wood's 2009 468B textbook when it was first published ("Robert Wood and 468B Funds") and S2KM's earlier review is generally applicable to Wood's newer work. Wood's newer publication, however, is more condensed (64 pages plus worksheets and bibliographies) than his textbook. Wood's 468B portfolio also includes a comprehensive Table of Contents which makes the portfolio's content easy to navigate.

Wood's new 468B treatise features the same excellent analysis of the single claimant controversy as his earlier 468B textbook which S2KM summarized in reviewing Wood's textbook. In both publications, Wood's single claimant analysis addresses:

• What constitutes multiple claimants?
• Control and commissions
• Doctrine of constructive receipt
• Economic benefit doctrine
• Periodic payments to personal physical injury claimants

In the context of 468B distributions, Wood's two 468B publications also address:

• Structured settlement distributions
• Structuring attorney fees
• Taxable non-qualified structures

In addition to Wood's own work, two recent developments have supplemented and supported his single claimant analysis:

• The tax treatment of single-claimant 468B qualified settlement funds (QSFs) has been eliminated from the U.S. Treasury Priority Guidance Plan (see:"U.S. Treasury Priority Guidance Plan 2009-2010") underscoring Wood's observation: "there appears to be no authorities on the point one way or the other."
• Jeremy Babener's 2009 article "Structured Settlements and Single-Claimant Qualified Settlement Funds: Regulating in Accordance with Structured Settlement History" (see: "Jeremy Babener's QSF Paper") which:
  • Traces how far Congress and the IRS have eroded the original application of two tax doctrines, economic benefit and constructive receipt, to structured settlements; and
  • Recommends the United States Treasury eliminate any ambiguity about 468B single-claimant QSFs and allow such use consistent with existing structured settlement public policy and structured settlement tax law.

Significantly and unfortunately, the traditional structured settlement industry continues to avoid the topics of 468B QSFs and the single claimant controversy in its general education programs, despite:

• The importance and increasing use of 468B QSFs;
• The advantages 468B QSFs offer defendants, plaintiffs - and the U.S. Treasury;
• The availability of excellent 468B educators and educational resources.

As Wood points out in his 468B portfolio: much of the "hysteria" surrounding the single claimant controversy results from a structured settlement problem: control and commissions.

Rather than addressing 468B QSFs and the single claimant controversy openly and intelligently, the traditional structured settlement industry (in S2KM's opinion) has adopted a combative "protect and preserve" attitude. Not only does this "protect and preserve" attitude toward 468B QSFs represent a conflict with, and disservice to, the structured settlement industry's clients and customers, it also restricts necessary and meaningful discussion about how to improve and grow the structured settlement industry itself.

The Wood & Porter website provides a comprehensive list of books and articles written by Robert Wood.

Additional S2KM reporting and analysis about IRC 468B Qualified Settlement Funds:

• 468B Settlement Funds - Definitions
• Robert Wood QSF Interview
• Jeremy Babener Interview-2
• IRC 468B Funds Revisited - 3
• IRC 468B and 5891

MSAs and Liability Cases - 2

A prior S2KM blog post ("MSAs and Liability Cases") highlighted a challenging settlement planning priority: although no statutory or regulatory authority requires Medicare set-aside arrangements (MSAs) in third party liability settlements, confusion continues as to whether and when MSAs are necessary and/or appropriate for such cases.

In that earlier post, S2KM summarized recent recommendations for MSAs in liability cases issued by the National Academy of Elder Law Attorneys (NAELA) and the American Bar Association (ABA) respectively for special need attorneys (case specific) and the United States Congress (legislative).

A new article written by Peter Wayne offers advice to plaintiff attorneys about Medicare compliance in liability cases in the context of this statutory and regulatory uncertainty. Titled "Medicare Update: Information to Help with the Darkness of Medicare Compliance", Wayne's article was recently published in both the 2011 Winter Edition of the Arkansas Trial Lawyers Association's Docket and the NAELA Special Needs Law Section's Spring Newsletter.

While advising plaintiff attorneys, Wayne is sympathetic for defendants and liability insurers whom he characterizes as "hyper sensitive" to Medicare issues for two primary reasons:

• Dissemination of bad Medicare advice by attorneys, consultants and product providers who are positioned to benefit financially from uncertainty; and
• Continued extension by CMS of its enforcement deadline for liability claim reporting under the Medicare, Medicaid and SCHIP Extension Act of 2007 (MMSEA) now re-scheduled to begin the first quarter of 2012.

Wayne's article explains and differentiates current Medicare liability case compliance requirements for:

• "Conditional payments" (amounts paid by Medicare for injury related medical care between the time of injury and settlement) where several parties, including plaintiffs and defendants, run the risk of liability for failing to properly protect Medicare’s interest; and
• "Future interests" (using, for example, an MSA) where the plaintiff and plaintiff’s attorney are responsible, but not the defendant or its insurer.

Conditional Payments - Summary of Wayne's advice for plaintiff attorneys:

• Notify the Medicare Coordinator of Benefits Contractor (“COBC”) of the cause of action.
• Then COBC will assign the case to the Medicare Secondary Payer Recovery Contractor (“MSPRC”).
• Provide the required information along with a signed retainer agreement or proof of representation form.
• Then MSPRC will send the attorney a conditional payment summary within 60-90 days.
• Medicare will send a final demand once the MSPRC is notified of the final settlement and provided with the final settlement detail.
• Pay the final Medicare demand within 60 days of receipt in order to avoid incurring interest and penalties.

Wayne's article also highlights H.R. 4796, the Medicare Secondary Payer Enhancement Act, which proposes these improvements for conditional payments:

• Three year statute of limitations for Medicare to recover their conditional payments;
• Primary payer right of appeal;
• Eliminating the use of private information for MMSEA compliance;
• $5000 minimum threshold for all Medicare Secondary Payer (MSP) claims;
• Changing the MMSEA penalty provision from mandatory to discretionary;
• Simplifying the conditional payment process.

Future Interests - Summary of Wayne's advice for plaintiff attorneys:

• Unlike conditional payments, the obligation to satisfy Medicare’s future interests is solely the responsibility of the plaintiff and plaintiff’s attorney.
• CMS has not offered any definitive statements about whether MSAs are needed to account for future medical expenses in liability settlements.
• In workers compensation settlements, MSAs are simply CMS’ preferred methodology for protecting Medicare’s future interest and are not required by law.
• Section 111 of the MMSEA addresses reporting requirements and does not address or require MSAs.
• Circumstances where a plaintiff attorney should consider establishing an MSA or obtaining an objective third party opinion for a liability settlement:
  • If the liability settlement will create a permanent shift of the burden for paying for the Medicare beneficiary’s future injury‐related medical expenses from the liability insurance policy or plan to Medicare; and
  • The liability settlement provides a definitive allocation of settlement money to the plaintiff’s future injury‐related medical care.

For additional information about Medicare and structured settlements, see Section 15.03 of "Structured Settlements and Periodic Payment Judgments".

Death and Damages

Jeremy Babener has written a new tax article titled "Death and Damages Can be Taxing" which appears in the April 2011 issue of Trusts & Estates magazine. Written for estate planning professionals, Babener's article addresses both income and estate tax issues involved with lump sum and structured settlements.

Babener's article considers physical and emotional damages resulting from three categories of cases: wrongful death, survivor lawsuits, and pre-death causes of action. In addition to his tax analysis, Babener provides three instructive case examples plus practice tips, a summary table and extensive footnotes.

Babener's article re-affirms, from S2KM's perspective, several important settlement planning lessons:

• The complexity of settlement planning and the importance for many recipients of personal injury and wrongful death settlements to receive timely and related tax advice from tax professionals. Although Babener's audience consists of estate planning professionals who may not always contribute to case-specific pre-settlement planning, they may be called upon post-settlement to address income or estate tax problems created by a poorly planned settlement. Classic "red flag" structured settlement cases include large periodic payouts with long certain periods or large deferred lump sums.
• The importance, when planning settlements, to consider potential future tax changes including estate tax rates and/or the amounts of allowable estate tax exclusions and deductions. Recent estate tax exemptions that shelter extensive sums from any estate tax may not exist when current structured settlement recipients die with still-to-be paid periodic payments.
• The role of allocations in settlement tax planning and tax calculations. As one example, Babener discusses a wrongful death preceded by substantial pain and suffering related to the accident causing the death. Although proceeds from a wrongful death settlement are not subject to estate tax, proceeds related to the pain and suffering will be included in the decedent's estate and will be subject to a potential estate tax. In another example involving co-plaintiffs, Babener suggests naming the more injured party as the primary structured settlement payee and the less-(emotionally) injured plaintiff as contingent structured settlement beneficiary.
• The potential estate planning problems created by structured settlements including valuation of any periodic payments remaining when the primary payee dies and the potential lack of liquidity to pay estate taxes. Babener highlights a current judicial controversy potentially applicable to structured settlements related to Treasury regulations issued in 1995. These regulations provide that a "restricted beneficial interest subject to any contingency, power or other restriction" will be valued for estate tax purposes based on all facts and circumstances rather than by Treasury tables. Whether structured settlement payments are considered to be "restricted beneficial interests" (due to non-assignability clauses) becomes financially significant in calculating estate tax liability. Babener also points out the potential value or need for commutations or factoring transactions to pay estate taxes resulting from structured settlements.
• The risks for claimants and their attorneys in relying on non-tax professionals for settlement planning tax advice. This caveat was highlighted in Adrian v. Mesirow Financial Structured Settlements, a 2010 judicial decision (not mentioned in Babener's article) where a claimant alleged she was mislead by a defense broker about the favorable tax consequences of a structured settlement. In holding that the defense owed no duty to the claimant, the court found that the broker's education, certifications and years of experience related only to her work in life insurance and structured settlements and did not and should not suggest any expertise or special knowledge of tax law.

For additional tax and structured settlement articles by Jeremy Babener, see his Tax Structuring website and S2KM's structured settlement public policy wiki.

For additional information about the taxation of structured settlements, see Chapter 2 of "Structured Settlements and Periodic Payment Judgments" (S2P2J).

Deducting Punitive Damages

The income tax exemption provided in Section 104(a)(2) of the Internal Revenue Code for "any damages" received "on account of personal physical injuries or physical sickness" specifically excludes "punitive damages".

A separate but related issue: should defendants be able to deduct punitive damages on their tax returns?  Right now, they can. The benefit to defendants is obvious. What about plaintiffs?  Since the after-tax cost of every dollar paid is lower, should plaintiffs receive more?

Proposals to disallow the deduction have been made multiple times. The Clinton administration proposed it in the 1990s, and the Obama Administration has resurrected the idea. In response, several policy articles have been published debating the merits of allowing defendants to deduct punitive damages, and discussing alternative policies. SK2M asked Jeremy Babener, a 2010-11 NYU Tax Policy Fellow, to explain the tax issues involved and the arguments being made.

Introduction

As part of his 2010, 2011, and 2012 revenue proposals, President Obama proposed to end defendants’ ability to deduct punitive damages.

Currently, punitive damages incurred in connection with a defendant’s business are tax deductible. Consider a plaintiff’s request to a jury for $1 million in punitive damages. If the defendant can deduct the $1 million of damages against $1 million of income taxed at 35%, the true cost of the award to defendant is $650,000. Juries are sometimes informed of the tax consequences of damages, and sometimes not.

The Obama Administration argues that the deduction's effect of lowering the true cost to defendants “undermines the role of such damages in discouraging and penalizing certain undesirable actions or activities.”

Polsky and Markel

Gregg Polsky (University of North Carolina School of Law) and Dan Markel (Florida State University College of Law) argue in Taxing Punitive Damages that rather than changing tax law, juries should be informed of the tax consequences of damages. Thus, in the above example, a jury might award plaintiff $1.5 million, knowing that the after-tax cost to defendant would be $1 million. The effect of the Obama proposal, they posit, would likely be circumvented by settlements that allocate less to nondeductible punitive damages, and more to deductible compensatory damages. The IRS may find it difficult to identify and correct such improper settlement allocations.

Zelenak

Lawrence Zelenak (Duke University School of Law), in response to Polsky and Markel, makes two points. First, he suggests that while it might be better to end deductions for punitive portions of damage awards, punitive portions of settlements should remain deductible. Less than five percent of plaintiffs who go to trial are awarded punitive damages. Since it is impossible to identify which settling defendants would have been forced to pay punitive damages, and to determine the amount of such damages, Zelenak argues that punitive damage portions of settlements should be fully deductible.

Second, Zelenak argues that the Polsky and Markel solution ignores the deterrence role of punitive damages. In part, punitive damages are supposed to force a defendant to pay for the costs to injured parties who could not or would not bring legal action. If those injured parties had sued, the defendant would have been able to deduct the resulting compensatory damages. From a deterrence point of view, therefore, the defendant should be able to deduct the punitive damages paid to plaintiff that substitute for deductible compensatory damages. Zelenak writes that Polsky and Markel focused only on the punishment rationale for punitive damages, which suggests that a reduction in the true cost of punitive damages, via deductibility, reduces defendants' intended punishment. Of course, as Zelenak concludes, balancing the punishment and deterrence rationales of punitive damages is very difficult.

Mogin

Paul Mogin (Williams & Connolly, LLP), also in response to Polsky and Markel, argues three separate points. First, many courts prevent defendants from encouraging reductions in damage awards by either informing juries when plaintiffs will receive damages tax-free, or by introducing evidence of a plaintiff’s previous reimbursement for economic losses. Therefore, Mogin writes, allowing plaintiff to introduce defendant’s ability to deduct punitive damages would create a “pro-plaintiff imbalance.”

Second, Mogin asserts that providing juries with additional encouragement to increase punitive damages would exacerbate juries’ already distorted pro-plaintiff perception of corporate defendants. While evidence of a defendant’s wealth is generally inadmissible in court, the rule does not typically hold for punitive damages. The U.S. Supreme Court has recognized that the presentation of a defendant’s wealth “creates the potential that juries will use their verdicts to express biases against big business.” Thus, Mogin argues, juries should not be further encouraged to increase punitive damages awards.

Third, Mogin criticizes Polsky and Markel for elevating the jury’s assessment of punitive damages above its rightful place. Historically, judges have reduced or set aside unduly harsh punitive damages. Moreover, while the jury’s role is one of fact-finder, the measure of punitive damages is hardly factual. Why then should it be so important that the true cost of defendant’s damages are exactly equal to the amount the jury intended?

There's Always More

Several other papers have been written on disallowing defendant deductions for punitive damages, including a 2010 article published by the Heritage Foundation, and a 2001 report by the New York State Bar Association.

Jeremy Babener's articles on the taxation of personal injury damages and structured settlements are available at TaxStructuring.Com. Babener is a 2010-11 NYU Tax Policy Fellow. Having worked for the U.S. Department of the Treasury's Office of Tax Policy in the Fall of 2010, he will graduate from NYU School of Law's Graduate Tax Program this Spring.

For additional information about Internal Revenue Code Section 104(a)(2), punitive damages and the allocation of damages for tax purposes, see section 2.03 of "Structured Settlements and Periodic Payment Judgments".

S2P2J Release 49

Publisher American Lawyer Media (ALM) has announced May 1, 2011 as the distribution date for Release 49 of "Structured Settlements and Periodic Payment Judgments" (S2P2J). First published in 1986, S2P2J is co-authored and updated semi-annually by Daniel W. Hindert, Joseph J. Dehner and Patrick J. Hindert. Both the National Structured Settlement Trade Association (NSSTA) and the Society of Settlement Planners (SSP) utilize S2P2J as an educational resource for their certification programs.

S2P2J Release 49 Highlights

• Expanded guidance on Medicare reimbursement procedures including:
  • A new section on how the Medicare Secondary Payer rules affect plaintiffs, defendants, plaintiffs’ attorneys and insurers; and
  • How each such case participant can comply with increasing government efforts to recoup prior payments from settlements.
• How allocations in settlement agreements affect a claimant's tax treatment.
• Structured settlement tax decisions in recent cases including:
  • No-fault;
  • Emotional distress; and
  • Wrongful incarceration.
• How the Gramm-Leach-Bliley Act privacy rules impact the structured settlement process.
• Discoverability of claimant Social Security numbers
• Impact of structured settlement tax and timing issues on potential legal liability for;
  • Defense and plaintiff attorneys; and
  • Structured settlement consultants.
• How inadequate beneficiary designations create subsequent legal disputes.
• Whether an arbitration award can be converted to a periodic payment judgment.
• Qualifying annuitists as expert witnesses.
• Impact of anti-assignment provisions in:
  • Workers compensation cases; and
  • U.S. government as defendant cases.
• Recent secondary market judicial decisions:
  • Rejecting transfers of structured settlement payment rights for failure to meet the "best interest" test; and
  • Approving the sale of payment rights in a payee’s bankruptcy.
• How structured settlement payment rights are treated in bankruptcy, child support, marital asset and minor cases.
• New structured settlement and periodic payment developments in Ireland, Canada, New Zealand and the United Kingdom.

For highlights from past releases of "Structured Settlements and Periodic Payment Judgments", see S2KM's structured settlement wiki.