Voices at the 104(a)(2) Treasury Hearing

By Jeremy Babener, S2KM Contributing Author

Yesterday, February 23, 2010, the Treasury conducted a hearing on proposed regulations to section 104 of the Tax Code. This article summarizes the hearing, as relevant to parties in the structured settlement industry.

As written previously, the proposed regulations would, in essence:

• Eliminate the requirement that damages be based on “tort or tort type rights” in order to qualify for the section 104(a)(2) tax exclusion, and
• Incorporate 1996 legislation requiring that personal injuries and sickness damages be “physical” in order to qualify for the section 104(a)(2) exclusion.

The Treasury received several written submissions from the structured settlement community, including letters from:

• Joseph Ricci, Executive Director, National Structured Settlements Trade Association (NSSTA)
• John Stanton, Counsel, NSSTA
• John McCulloch, Vice-President, Integrated Financial Settlements
• Dick Risk, Attorney, Risk Law Firm
• David Higgins, Attorney, Higgins Settlement Law
• Jack Meligan, President, Settlement Professionals Inc.

McCulloch, Stanton, Risk, and Meligan spoke at the Treasury hearing. As in their written submissions, the speakers focused on two questions. First, when do personal injury damages constitute “physical” injury damages, such that they may be excluded from plaintiffs’ taxable income? Second, can settlement monies be directed into qualified settlement funds (QSFs) in single-claimant cases without triggering economic benefit? If so, the structured settlement tax subsidy would be available to settlements involving single-claimant QSFs.

Of the five speakers (including one from the Consumers for Civil Justice who spoke briefly), only McCulloch focused on the “physical” issue, while the other three argued single-claimant QSFs.

John McCulloch:
McCulloch argued that the damages received by victims of prolonged sexual abuse or false imprisonment should always be deemed “physical,” whether or not evidence is available to demonstrate physical injury. This would, he argued, appropriately expand the “observable bodily harm” understanding of “physical” from private letter ruling in 2000. His arguments, which mirrored those in his written submission, were previously reviewed here.

Treasury Panel Response:
The panel queried McCulloch on both substantive and procedural grounds. McCulloch was asked whether his rule would define sexual abuse and wrongful imprisonment as “physical,” or establish an irrebuttable presumption that such damages are “physical.” Very likely, the question was asked with a 2008 private letter ruling in mind, which presumed physicality where the injury took place long ago. McCulloch suggested that neither sexual abuse nor wrongful imprisonment cases should be considered non-physical.

It is noteworthy that two of the panel members stressed the non-precedential nature of private letter rulings. While private letter rulings are certainly non-precedential, the panel seemed to imply that the “observable bodily harm” language from the 2000 private letter ruling is simply irrelevant for future interpretations of “physical.”

The panel also asked McCulloch a procedural question, one repeated in the single-claimant QSF discussion: Even if Treasury agrees, could it change the proposed regulations without being forced to conduct another notice and comment hearing?

Dick Risk and Jack Meligan:
Dick Risk and Jack Meligan both recommended that the Treasury issue regulations explicitly holding the economic benefit doctrine not to be triggered in the context of single-claimant QSFs. Each argued that such regulations are necessary as a result of the power imbalance in plaintiff-defendant negotiations.

Treasury Panel Response:
It became immediately apparent that the panel believed regulations concerning the single-claimant QSF issue could not be added to the proposed regulations without necessitating a new notice and comment period. It seemed implicit in the panel’s comments that the appropriate time to request regulations on the QSF issue would be the next time that taxpayers are asked for proposed issues. When asked why the issue had been removed after several years on the IRS Priority Guidance Plan, those on the panel declined to respond.

One member of the panel was particularly interested in the need for single-claimant QSF guidance based on the alleged power imbalance in plaintiff-defendant negotiations. Why, Risk was asked, is guidance necessary to establish a balance if single-claimant QSFs are already occurring? Moreover, how, since most plaintiffs have representation with knowledge of structured settlements, is there still an imbalance? Risk and Meligan both suggested that this imbalance is inherent in personal injury settlement negotiations, unless the defendant can be removed from the scene and replaced with a QSF.

John Stanton:
Stanton briefly repeated the procedural point of those on the panel that the current hearing was the wrong time and place for the single-claimant QSF issue to be discussed. He also urged that since current tax law of structured settlements has served all parties well, the Treasury should not make changes on the QSF front. The Treasury had no comments or questions for Stanton.

Series Note:
This article is the third in a series on the February 23, 2010 Treasury hearing on proposed regulations concerning section 104.

• Part 1: Treasury Hearing on IRC 104 Regulations
• Part 2: A Common Cause at the Treasury Regulation Hearing

S2KM Footnote:

• Jeremy Babener and S2KM Limited have agreed to feature occasional articles written by Babener on S2KM's blog. Except for articles including Jeremy Babener's byline or interviews featuring Babener, he does not contribute to or endorse S2KM opinions or writing.
• Babener's articles also appear on S2KM's structured settlement public policy wiki.
• Babener is a third year law student at NYU School of Law, and has written extensively about structured settlements (articles available at TaxStructuring.Com).