Since first meeting Jeremy Babener at the SSP 2009 Annual Meeting, S2KM has reviewed, analyzed and featured his writing about structured settlements. For prior S2KM blog posts about Jeremy Babener and his structured settlement writing, see S2KM's structured settlement public policy wiki.
S2KM published an advanced summary ("Babener Proposes Expanded S2 Tax Subsidy") of Babener's most recent structured settlement article (titled "Expanding the Structured Settlement Tax Exclusion") which is featured in this week's edition of Tax Notes. The article also appears on Babener's website TaxStructuring.com. Babener has granted S2KM the following exclusive interview about his most recent article.
S2KM: Greetings Jeremy. Our first and only prior S2KM interview (Jeremy Babener Interview) was published June 23, 2009 and highlighted your research about dissipation studies. What structured settlement articles have you written since your dissipation paper?
Jeremy Babener: I have written
several articles since. The first provided context when the Treasury removed the
single-claimant qualified settlement fund issue from their Priority
Guidance Plan. The second discussed a Treasury hearing on Section
104(a)(2) regulations focused on the different tax treatment for
physical and non-physical damages, as well as a recent proposal to
eliminate the distinction by the National Taxpayer Advocate. The third, a longer law journal article, provides the
history of the structured settlement and factoring industries, and makes
the public policy argument in favor of Treasury regulations for
single-claimant qualified settlement funds. This most recent piece introduces the possibility of
converting the structured settlement tax exclusion into a tax credit.
S2KM: What reactions have you received to your structured settlement
writing?
Jeremy Babener: I have enjoyed
receiving feedback from industry practitioners. Many have contacted me
with questions, which I am happy to discuss. In terms of recommendations
that I have and am making, while I have received a lot of positive
responses, the question is whether those with decision-making powers will
consider them.
S2KM: Let's talk about your most recent article. What is the title
and where and when was it published?
Jeremy Babener: It is titled, "Expanding the Structured Settlement Tax Exclusion," and was published on April 19th in Tax Notes.
S2KM: Who is your target audience and why should they read your most recent article?
Jeremy Babener: The article is aimed at legislators and those interested in affecting structured settlement policy. It is meant to restructure the 1982 legislation that established the current tax exclusion to better accomplish the purpose of the 1982 Congress. Of course, those in the structured settlement industry are the more practical audience. They would economically benefit from the proposal and are therefore the likeliest group to be interested.
S2KM: What is your core message?
Jeremy Babener: My article focuses on who benefits from the structured settlement exclusion. Like all exclusions, it is of little use to those who, even without the exclusion, would incur no taxable income. The article suggests that a uniform refundable tax credit for structured settlements, or a financial supplement to structured settlement recipients with less income, might better accomplish Congress’ purpose of discouraging premature and inappropriate dissipation.
S2KM: What is the difference between an exclusion and a credit?
Jeremy Babener: Let's say that my
taxable income is $100,000, and that I have a 50% tax rate. That means
that I pay $50,000 in taxes. A $1,000 exclusion reduces my taxable
income to $99,000, and thus I pay $49,500 in taxes. As you can see, the
$1,000 exclusion was only worth $500 to me. Tax credits, quite
differently, are generally "dollar for dollar." This means that a $1,000
tax credit actually reduces my taxes, not my taxable income, by $1,000.
Thus, I would pay $49,000 after the tax credit, rather than $49,500
after the tax exclusion. Of course, someone with a lower tax rate, such
as 10% will get even less out of a tax exclusion. For them an exclusion
would be worth $100, as opposed to $500 for someone with a rate of 50%.
A refundable tax credit provides the value of the tax credit to
someone whether or not they have any tax liability. Thus, $100 of
tax credit to someone with no tax liability results in a $100 check
from the government. A uniform refundable tax credit provides the
same value to all, regardless of tax brackets. Thus, everyone might
subtract the same $100 tax credit from their tax liability. A person who
owes $50,000 in taxes would subsequently owe $49,900. A person who owes
nothing in taxes receives a $100 check from the government ($100 in
"negative taxes").
S2KM: Who gets the most out of the structured settlement exclusion,
and who gets the least?
Jeremy Babener: Those who generate sufficient income after a settlement to place them in the highest tax-bracket get the most out of the exclusion. As illustrated above, the higher one's tax rate is, the more one gets out of an exclusion. Those who have no tax liability do not benefit at all from the exclusion.
S2KM: Recent estimates state that 47 percent of potentially eligible U.S. taxpayers pay no federal income tax. Is that statistic accurate and, if so, how does that statistic impact your proposal?
Jeremy Babener: Yes. The Tax
Policy Center found this to be the case. We do not
know how many personal injury victims pay no federal income tax, but
since injury often makes work difficult, I would guess that the
percentage would be even higher. That means that the current tax
exclusion may fail to incentivize half or more of those who could choose
to structure, providing them with no economic benefit for doing so.
S2KM: Why does it matter that some structured settlement recipients get more out of the exclusion than others?
Jeremy Babener: The purpose of the exclusion is to prevent premature and inappropriate dissipation of lump sum settlements. Unless Congress believes that such dissipation is more likely among plaintiffs earning higher incomes after their settlements, which seems unlikely, the exclusion’s design is not economically efficient.
S2KM: Should we be particularly concerned that potential structured settlement recipients expecting lower incomes have a weaker incentive to structure?
Jeremy Babener: Probably. We do not have proven data on this, but it seems likely that those with lower income are those more likely to dissipate. A low income after settlement might result from a debilitating injury and high injury-related expenses. It would seem that persons in such a situation are more likely to need every last cent of their settlement compensation because they may not be able to make up for dissipation by working more. Thus, they may be the most likely people to end up requiring government assistance as a result of dissipating.
S2KM: How could the exclusion be modified to incentivise potential structured settlement recipients expecting lower incomes?
Jeremy Babener: If Congress wishes to incentivise all potential structured settlement recipients equally, the exclusion could be turned into a uniform refundable tax credit. Such a credit would provide the same amount of value, whether by reducing tax liability or providing a tax refund, to all structured settlement recipients.
S2KM: If those earning a lower income are more likely to dissipate, why should we not just direct the structured settlement subsidy to them?
Jeremy Babener: Congress could do just that. But, there are reasons not to at this time. First of all, we do not have proven evidence on the matter. Economic literature posits that when we lack such evidence, it is most economically efficient to incentivise all equally. Secondly, not everyone knows what they will be making after a settlement. Since the exclusion is meant to encourage a particular decision at the time of settlement, it may be best to guarantee the benefit to all potential structured settlement recipients.
S2KM: Who would win and who would lose if Congress goes with a uniform tax credit?
Jeremy Babener: Clearly, those who could take advantage of the structured settlement exclusion, who could not before, would benefit. The “loser,” if there is one, depends on the structure of the credit. The tax credit would cost the government, just as the current exclusion does. Since the benefit would go to more people under this proposal, Congress would have to decide whether to allow an increase in lost revenue, or decrease the benefit to potential structured settlement recipients. Of course, allowing an increase in lost revenue may save the government from future increases in government assistance payments due to dissipation.
S2KM: What are you hoping to accomplish by writing this article?
Jeremy Babener: The article is not a sophisticated and ready-to-go proposal for Congress. It introduces an idea that I hope the structured settlement industry will take on and make its own. An expansion of the exclusion could benefit plaintiffs (by increasing their settlement value), defendants (by decreasing their settlement cost), brokers (who will earn more commissions), and insurance companies (who will increase annuity sales). I encourage the National Structured Settlements Trade Association (NSSTA) and the Society of Settlement Planners (SSP) to consider the proposal in the future. In fact, even the National Association of Settlement Purchasers (NASP) might weigh in, as the secondary market would be impacted by such a policy change. When the entire structured settlement industry stands to gain, these three associations should work together to further their mutual interests.
S2KM: Given your previous finding that no empirical data has proven that 90% of lump sum plaintiffs dissipate their money in five years, why would you recommend an expansion of a tax exclusion meant to prevent dissipation?
Jeremy Babener: In my research I found that the many citations to statistical findings of dissipation are not substantiated. However, I have also spoken with many in the industry. The anecdotal evidence certainly exists. It is the responsibility and prerogative of Congress to decide how much evidence is needed to legislate, and this was certainly not the first or last time that anecdotal evidence was relied upon for that purpose. My recommendation for a uniform refundable tax credit is meant to better accomplish Congress' goal.
S2KM: As a participant in the upcoming SSP tax panel (May 3 - Washington, D.C.), what tax issues interest you the most about structured settlements and personal injury settlement consulting?
Jeremy Babener: Clearly, I am interested in reactions to this proposal. Among other issues, I am also very interested to discuss the National Taxpayer Advocate's proposal to eliminate the difference in tax treatment between physical and non-physical injury. Currently, the proposal does not take the purpose of the structured settlement exclusion into account. The Advocate's proposal seeks to repeal the 1996 amendment to Section 104(a)(2) limiting the favorable tax treatment of damages to those received on account of "personal physical injury or physical sickness," rather than simply "personal injury or sickness." Unfortunately, the proposal does not seek to repeal the amendment to Section 130 in the Tax Reform Act of 1986 limiting the favorable tax treatment for structured settlement assignment companies to cases "involving physical injury or physical sickness." Thus, while the purpose of the Advocate's proposal is consistent with bringing non-physical damages back into the structured settlement tax-favored fold, it does not.
For prior S2KM blog posts directly or indirectly related to Jeremy Babener, see:
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