Beyond Structured Settlements

Expanding Section 104(a)(2)'s Tax Exclusion

In a 2010 article titled "How Plaintiffs Might Receive Emotional Distress Damages Tax-Free After 2010", published in the "North Carolina Lawyers Weekly", Jeremy Babener asked a pointed and strategic question: how can the structured settlement industry encourage more damages to be received tax-free? Doing so, presumably, would expand the structured settlement market.

Several proposals to accomplish these objectives have been offered during the past few months - some of which resulted from a U.S. Department of the Treasury public hearing held on February 23, 2010 to consider proposed new Treasury regulations for IRC section 104(a)(2). If adopted, these proposed new Treasury regulations would make two primary changes to current regulations: 

• 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.

In the context of these proposed new Treasury regulations, the structured settlement industry would benefit from greater discussion and a better understanding of the following recent tax proposals to expand application of the section 104(a)(2) tax exclusion:

• The National Taxpayer Advocate, which considers taxpayer considerations from inside the IRS, has recommended that section 104(a)(2) exempt non-physical damages, specifically emotional distress, mental anguish, and pain and suffering.
• John McCulloch proposed, during the February 23, 2010 public Treasury hearing, that damages received by victims of prolonged sexual abuse or false imprisonment should always be deemed “physical” for purposes of IRC section 104(a)(2) whether or not evidence is available to demonstrate physical injury.
• Richard Risk and Jack Meligan each recommended, during the same public hearing, that Treasury issue regulations explicitly holding the economic benefit doctrine will not be triggered in the context of single-claimant 468B Qualified Settlement Funds.
• David Higgins has proposed two recent tax recommendations. In a written submission for the Treasury public hearing, Higgins argued that the IRS’ definition of "physical" is inadequate: “direct unwanted or uninvited physical contacts resulting in observable bodily harm such as bruises, cuts, swelling, and bleeding.” Higgins recommends a broader definition, including damages for:
  • A doctor’s misdiagnosis resulting in death or serious injury from delayed or missing treatment;
  • Child neglect resulting in starvation or illness;
  • Rape committed under threat of bodily harm; and
  • Other situations where traditional physical injury torts occur without unwanted or uninvited physical contact or observable bodily harm.
• Higgins directed his second recommendation to Senator Max Baucus (Chairman of the Senate Finance Committee), Congressman Dave Camp (Chairman of the House Committee on Ways and Means), and Michael Mundaca (Assistant Secretary of the Treasury for Tax Policy). In his communication, Higgins recommended a "rollover provision" to replace Section 130 of the Tax Code. Higgins' proposal would allow personal injury plaintiffs to accept a check from defendants and invest the money within a given period (likely limiting the investment options to annuities and Treasury bonds), without losing the tax benefit currently available to them only by agreeing to a structured settlement with a counter-party.
• Jeremy Babener has proposed a legislative conversion of the structured settlement exclusion to a refundable tax credit. The premise of Babener's proposal is that high-income taxpayers benefit more from the structured settlement subsidy than low-income taxpayers, who sometimes do not benefit at all. A refundable tax credit would provide the same incentive value to all structured settlement recipients, high-income or low-income.

Most recently, McCulloch has incorporated his earlier recommendations into a request to Treasury and the IRS that final regulations under IRC Section 104(a)(2) should clarify the scope of the exclusion for damages received on account of personal "physical" injuries or "physical" sickness. McCulloch's request seeks guidance and a determination as part of Treasury's 2011-2012 Guidance Priority List that sexual abuse cases and long-term wrongful incarceration (at least one year of restraint) are per se physical injuries under Section 104(a)(2).

In support of his proposal, McCulloch states: "There is a significant body of literature that recognizes sexual abuse as a serious medical problem with long lasting and severe physical effects, many of which can only be treated by a licensed medical practitioner or through the prescription of controlled medications. There are similar medical studies that demonstrate the persistent physical damage that results from long-term incarceration."

The purpose of the Treasury's Priority Guidance Plan is to focus United States government resources "on guidance items that are most important to taxpayers and tax administration." In reviewing recommendations and selecting projects for inclusion on the 2011-2012 Guidance Priority list, the Treasury and the IRS have stated they will consider whether the recommended guidance:

• Resolves significant issues relevant to many taxpayers;
• Promotes sound tax administration;
• Can be drafted in a manner that will enable taxpayers to easily understand and apply the guidance;
• Involves regulations that are outmoded, ineffective, insufficient, or excessively burdensome and that should be modified, streamlined, expanded, or repealed;
• Reduces controversy and lessens the burden on taxpayers or the IRS; and
• Whether the IRS can administer the recommended guidance on a uniform basis.

McCulloch maintains his request for guidance satisfies the above criteria:

• Since Section 104(a)(2) was amended in 1996, taxpayers have needed guidance to determine the scope of the terms "physical injury" and "physical sickness" for which no definitions exist.
• The 1996 amendment did not specifically consider its application to victims of sexual abuse and wrongful incarceration and needs modification because it affects a large and growing number of taxpayers:
  • For sexual abuse victims, because of greater opportunities for victims resulting from legislation in many states which extends applicable statutes of limitations.
  • For wrongful incarceration victims, because more widely available DNA-testing absolves wrongfully convicted prisoners.
• The requested guidance would promote sound tax administration by providing an understandable tax rule thereby minimizing the likelihood of future controversies.
• It would also provide consistency in tax treatment among such victims who face uncertainties and expense when they currently attempt to address these issues individually.

In S2KM's opinion, industry support for McCulloch's proposal would provide one immediate answer to Jeremy Babener's strategic question about how the structured settlement industry can cooperate to improve and grow its market by encouraging more damages to be received tax-free under IRC section 104(a)(2).

For additional information about taxation of damages received by personal injury victims, see Chapter 2 of "Structured Settlements and Periodic Payment Judgments" (S2P2J)

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

David Higgins' Tax Proposal

David Higgins, of Higgins Settlement Law, LLP, submitted a legislative recommendation on January 11, 2011 proposing a change to how plaintiffs enter into structured settlements. Higgins is the author of the Periodic Payments Settlement Act of 1982 and served as the first Executive Director and the first General Counsel of the National Structured Settlement Trade Association (NSSTA).

Higgins submitted his recommendation to Senator Max Baucus (Chairman of the Senate Finance Committee), Congressman Dave Camp (Chairman of the House Committee on Ways and Means), and Michael Mundaca (Assistant Secretary of the Treasury for Tax Policy).

S2KM asked Jeremy Babener, formerly a Tax Policy Fellow at the U.S. Treasury’s Office of Tax Policy, now a Tax LL.M. at NYU School of Law, to provide S2KM readers with the following summary of Higgins' proposal.

David Higgins has recommended a "rollover provision" to replace Section 130 of the Tax Code. His proposal would allow personal injury plaintiffs to accept a check from defendants and invest the money within a given period (likely limiting the investment options to annuities and Treasury bonds), without losing the tax benefit currently available to them only by agreeing to a structured settlement with a counter-party.

Currently, when a personal injury plaintiff receives a defendant’s settlement check, successful investment of the money results in taxable income (with few exceptions). Alternatively, a plaintiff can agree to a structured settlement, in which case plaintiff only receives the settlement money (in fact, and for tax purposes) over time. Often, the defendant will transfer money and liability to an assignment company, which is thereafter responsible for plaintiff’s periodic payments.

The tax savings can be significant. But, to take advantage of the benefit, plaintiff must come to an agreement regarding the future income stream with a counter-party. Section 130 of the Tax Code allows an assignment company to exclude the portion of the transferred money used to fund the liability payments, but comes with various requirements (e.g. the liability payments required must be “fixed and determinable”).

Higgins, who played a central role in the 1982 legislation governing the taxation of structured settlements, recommends that Section 130 be repealed and replaced by a provision that allows for personal injury plaintiffs to access the same tax savings, even when plaintiffs actually receive the settlement money and subsequently invest. Higgins’ letter refers to a limited period in which plaintiffs might have to re-invest the settlement money received. Such “rollover” type provisions, though inconsistent with tax doctrines like “constructive receipt” and “economic benefit” have been allowed for certain retirement income.

“Section 130,” Higgins argues, “adds considerable complexity to a structured settlement transaction.” Though light on specifics, Higgins seems to suggest maintaining many of the limitations of Section 130 required to take advantage of the current tax benefit. For example, he writes, “The limitation to annuities and Treasury bonds seems to be working well.” He implies that the “fixed and determinable” requirement should also be kept, arguing that it has been stretched to the breaking point (based on a past IRS decision approving of qualified assignments including variable amounts based on a mutual fund portfolio). These types of limitations were put in place to protect the plaintiff from dissipating the settlement money. Higgins suggests the implementation of non-alienation requirements, though it is unclear if these would change plaintiffs’ current ability to factor.

Higgins notes potential opposition that might be voiced by the Treasury, with respect to part of the tax benefit, and the insurance industry, objecting to “expanding the exclusive distribution channels for settlement annuities that such simplification would create.” Ending with rhetorical flare, Higgins writes, “Simplification is, I suppose, not simple.” Given the considerable effort expended to establish the original legislation in the early 1980s (much of it documented in Higgins’ letter), and the similar experience in the late 1990s and early 2000s with respect to legislation on factoring, he is probably correct.

Babener's articles on the taxation of personal injury awards, structured settlements, and qualified settlement funds, are available on his web site www.taxstructuring.com. His upcoming article, "Death Then Taxes: Anticipating the Taxation of Personal Injury Proceeds at Victim's Death," will be published by Trusts & Estates Magazine in March, 2011.

For a history and analysis of the Periodic Payment Settlement Act of 1982, see "Structured Settlements and Periodic Payment Judgments" co-authored by Daniel Hindert, Joseph Dehner and Patrick Hindert.

Structured Settlements in 2010 - 2

Beginning in 2004, S2KM has utilized this blog ("Beyond Structured Settlements") and related web 2.0 publications to report and analyze strategic developments impacting the structured settlement and special needs settlement planning (aka settlement consulting) industries.

Featuring industry leaders, commentators and professional association conferences, S2KM has attempted to highlight how legal and technology changes are redefining the traditional (pre-2001) structured settlement market including structured settlement public policy as well as structured settlement business standards, business practices and business models.

From S2KM's perspective, the following categories, people and developments defined the structured settlement and special needs settlement planning industries in 2010:

Professional associations

• S2KM attended seven professional educational conferences during 2010 which addressed structured settlement and/or special needs settlement planning issues:
  • National Structured Settlement Trade Association (NSSTA) - 2
  • Society of Settlement Planners (SSP)
  • National Association of Settlement Purchasers (NASP)
  • National Alliance of Medicare Set-Aside Professionals (NAMSAP)
  • National Academy of Elder Law Attorneys (NAELA)
  • Academy of Special Needs Planners (ASNP)
• As a general observation, all of these conferences were valuable and complementary. For S2KM's 2010 (plus historical) conference reports, see S2KM's structured settlement wiki.
• SSP, NASP and NAMSAP deserve special recognition for their 2010 strategic educational discussions featuring industry leaders, commentators and critics who offered alternative perspectives for improving and growing the structured settlement and special needs settlement planning markets.
• By comparison, NSSTA remains reluctant to openly discuss strategic industry issues or to include alternative perspectives in their educational programs. More positively, NSSTA representatives and members increasingly attend and speak at non-NSSTA structured settlement and special needs settlement planning conferences.
• NAELA's educational conferences are noteworthy because they regularly feature sections or entire programs titled "unprograms". NAELA's unprograms are moderated group discussions about specific topics. NAELA's 2010 Special Needs Summit included six separate one hour unprograms with a concluding unprogram wrap-up session. One example of a 2010 NAELA unprogram was titled "Collaboration Opportunities for Special Needs Attorneys and Financial Planners".

Industry leaders

• NSSTA promoted Eric Vaughn, who previously served as NSSTA's lobbyist, to replace Joseph Ricci as NSSTA's new Executive Director effective July 1, 2010. Peter Arnold, previously NSSTA's Marketing Director, was similarly promoted to serve as NSSTA's Associate Executive Director. NSSTA's Board of Directors elected Michael Kelly as its 2010 President and Dan Finn as its President-elect. NSSTA honored Congressman Peter Stark during its Annual Meeting as its 2010 Legislator of the Year. NSSTA also gave special recognition to Karen Meyers and Joseph Bornstein for their contributions to NSSTA's CSSC and NSSTAPAC programs respectively..
• SSP elected Jason Lazarus as its President for 2010-11 and Charles Schell as Vice President. SSP honored Richard Risk with the designation of "life member" for his contributions to SSP and the settlement planning industry. Joseph Tombs continues as Director of SSP's RSP certification program.
• NASP named Matthew Bracy as its new President succeeding Robin Shapiro. Earl Nesbitt continues as NASP's Executive Director.
• NAMSAP elected Michael Westcott as its President.
• NAELA honored Dick Traum as the first recipient of NAELA's Special Needs Leadership Award. Traum is the founder and CEO of Achilles International, a non-profit organization providing community support for athletes with disabilities with members in more than 70 countries.
• Amy Palmiero-Winters, ultra-marathoner and lower-leg amputee, was named during 2010 as the winner of the 2009 James E. Sullivan Award given annually to the top amateur athlete in the United States.

Industry commentators

• For the past several years, Robert Wood has been the preeminent tax commentator and author for the structured settlement and settlement planning industries. Wood's publications appear on the Wood & Porter website.
• During 2010, Jeremy Babener emerged as an important new structured settlement tax commentator and author specializing in public policy and proposing an expanded structured settlement tax subsidy. In addition to authoring several structured settlement articles for tax and legal journals, Babener participated as a featured speaker at both the SSP and NASP 2010 Annual Meetings and authored two blog posts for S2KM during 2010. Babener discussed his structured settlement writing (accessible on S2KM's structured settlement public policy wiki and Babener's Tax Structuring website) in this 2010 S2KM interview.
• Additional authors who wrote and published 2010 legal articles about structured settlement and special needs settlement planning issues included: Daniel Hindert, Matt Garretson, Sylvius von Saucken, Peter Wayne, Mark Popolizio, Gregg Polsky and Brant Hellwig.
• Both the Legal Broadcast Network and Ringler Radio continued to produce and distribute podcasts featuring structured settlement commentators during 2010.
• An increasing number of structured settlement and special needs settlement planning professionals published blogs during 2010 joining industry blogging pioneers such as John Darer, Mark Wahlstrom, Matthew Bracy and Jack Meligan.
• Incisive Media published two new updates (Release 47 and Release 48) for "Structured Settlements and Periodic Payment Judgments" during 2010.

Legislation

• Both the Patient Protection and Affordable Care Act (Health Care Reform) and the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank) redesign the legal environment in which the structured settlement and personal injury settlement planning markets operate.
• Among the anticipated strategic consequences of health care reform:
  • An estimated 16 million more Medicaid participants - and therefore:
  • More special needs trusts;
  • More special needs attorneys;
  • More structured settlement annuities payable to trustees.
• Dodd-Frank re-writes federal banking law and creates a new Bureau of Consumer Financial Protection. A key question, as yet unanswered, is whether the sale and/or purchase of structured settlement annuities constitutes a "financial product or service" under Dodd-Frank requiring regulatory supervision by the Bureau.

Regulations

• The United States Department of Treasury held a public hearing on February 23, 2010 focused on proposed new regulations for Internal Revenue Code section 104(a)(2). The proposed regulations, if enacted, would:
  • 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) tax exclusion.
  • A subsequent S2KM interview featured John McCullough and Richard Risk, two of the structured settlement industry members who spoke at the hearing.
• The Centers for Medicare and Medicaid Services (CMS) continued to issue administrative guidance during 2010 for enforcement of the Medicare Secondary Payer (MSP) Act of 1980 and the Medicare, Medicaid and SCHIP Extension Act of 2007 (MMSEA) reporting requirements for insurers. Featured discussions during the NAMSAP 2010 Annual meeting highlighted:
  • The increasing importance and complexity of the MSP statute for all personal injury stakeholders;
  • The need for these personal injury stakeholders (and their professional associations) to cooperate politically and educationally;
  • The challenges of integrating structured settlements, including rated ages, with Medicare set-aside arrangements (MSAs) in the context of health care reform, CMS MSA regulations and related judicial rulings;
  • The evolving business models, claim management strategies and professional skill sets which are now emerging to address these challenges.

Case law

• The Spencer v. Hartford class action lawsuit which settled in 2010 represents one of the most important legal developments in the history of the structured settlement industry.
• Hartford's gross settlement payment of $72.5 million represents 4.5% of total premium dollars Hartford used to purchase structured settlement annuities for class members from January 1, 1997 to June 7, 2010.
• Among the plaintiffs allegations:
  • Hartford and its attorneys, brokers and agents violated the Racketeer Influenced and Corrupt Organizations Act (RICO) and committed common law fraud in structuring its settlements.
  • Hartford's structured settlements were priced so Hartford retained 15% of the value of the structured settlements.
  • Hartford and its attorneys, brokers and agents misrepresented structured settlements including explicit or implicit reference to:
    • The "cost" of the annuity or structured settlement or portion of the settlement being structured; and/or
    • The "value" of the annuity or structured settlement or portion of the settlement being structured.
• Hartford, which stopped writing new structured settlement business in 2009, denied the allegations.

Technology

• Despite the accelerating technology advances revolutionizing society generally, the structured settlement and special needs settlement planning industries have been slow to study and incorporate these advances into their educational programs and business models.
• The best industry-sponsored technology education programs during 2010 were offered by Mark Miller during a NAELA webinar and Harry Margolis at the ASNP 2010 Annual Meeting. Both presentations provided introductory overviews of web 2.0 and including recommendations for integrating specific social networking tools into special needs legal practices.
• NSSTA initiated a NSSTA blog during 2010 and offered an educational program about Internet marketing during its 2010 Fall Education program.

Public policy

• Both SSP and NASP featured specific discussions and presentations about structured settlement public policy during their 2010 Annual Meetings. The discussions included industry commentators representing diverse viewpoints and priorities.
• Jeremy Babener followed his 2009 paper debunking industry myths concerning "structured settlement dissipation studies" with several 2010 articles and papers addressing structured settlement public policy issues. Babener's public policy writing is featured on S2KM's structured settlement public policy wiki.
• Release 47 of "Structured Settlements and Periodic Payment Judgments" re-examined several structured settlement public policy issues related to single claimant 468B funds, structured settlement factoring transactions, dissipation by personal injury victims, the Deficit Reduction Act of 2005, special needs trusts and Medicare set-aside arrangements.
• In a 2010 Boston College Law Review article, professors Gregg Polsky and Brant Hellwig challenged the application of any structured settlement tax benefit for deferring attorney fees or payments to non-physically injured tort plaintiffs under general common law tax principles.

Business standards and practices

• The Spencer v. Hartford case raises many issues about structured settlement business standards and practices which require greater education and analysis if the primary market expects to improve and grow. For example;
  • Is the primary structured settlement market capable of self-regulation?
  • Why shouldn't key elements of the state structured settlement protection statutes (judicial approval; best interest test; compensation disclosure) be applied to primary market transactions?
  • As an additional requirement, or as an alternative, why haven't plaintiff attorneys and plaintiff consultants insisted upon a claimant's written informed consent before entering into a structured settlement?
  • Why haven't the SSP's Standards of Professional Conduct received more public discussion and analysis within the structured settlement industry?
• "Cash now" advertising represents one of the most highly criticized secondary market business practices. Although this practice continues to exist, NASP took an important educational step during its 2010 Annual Meeting by highlighting this issue and inviting secondary market critics to participate in the discussion.

Business models

• While other segments of, and products within, the special needs settlement planning market have expanded and improved in recent years, the structured settlement primary market in general has stagnated and retrenched.
• During 2010, however, representatives of the primary structured settlement market increasingly recognized their interdependency, and interacted, with other settlement planning professionals and professional associations such as special needs attorneys, life care planners, Medicare set-aside professionals and secondary structured settlement market participants.
• Future industry improvement and growth will require even greater appreciation and identification of shared interests as well as expanded implementation of shared political strategies, educational programs and business models.

Prior S2KM annual reports about the structured settlement industry and reports about industry association conferences are available on S2KM's structured settlement wiki.

Using Medical Costs to Lower Taxes on Emotional Distress Damages

Jeremy Babener, author of previous legal articles about structured settlements and taxation of personal injury damages, has published a new article titled "Maximizing the Medical Care Exception to the Tax on Emotional Distress Damages" in the September issue of Practical Tax Strategies.

Babener's new article, available on his Tax Structuring website, continues and expands Babener's analysis of medical expense deductions in personal injury cases. S2KM featured Babener's recent, related article titled "Taking Medical Expense Deductions Before and After a Personal Injury Suit" in this August 30, 2010 blog post,

Synopsis of Babener's new article: settlement attorneys and consultants should be aware that physical injury damages generally are received tax-free. Non-physical injury (e.g. emotional distress) damages without a physical cause, however, generally are not received tax-free. Moreover, damages received for physical symptoms resulting from emotional distress are taxable. However, if structured correctly, damages received to offset medical care costs incurred as a result of the injuries should not generate additional tax liability. Babener's new article explains how to design a settlement to maximize use of the medical care exception in cases involving emotional distress damages.

Babener has been named a 2010-11 NYU Tax Policy Fellow. In that role, he currently works at the U.S. Department of the Treasury’s Office of Tax Policy. Babener anticipates receiving his LL.M. in Taxation from NYU School of Law in Spring 2011. The NYU School of Law Magazine recently featured Babener and his writing about structured settlements.

S2KM has published a compendium of blog posts featuring Jeremy Babener's writing in S2KM's  structured settlement public policy wiki.

Maximizing the Medical Expense Deduction

Jeremy Babener, author of previous articles on structured settlement taxation, has published Taking Medical Expense Deductions Before and After a Personal Injury Suit in the August issue of Practical Tax Strategies. The article is available at his web site, www.taxstructuring.com. Babener's writing is also featured on S2KM's structured settlement public policy wiki.

Babener's newest article provides plaintiff and defense advisors with the necessary tax law knowledge to maximize the medical expense deduction at every stage of a personal injury lawsuit. The IRS and case law are not always in agreement, but there are basic steps advisors can take to save clients money and possibly bridge the gap between a defendant’s offer and plaintiff’s needs.

Babener has been named a 2010-11 NYU Tax Policy Fellow. In that role, he will work at the U.S. Department of the Treasury’s Office of Tax Policy this Fall, and receive his LL.M. in Taxation from NYU School of Law in the Spring.

Babener will be publishing a follow-up article in Practical Tax Strategies in September detailing how to take advantage of the medical care exception to the tax on emotional distress damages.

Legislation to Expand the Structured Settlement Industry

Jeremy Babener, third year student at NYU School of Law, has published a new article in the North Carolina Lawyers Weekly, titled: "How Plaintiffs Might Receive Emotional Distress Damages Tax-Free After 2010." This article, as well as Babener's other online writing, is available on his tax resources web site TaxStructuring.Com as well as S2KM's blog and structured settlement public policy wiki.

Babener's newest article examines past and future avenues for expanding the structured settlement industry by enlarging the tax exclusion for personal injury damages through regulation and legislation.

Babener's article begins with a summary of attempts by plaintiff attorneys and other structured settlement stakeholders to expand the definition of " physical" at the February 23, 2010 Treasury hearing, so that more damages are exempt from taxation under section 104(a)(2)'s exclusion of payments made "on account of personal physical injuries."

According to Babener, the U.S Treasury used the Administrative Procedure Act as one reason for not accepting some of the suggestions made at the recent Treasury hearing about IRC 104(a)(2) regulations. Babener's article, however, explains how the use of notice and comment periods for " interpretive" regulations are not necessarily required, even if ordinarily used.

Babener's article asks a pointed and strategic question: how can the structured settlement industry encourage more damages to be received tax-free? Doing so, presumably, would expand the structured settlement market. Babener recommends new tax legislation as one next step for industry growth.

The National Taxpayer Advocate, which considers taxpayer considerations from inside the IRS, recently recommended that section 104(a)(2) exempt non-physical damages, specifically emotional distress, mental anguish, and pain and suffering. This recommendation can be found in the Legislative Recommendations of the 2009 Report to Congress. If enacted, this recommendation would essentially undo the 1996 legislation requiring damages to be physical in order to be eligible for the 104(a)(2) tax exemption, and specifically holding emotional distress damages to be taxable.

Recounting the structured settlement industry's past lobbying successes, Babener recommends 2010 as the year for collaborative structured settlement industry political action. His article concludes, "It would seem that those opposed to the physical requirement of the tax exclusion have the momentum, planned or otherwise. If there was a year to reverse the 1996 legislation’s impact, it looks like that year is 2010."

S2KM agrees with Babener's recommendations and encourages structured settlement industry leaders to read all of Babener's structured settlement articles and also to continue to feature tax legislation as fundamental educational and lobbying components for industry growth.

NAELA's Special Needs Summit - 2

This S2KM blog post strategically analyzes the National Academy of Elder Law Attorneys (NAELA) 2010 Special Needs Summit from a structured settlement perspective. A prior S2KM post summarized the NAELA Special Needs Summit. A subsequent S2KM post will strategically analyze the NAELA Special Needs Summit from the perspective of Internet-based knowledge management.

For related S2KM learning resources, see S2KM's public read-only wikis:

• Structured settlement
• Structured settlement public policy
• Web 2.0 for lawyers

From a structured settlement perspective, the strategic business overlap with special needs attorneys encompasses disabled personal injury victims, their families and trial attorneys. Various knowledge leaders, knowledge networks and communities of practice within this strategic business and public domain utilize alternative terminology to describe their businesses without comparative analysis of the terminology itself. Here are some recommended resources to help special needs attorneys understand this growing legal market segment:

• Settlement law - hardcopy textbooks:
  • Robert W. Wood
    • "Taxation of Damage Awards and Settlement Payments"
    • "Qualified Settlement Funds and 468B"
  • Matt Garretson: "Negotiating and Settling Tort Cases"
  • Stuart Zimring, Rebecca Morgan and Bradley Frigon: "Fundamentals of Special Needs Trusts"
• Structured settlement law - Daniel Hindert, Joseph Dehner and Patrick Hindert: "Structured Settlements and Periodic Payment Judgments"
• Settlement consulting - see S2KM's report and analysis of Joseph DiGangi's presentation at the 2009 NSSTA winter meeting.
• Settlement planning - see S2KM's report about the SSP 2009 conference.
• Special needs settlement planning - see S2KM's report about the ASNP 2009 conference and Tim Nay interview.

S2KM regularly attends and publishes reports summarizing and analyzing national educational conferences sponsored by selected professional associations and universities whose speakers and attendees participate within the strategic business overlap of structured settlements and special needs law:

• National Structured Settlement Trade Association (NSSTA)
• Society of Settlement Planners (SSP)
• National Association of Settlement Purchasers (NASP)
• American Association for Justice (AAJ)
• National Academy of Elder Law Attorneys (NAELA)
• Academy of Special Needs Planners (ASNP)
• National Alliance of Medicare Set-Aside Professionals (NAMSAP)
• Stetson Law School - Special Needs Trust conference

Strategic question: from a structured settlement perspective, what was most important about NAELA's first-ever Special Needs Summit? 

Strategic answer: None of the NAELA speakers or unprograms:

• Attempted to define "special needs law" or any of its ancillary legal and business domains.
• Addressed any of the following structured settlement legal priorities and developments - all of which are strategically important for special needs attorneys:
  • IRC sections 104(a), 130, 468B or 5891;
  • Treasury Hearings for IRC 104(a)(2) regulations
  • Treasury 2009-10 Priority Guidance Plan - dropping single claimant 468B.
  • Spencer v. Hartford class action lawsuit - alleging civil RICO violations.
  • Unauthorized practice of law
  • Dissipation studies
  • Single claimant 468B funds
  • Executive Life of New York
  • Secondary structured settlement annuity market:
    • State structured settlement protection statutes.
    • J.G. Wentworth bankruptcy
    • Fresno County factoring cases
    • Rapid Settlements arbitration model
    • California protection statute amendments - including "best interest" definition

Why should special needs attorneys be interested in structured settlement law? This S2KM structured settlement diagram summarizes a complex legal and financial transaction that requires special needs legal knowledge, documentation and representation and also presents business and career opportunities for special needs attorneys:

• IRC 468B qualified settlement funds
• IRC 130 qualified and non-qualified assignments
• Special needs trusts
• Medicare set-aside arrangements
• Structured settlement transfers

Additional S2KM structured settlement resources for special needs attorneys interested in learning more about structured settlement law:

• Market surveys
• Growing the market
• Structured settlements in 2009
• structured settlement wiki
• structured settlement public policy wiki.

S2KM's next blog post will analyze NAELA's Special Needs Summit from an Internet-based knowledge management perspective.

Speaker Comments at the Treasury Hearing

After the Treasury hearing on February 23, 2010, S2KM asked structured settlement industry members who spoke at the hearing to comment on their reactions. John McCulloch, Vice-President of Integrated Financial Settlements, and Dick Risk, Attorney at the Risk Law Firm, provided their thoughts below.

John McCulloch, Vice-President, Integrated Financial Settlements

S2KM: The Treasury panel noted that private letter rulings are not “black-letter law” more than once when you discussed the “observable bodily harm” understanding of “physical,” which stems from a 2000 private letter ruling. Did their comments or questions change how you thought about that standard at all?

McCulloch: While PLR’s may not be cited as precedent, courts routinely include them and cite them in their analysis and they are generally a good indication of the Service’s thoughts on a specific issue. The “bruise ruling” has been the only guidance, informal though it may be, on what the Service considers a physical injury. My thoughts on the matter haven’t changed; taxpayers need clarity when it comes to certain types of injuries that fall within a grey area.

S2KM: One member of the Treasury panel asked you if it would be difficult to prove that a tort caused plaintiff an increase in blood pressure. Does this suggest to you that proving that a significant increase in blood pressure resulted from, for example, sexual harassment, could render a portion of sexual harassment damages non-taxable? How might this impact the argument that damages for causing a plaintiff’s mental chemistry to change should be non-taxable because they are on account of “physical” injuries or “physical” sickness?

McCulloch: I was pleased she was open to this line of reasoning, but I think it would be very difficult to sustain. Congressional intent in 1996 was to eliminate the exclusion being used for employment cases. The change in the law shut the door pretty firmly on employment damages and it would likely take a change in the law to open that door again. While the tax arguments can be made, one must balance that with any revenue loss that would be incurred when exempting all non-physical injuries from taxation.

S2KM: In arguing for more damages to be excluded as “physical,” you limited your recommendation to sexual abuse and wrongful imprisonment damages. Why?

McCulloch: These are two types of cases that are clearly distinguishable and have well-documented, long term effects, as opposed to being short lived or transitory emotional/mental distress damages. As there was no Congressional intent to tax these two types of claims in the 1996, it followed that they should be excluded. Attempting to define what “is” physical on a broad basis is too difficult; taking specific types of injuries and making them per se physical resolves the difficulty in trying to make a broad, one-size fits all standard. Further, because these are two very small groups of claimants, the revenue loss would be negligible.

S2KM: From a structured settlement industry perspective, was this hearing a success? What could or should the different groups in the industry have done better?

McCulloch: It’s too early to tell what the results will be, whether it was successful or not. I was pleased the Service and Treasury were receptive to my comments, asked a lot of questions and encouraged me to seek further support from the Hill.

Dick Risk, Attorney, Risk Law Firm
Risk offered two comments after the hearing. First, what he, as commissioner of the IRS, would say to staff.

The proposed revision is deficient, as pointed out in the written public comments and in the testimony at the hearing, as it fails to “prescribe all needful rules and regulations for the enforcement” of Code section 104, as the law requires. The clarification of the single-claimant issue can be resolved with a single paragraph, consistent with congressional history, court decisions and the agency’s previous rulings, without creating new policy. The definition of “personal physical injury or physical sickness,” as Congress has prescribed, which other commentators have recommended, also merits inclusion in this regulation. Fix it and publish it again as a revised proposal. I do not concur that the revision should be made final in its current state. Your duty is to serve the people, not operate for the convenience of the staff. Further, it is abusive to the people you are here to serve to have suggested during the hearing that they start the process over again by requesting that the single-claimant issue be placed on the Priority Guidance Plan, without giving any assurance that the result would be any different than when the request was first made, in June 2003, accepted as a project in April 2004, and finally abandoned in late 2009.

Second, his overall take of the hearing.

I am extremely disappointed at the staff’s position in favor of pushing through a shoddy and deficient product for its own convenience that fails to address legitimate issues brought to its attention by comments from the public, rather than doing the job right.

S2KM Footnote: S2KM readers can find the various hearing-related writings of structured settlement commentators here .

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).