Tax-Deferred Structures Getting Noticed
Attorneys are beginning to look beyond cases typically targeted for structured settlements and recommending the settlement option to clients in a number of non-traditional, non-physical injury recoveries. These settlements are structured in a similar manner as physical injury case recoveries with the primary difference being that physical injury recoveries are tax-free while non-physical injury recoveries are partially or fully taxable over time. Taxes owed on the interest earned from the settlement proceeds can be deferred until settlement funds are actually withdrawn.
Almost any type of non-physical settlement can and is being structured. They include:
- Emotional distress, sexual harassment
- Employment discrimination and wrongful termination
- Property damage
- Construction defect
- Errors & Omissions
- Long-term disability
- Punitive damages
- Mass torts
- Business disputes and partnership dissolutions
In one case, a 37-year-old female worker at a manufacturing plant was verbally abused and subjected to obscene jokes. She was denied promotions when she refused to grant sexual favors. She quit her job and sued her employer. The case settled before trial. She received a $100,000 cash payment immediately. As part of her settlement, she is receiving another $2,150 per month, guaranteed over 20 years, increasing at a 3 percent rate, compounded annually. The guaranteed payout over 20 years is $693,256. The initial $100,000 payment is immediately subject to taxation. The $2,150 monthly payments are taxable only when received.
As with physical injury cases, non-physical injury annuity settlements benefit both the claimant and the defendant. The structure option resolves disputes before trial thus avoiding expensive and uncertain litigation outcomes for both parties. Structures transfer investment risks from the claimant to the annuity provider. For the defendant, payment obligations move to the annuity provider.
Just as with tax-free structures, tax-deferred, non-qualifed structures can create flexible, customized periodic payment plans to fit the claimant’s future financial needs. Claimants can choose to receive tax savings through a structured settlement by receiving payouts in later, retirement years when tax rates are typically lower. Or, they can choose to receive future lump sum payments to help cover expected costs such as college expenses or new home or car purchases. Income must be reported on IRS Form 1099 Misc. in the year in which it is received.
In a construction defect case, a large church had new windows installed throughout its facility and later sued the window installer when the windows repeatedly leaked. The case settled with an upfront cash payment to the church of $400,000 and an annuity that would be used to cover the cost to replace the windows every 10 years if necessary. The church will also receive a $750,000 cash payment in 30 years to cover any future improvement needs.
Annuities are guaranteed by the issuing life insurance company. Only those highly rated by the rating agencies (Moody’s, A.M. Best, Standard & Poor’s) are selected for structured settlement annuities. In California, companies offering structured settlements must be first approved by the California Department of Insurance. The department evaluates the insurance carrier’s solvency and whether the carrier complies with California regulations. Carriers are also subject to mandatory annual audits and other financial compliance requirements.
American General, John Hancock, Pacific Life, Liberty Mutual, New York Life, MetLife, Allstate, Symetra Financial and Prudential are all major players in writing structured settlement annuities. None has ever failed to make an annuity payment.
Despite turbulent financial times, annuity companies have stayed mostly immune to the debt problems faced by other financial institutions. Why? By regulation, all annuity reserves must have assets that are equal to or exceed the corresponding payment obligations. In addition, the assets supporting these reserves may not be removed from the insurance company. Reserve sufficiency is mandatory and is frequently monitored by state legislators and auditors. State insurance commissioners have developed these regulations to preserve the solvency of general accounts in which assets are held so that contractual obligations to policyholders are met. These general accounts support only the obligations of the insurance companies–and not the obligations of a parent company or other subsidiaries. Even American General, the life insurance and annuity arm of AIG, was protected from AIG’s economic meltdown.
Attorney Fee Structures
Attorney fees can also be structured when they are payment for work on non-physical injury, contingency fee cases under Int. Rev. Code § 104(a)(2). For these types of cases, annuity-like periodic payment assumption reinsurance agreements and non-qualified assigned annuities are used.
For the structured settlement to be viable, it must meet a number of criteria. The attorney’s contingency fee attorney-client agreement must allow fee structuring, the attorney or law firm must not receive fees prior to creation of the structured settlement, the attorneys’ fee structured settlement must be created prior to or concurrent with the client’s settlement and the guidelines of the settlement annuity’s issuer must be adhered.
In one example, a 43-year-old attorney structured $150,000 of his fees with a non-qualified, tax-deferred annuity that would begin at age 55. At 55, he will receive $1,443.35 per month, guaranteed for 20 years. While the cost for the annuity was $150,000, the guaranteed yield is $346,404. When factoring in life expectancy, an additional 10 years of payments could be received, bringing the expected yield to $519,606.
Life insurers are seeing attorney fee annuities as a growing part of their portfolio. MetLife, one of the world’s largest annuity providers, recently expanded it beneficiary parameters to its Attorney Fee Structure Program. Beneficiaries of a MetLife annuity are no longer limited to the attorney’s estate or law firm as they once were. Attorneys can now name their spouse and/or children as beneficiaries. MetLife’s hold harmless agreement reads, in part, “payments after my death must be paid to my estate, law firm, spouse or named children, as provided under the Settlement Agreement, or subsequent valid beneficiary designations.” The beneficiary designation must be clearly stated in the settlement agreement.
Also, designations are no longer irrevocable. They are now revocable but require MetLife’s consent, as the assignee, at the time of the change. MetLife requires Hold Harmless and W-9 forms be signed and submitted with a valid Tax Identification Number before making payments to an attorney. If not submitted properly, the payments will be subject to backup tax withholding.
Remember, all annuity payments as a result of attorney fees received during a calendar year must be reported on IRS Form 1099 Misc. Look for other annuity companies to follow MetLife’s lead.
Is a tax-deferred, nonqualified settlement appropriate for your client or your legal fee? Each client and situation is different. If long-term planning and guaranteed income are a priority, than the payment option should be carefully considered.
Patrick C. Farber is a structured settlements broker in California. He specializes in settling medical malpractice, physical injury, non-physical injury, product liability, workers’ compensation, mass torts, punitive damages, employment and elder abuse cases with structured settlements in court hearings, arbitrations and settlement conferences. firstname.lastname@example.org