Transfer of Payee on Structure for Estate Planning Purposes
Below is the response from the IRS to an inquiry as to whether the payee of a structured settlement can be transferred without incurring adverse tax consequences. Below, please find the favorable reply from the IRS.
The facts in my particular matter were as follows:
1. The wife had a significant medical malpractice injury, which caused her to be mentally incompetent and to permanently reside in a nursing home. The husband had a cause of action for loss of consortium. This is a New York action.
2. The case settled for six million dollars. Of that amount, one million was allocated to the husband's cause of action and the remainder was allocated to the wife's cause of action. The husband's payment was made partially in cash and partially through a structure. The wife's payment was divided into four component: cash for payment of the Medicaid lien and for cash in a Special Needs Trust and three annuities at a cost of $1,000,000, $700,000 and $500,000. The intent was to be able to transfer the "payee" on the later two annuities to the husband, retaining the wife's rated age. Based upon this plan, the personal injury attorney was able to settle the case and the structured settlement broker was able to structure the majority of the settlement.
3. The trial court ordered the proposed settlement. The court's order indicated that there was a plan to transfer the "payee" on two annuities from the wife to the husband. After receipt of the court order settling the case, we then proceeded with a guardianship for purposes of investing the funds to be received by the wife and for purposes of transferring the "payee" on the annuities which cost $700,000 and $500,000 to the husband. The guardianship court granted the relief requested.
As a result of the above planning, we were able to obtain the husband's agreement to settle the matter, assist the structured settlement broker in structuring a significant amount of the gross settlement of six million dollars, potentially save on estate taxes should the wife die with a taxable estate (at present rates, we would save approximately $700,000 in estate taxes) and an improve the husband's life with the increase in funds to him. The wife, being in a nursing home, would not have benefitted from the funds.
I believe that the above plan can be useful in settling matters, as well as in creating additional opportunities for structures. Had there be an IRC 104(a)(2) problem with the above plan, the $1,200,000 in structures, in which the "payee" was transferred to the husband, would have had to be paid out in cash to the wife and then the cash transferred to the husband. The response from the IRS states that this type of planning can be performed without negative income tax consequences. It is further possible that the IRS response creates additional possibilities for planning.
Postscript: This is the third time I have petitioned the court to transfer significant assets from the injured spouse to the well spouse. In this and another matter, we were able to have the well spouse agree to structuring the amounts anticipated to be transferred. In one matter, the well spouse refused to accept a structure. In the later matter, in the course of a year, the well spouse, the wife, had given almost all of the funds received from her husband's settlement to her children, who proceeded to "waste" the monies, leaving the wife with little remaining and no funds remaining in the hands of the children. In another matter, where the son was in a serious automobile accident (and is in a nursing home), we are presently transferring funds from the son to his mother and then annuitizing those funds so that the mother will retain the benefit of the funds for the remainder of her life, without the threat of those funds being lost. That annuity is not a 104 (a) (2) qualified annuity, although based upon the IRS response, perhaps we can re-structure the payment to keep the 104 (a) (2) benefits. Without this latter plan, the case would not have settled.
Below is the communication with the IRS.
Your Question Was:
My question has to do with IRC Sec. 104(a)(2). The medical malpractice matter has settled. The party physically injured was the wife. Both the husband and the wife received an award. All of the award was on account of a physical injury. The husband s claim was for loss of consortium. The matter was settled for cash and for a structured settlement, with certain annuity payments to the wife and certain to the husband. Thereafter, the court agreed to transfer the payee on certain of the periodic payment annuities from the wife to the husband. Therefore, the husband will receive periodic payments that otherwise would have been paid to the wife. The life company agreed to make such payments in this manner. The proposed order for the transfer of payee is presently before the court. This transfer is certainly for no consideration and, therefore, the factoring rules do not apply. The question is whether there are any income tax consequences due to the periodic payments that the husband will receive, which otherwise would have gone to the wife, but for the anticipated court order transferring the payee of the annuities to him. As the order is presently before the Court for signature, an answer as quickly as possible would be most appreciated. Please let me know when I might expect an answer, which I presume will be in the form of a private letter ruling. Thank you. Jay J. Sangerman, Esq. 212-922-0711 212-922-0709 (facsimile)
The Answer To Your Question Is:
Thank you for your inquiry about whether an award on account of physical injury is still nontaxable under Internal Revenue Code section 104(a)(2) if part is paid to the spouse of the injured party due to loss of consortium, and whether a subsequent change in the payee on some of the payments would change the taxability. We apologize for the delay in our response. Under Internal Revenue Code section 104(a)(2) the amount of any damages (other than punitive damages) received (whether by suit or agreement and whether as lump sums or as periodic payments) on account of personal physical injuries or sickness are not taxable. The House Committee Report for the Small Business Job Protection Act of 1996 (Public Law 104-188) which amended Internal Revenue Code section 104(a)(2) states: [Beginning of excerpt] If an action has its origin in a physical injury or physical sickness, then all damages (other than punitive) that flow therefrom are treated as payments received on account of physical injury or physical sickness whether or not the recipient of the damages is the injured party. For example, damages (other than punitive) received by an individual on account of a claim for loss of consortium due to the physical injury or physical sickness of such individual's spouse are excludable from gross income. [End of excerpt] Thus it was the clear intent of Congress to classify a compensatory award paid to the spouse of the physically injured party due to loss of consortium as nontaxable on account of physical injury. Thus all the amounts involved are being paid as compensation for physical injury, which is nontaxable under Internal Revenue Code section 104(a)(2). Changing the payee on some of the payments does not change the reason for the payments so they are still nontaxable given that the change of payee is in the nature of a gift under Internal Revenue Code section 102 since there is no issue of divorce, separation or other consideration involved in the change of payee. We hope this information is helpful. This answer is based on our understanding of the facts you presented in your question. Omission of facts may affect the answer given.
Jay J. Sangerman, PLLC
60 East 42nd Street - Suite 650
New York, New York 10165
Telephone (212) 922-0711
Facsimile (212) 922-0709
4115 NW 60th Circle
Boca Raton, Florida 33496
Jay J. Sangerman & Associates
Lanidex Executive Center
100 Misty Lane
Parsippany, New Jersey 07054
RETURN TO INDEX