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CURRENT TAX LAW DISCOURAGES people from cashing in or tapping their retirement savings so that those funds serve their intended long-term purpose.
Why should structured settlement payments designed to meet current and future financial and medical needs of people be any different?
Currently, however, recipients of structured settlement payments can trade in that long-term security for the short-term gain of a lump-sum payment that invariably is worth far less than the value of their promised payments. There is a thriving industry of special finance companies, called factoring companies, that buy up all or a portion of the annuities used in structured settlements for a percentage of their worth and securitize these tax-free payments for resale on the secondary market, much like mortgage-backed securities.
We support legislation introduced in the House by Reps. E. Clay Shaw Jr., R-Fla., and Fortney "Pete" Stark, D-Calif., that would create disincentives for these transactions in the interest of protecting injured parties from the temptation of getting their hands on a pot of cash at the expense of their future needs.
Typically, structured settlements are arranged when the future financial needs of a claimant outstrip his or her current requirements. This is frequently the case with claimants who are minors, individuals who are totally disabled, or those who are incompetent to manage their affairs.
Many of these people have never had as large an amount of cash as they may be offered by a factoring company, and they are not equipped to handle the demands of managing it for their long-term needs -- exactly what the structured payments were designed to accomplish in the first place.
Therefore, even if the lump sum paid to the claimant is not quickly squandered on some form of immediate gratification, it is certain to disappear more quickly than the original benefit. That can put claimants between a rock and a hard place: They likely still have sizable expenses but no source of adequate income to cover them. Certainly, they have no recourse to seek damages from the party that originally settled their claim.
Where does that leave them -- especially if the circumstances of their claim have left them unable to earn a living? In all likelihood, at the doorstep of the taxpayer who finances Medicare, Medicaid and public assistance programs.
The proposal in Congress -- as well as bills introduced in a handful of states -- would greatly minimize this risk.
As we have reported, H.R. 4314 would create a new excise tax to be paid by the factoring companies that purchase structured settlements. The bill calls for a 50% excise tax on the difference between the value of the annuity payments and the discounted lump sum the factoring company pays for them. An exclusion would be allowed only in hardship cases authorized by court order.
We would support even more onerous tax penalties on factoring companies that prey like vultures on these injured parties and pay lump-sum amounts that are an outrageously small percentage of the original benefits. In some extreme cases, those lump sums may be discounted by as much as 60% of the value of total payments.
Are there cases where a whole or partial exchange of a long-term settlement payout for a lump sum may be warranted? Of course, but such situations should be clearly spelled out or reviewed by judges, as is proposed by the bill.
If the prognosis changes for a person receiving a long-term payout, for example, and he or she is expected to survive only a short while longer, then cashing in the payments to meet short-term financial and medical needs, or to provide a benefit to heirs, may make sense.
Alternatively, perhaps a settlement beneficiary needs to cash in part of his or her payments to purchase a first home or to meet tuition costs and is willing to accept the trade-off of a diminution of his or her long-term security.
In both cases, such safe harbors should be specified in the tax code, just as there are now steep excise taxes on withdrawals of retirement savings for all but a handful of circumstances deemed essential.
It is also worth noting that currently there is nothing to prevent a settlement from being structured so as to provide an upfront lump sum, in addition to regular future payments.
If the practice of buying out those future payments is not discouraged, the tax-favored status of these settlements could be in jeopardy. A change in the tax status could discourage companies and insurers from negotiating settlements of injury claims, as the cost of making such payments would have to increase to factor in the impact of taxes. The higher stakes likely would result in added litigation costs and delays in compensating deserving parties.
One caveat to the legislation raised by risk managers is that the proposed tax could raise the stakes in settlement negotiations to offset the excise tax. The risk managers suggest that plaintiffs attorneys and factoring companies could work in tandem to seek larger settlements, knowing that the ultimate value of the payments would be worth less if they were subject to taxes.
While anything is possible, we believe the excise tax penalty is likely to be onerous enough to curb these transactions, thereby making the risk of such inflated settlements relatively rare.
We also think that the risk is outweighed by the legislation's goal: discouraging companies that prey on disabled recipients of structured settlements, while protecting these people from making foolish decisions that may bring short-term gains but long-term ruin.