Yukevich AVOID THE PROBLEMS OF ALL-CASH NEGOTIATIONS EFFECTIVE NEGOTIATION THROUGH STRUCTURED SETTLEMENTS

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AVOID THE PROBLEMS OF ALL-CASH NEGOTIATIONS
EFFECTIVE NEGOTIATION THROUGH STRUCTURED SETTLEMENTS
by James J. Yukevich and Alexander Calfo

DECEMBER, 2005
FOR THE DEFENSE

For defense counsel, therefore, it is increasingly important to act on the potential appeal that structured annuity payments have for injured plaintiffs. This is particularly true for minors, spouses in wrongful death actions, and any plaintiff likely to have extended expenses relating to his or her tort claim. Also, in some circumstances (e.g., minors, the mentally disabled or workers compensation claims), structured payments may be required either by law or by the presiding court as a condition of approval.

Granted, structured settlements will not always be appropriate. If damages are expected to be less than $10,000 or if the plaintiff is near the end of life expectancy and has no dependants, the notion of deferred periodic payments may not have much value. But that still leaves considerable opportunity to involve deferred periodic payment options in pre- and post-trial negotiations.

This article will introduce the legal foundation of federal structured settlement law and describe common types of structured settlements and the situations for which they can be used. Throughout the article, we will also provide tips for involving and benefiting from having structured settlement consultants in the negotiation process.

Finally, as a service to its members, DRI has recently established a new (members only) section on its website devoted solely to structured settlements: [insert URL]. Designed for members who may be unfamiliar with aspects of the process, this page contains links to numerous applicable documents, including texts of federal structured settlement law and IRS private letter rulings, model settlement documents, and information for the claimant about the financial benefits of choosing tax-exempt payments.

Federal Law and Structured Settlements
There is no agreed-upon instance of the first periodic payment settlement, but most agree that the concept of deferred settlement payments emerged around 1970 as large jury verdicts became more commonplace. In 1962, Thalidomide was pulled from the U.S. market after being linked to thousands of birth defects. The resulting litigation produced not only large settlements, but also involved minors with long-term financial needs. Attorneys began settling cases with periodic payments, but the practice was not widespread because of limited federal guidance on the tax implications.

Since 1919, U.S. law has recognized that damages for physical injury should be excluded from income taxation (see Revenue Act of 1918, Pub. L. 65-254, 213(b)(6), 20 stat. 1057, 1066 (1919)). That law later became codified in Internal Revenue Code 104(a)(2), which holds that damages received in a lump sum "on account of" physical injury are excluded from a plaintiff's gross income. Under section 104(a)(2) as interpreted by the courts and the IRS, however, interest and investment earnings on a lump sum settlement are not excluded.

The uncertainty over what portion of the payments was "on account of," and what portion was interest, held back wider use of periodic payments. In 1983, Public Law 97-473 amended Section 104(a)(2) to clarify that the full amount of a structured settlement's periodic payments constituted damages free from federal tax liability. This includes the annuity's inside build-up. Second, federal law also established IRC Section 130 to facilitate periodic payments by allowing the periodic payment obligation of the defendant and its casualty insurer arising from settlement of the tort claim to be assigned to a third party. This allows the defendant to obtain a full release and close its books on the claim and the periodic payment liability. Thereafter, in 1997, in the wake of the great success structured settlements had resolving claims in tort cases, federal tax law was amended again to expand the use of structured settlements to workers compensation cases.

As a result of these laws, there is a near limitless ability to tailor a future payment stream to meet a claimant's living and medical needs. Among the advantages this provides claimants is the ability to focus on rehabilitation without worrying about the burdens of managing a large lump sum payment. In addition to being exempt from state and federal income tax, these payments offer exceptional security as federal law mandates that payments be funded by two of the most financially secure funding sources available-life insurance company annuities or U.S. Treasuries. Finally, because the full amount of the periodic payments is considered tax-free damages for the claimant, the after-tax returns to the claimant can be financially attractive compared with taxable equivalents (net of management fees).

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