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IRS Structured Settlement Definitions

The following definitions of terms used in section 5891 are not in alphabetical order, but are in an order where the succeeding definition helps to explain terminology in the prior definition:

Structured Settlement - The term “structured settlement” means an arrangement which is established by

1. suit or agreement for the periodic payment of damages excludable from the gross income of the recipient under section 104(a)(2), or
2. agreement for the periodic payment of compensation under any workers’ compensation law excludable from the gross income of the recipient under section 104(a)(1), and
3. under which the periodic payments are of the character described in subparagraphs (A) and (B) of section 130(c)(2), and payable by a person who is a party to the suit or agreement or to the workers’ compensation claim or by a person who has assumed the liability for such periodic payments under a qualified assignment in accordance with section 130. (IRC section 5891(c)(1)).

Note: IRC section 5891 applies only to transfers of payment rights under settlements providing for payments that are tax-free to the settlement recipient. Taxable structured settlement payments are rare, but if they were to become the subject of a structured settlement factoring transaction, the excise tax under IRC section 5891(a) would not apply.

Excludable from gross income under IRC section 104(a)(2) - Section 104(a)(2) generally provides that gross income for income tax purposes does not include the amount of any damages (other than punitive damages) received (whether by suit of agreement and whether as lump sums or as periodic payments) on account of personal physical injuries or physical sickness.

Excludable from gross income under section 104(a)(1) – Section 104(a)(1) generally provides that gross income for income tax purposes does not include amounts received under workmen’s compensation acts as compensation for personal injuries or sickness.

Under which the periodic payments are of the character described in subparagraphs (A) and (B) of section 130(c)(2) - Section 130(c)(2)(A) refers to periodic payments that “are fixed and determinable as to amount and time of payment.” Section 130(c)(2)(B) states that “such periodic payments cannot be accelerated, deferred, increased, or decreased by the recipient of such payments.”

Qualified assignment in accordance with section 130 – Section 130(c) states, “For purposes of this section, the term ‘qualified assignment’ means any assignment of a liability to make periodic payments as damages (whether by suit or agreement), or as compensation under any workmen’s compensation act, on account of personal injury or sickness (in a case involving physical injury or physical sickness) – (1) if the assignee assumes such liability from a person who is a party to the suit or agreement, or the workmen’s compensation claim, and (2) if (A) such periodic payments are fixed and determinable as to amount and time of payment, (B) such periodic payments cannot be accelerated, deferred, increased, or decreased by the recipient of such payments, (C) the assignee’s obligation on account of the personal injuries or sickness is no greater than the obligation of the person who assigned the liability, and (D) such periodic payments are excludable from the gross income of the recipient under paragraph (1) or (2) of section 104(a). (Note that the requirement set forth in clause D is also included in the definition of “structured settlement” in section 5891(c)(1).)

Structured settlement payment rights – means rights to receive payments under a structured settlement. (IRC § 5891(c)(2))

Structured settlement factoring transaction – means “a transfer of structured settlement payment rights (including portions of structured settlement payments) made for consideration by means of sale, assignment, pledge, or other form of encumbrance of alienation for consideration.” § 5891(c)(3)(A). It does not include (i) “the creation or perfection of a security interest in structured settlement payment rights under a blanket security agreement entered into with an insured depository institution in the absence of any action to redirect the structured settlement payments to such institution or otherwise to enforce such blanket security interest against the structured settlement payment rights,” or (ii) “a subsequent transfer of structured settlement payment rights acquired in a structured settlement factoring transaction.” § 5891(c)(3)(B). In other words, section 5891, including the 40% excise tax, does not apply to a transaction in which a bank lender acquires a security interest that extends to a borrower’s structured settlement payment rights as part of a blanket security arrangement covering other collateral, until and unless the lender seeks to collect the borrower’s structured settlement payments or otherwise to enforce its security interest in the structured settlement payment rights. Section 5891 also does not apply to secondary transactions in which structured settlement payment rights that have already been the subject of a structured settlement factoring transaction are reassigned (e.g., if a structured settlement factoring company securitizes payment rights that it has previously acquired). Section 5891 applies only to transfers of structured settlement payment rights made by settlement recipients, not to subsequent transfers made by structured settlement factoring companies.

Factoring Discount – means an amount equal to the excess of the aggregate undiscounted amount of structured settlement payments being acquired in the structured settlement factoring transaction, over the total amount actually paid by the acquirer to the person from whom such structured settlement payments are acquired. For example, John Doe, the payee under a structured settlement is entitled to receive $50,000 a year in structured settlement payments for a period of 10 years. After one year, XYZ Factoring Company offers to buy the rights to the remaining 9 years of payments for $200,000.00. The Factoring Discount would be $250,000, the excess of the structured settlement payments ($450,000) due to John Doe in the transaction over the amount paid ($200,000) by XYZ. (IRC § 5891(c)(4))

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