645 / Can a defendant who is making payments under a structured settlement agreement assign responsibility for payments to a third party? What are the tax consequences of such an assignment?

The defendant-payor under a structured settlement can assign responsibility to provide future payments to the plaintiff who is receiving payments under the settlement if the settlement was negotiated to compensate the plaintiff for personal physical injuries or sickness.¹ If the assignment is a “qualified assignment,” (see below) the assignee is not taxed on any amounts received from the defendant except to the extent that these amounts exceed the cost of any “qualified funding asset.”²

A “qualified assignment” is defined as the assignment of a defendant’s responsibility to make periodic payments as damages for a plaintiff’s personal injury or sickness if the following requirements are met:

(1)     the assignee is assuming liability from a party to the original lawsuit or settlement agreement,

(2)     the periodic payments are fixed and determinable as to the amount and time of payment,

(3)     the recipient of the payments does not have the right to accelerate, defer, increase or decrease the payments,

(4)     the assignee’s obligations under the structured settlement are no greater than the obligations of the person assigning the liability, and

(5)     the periodic payments that the plaintiff receives under the structured settlement are excludable from the plaintiff’s gross income under IRC Section 104.³

If the assignment satisfies the IRC requirements for a qualified assignment, any amounts that the defendant pays to the assignee who assumes payment obligations under the structured settlement will be tax-free to the assignee unless these amounts exceed the cost of purchasing a qualified funding asset (see below). If the cost of purchasing the qualified funding asset is less than the total amount that the assignee receives as consideration for assuming the settlement obligations, the difference must be included in the gross income of the assignee in the year in which the assignment took place.

A “qualified funding asset” is defined in the Code as an annuity contract used by the assignee to fund the periodic payments he or she has assumed under the structured settlement that meets the following requirements:

(1)     the payment periods provided under the annuity are reasonably related to the periodic payments under the structured settlement (and the amounts of the annuity payments do not exceed the amounts to be paid under the structured settlement),

(2)     the annuity contract is designated as an obligation purchased to satisfy the terms of the structured settlement, and

(3)     the annuity contract must be purchased not more than 60 days before the assignment and not more than 60 days after the assignment.⁴

The basis of the qualified funding asset will be reduced by any amounts that the assignee is able to exclude from gross income. If the assignee later sells the annuity contract used to fund payments, any gain realized on the sale is taxed as ordinary income to the assignee.⁵