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IRC section 5891(a) imposes a tax equal to 40% of the factoring discount on any person who acquires directly or indirectly structured settlement payment rights in a structured settlement factoring transaction that does not qualify for exemption under conditions that are specified in section 5891(b). The tax was implemented by the Victims of Terrorism Tax Relief Act of 2001, December 21, 2001, Public Law 107-134. The new law was a part of the tax relief and assistance package for the victims of the September 11 terrorist attacks. Temporary Regulation 157.5891-1T was issued and effective February 19th, 2003, and contained temporary regulations relating to the manner and method of reporting and paying the 40-percent excise tax imposed on any person who acquires structured settlement payment rights in a structured settlement factoring transaction that does not qualify for exemption. On July 8th, 2004, the IRS issued final regulations, Treasury Regulation section 157.5891-1, which substantially adopted and replaced the temporary regulation provisions.


In general, section 5891 applies to structured settlement factoring transactions entered into on or after February 22, 2002. The amount of the excise tax is 40% of the excess of (1) the undiscounted amount of the payments being acquired, over (2) the total amount actually paid to acquire them. The 40% excise tax does not apply, however, if the transfer is approved in advance in a final order, judgment or decree that: (1) finds that the transfer does not contravene any Federal or State statute or the order of any court or responsible administrative authority, (2) finds that the transfer is in the best interest of the payee, taking into account the welfare and support of the payee’s dependents; and (3) is issued under an applicable State statute by an applicable State court or, if applicable, by a “responsible administrative authority” with exclusive jurisdiction over the claim or proceeding resolved by the structured settlement. Rules are provided for identifying the applicable State statute and the applicable State court.


The new Excise Tax provision also provides that a factoring transaction does not affect the tax treatment of the parties to a structured settlement under the structured settlement tax rules, if those rules were satisfied at the time the structured settlement was entered into. The rules are IRC section 130 (relating to an exclusion from gross income for amounts received in connection with “qualified assignments” of liability for periodic payments, as damages or as workers compensation, on account of personal physical injury or physical sickness), IRC section 72 (relating to annuities), IRC sections 104(a)(1) and (2) (relating to an exclusion for amounts received under workers’ compensation acts or as damages on account of personal physical injuries or physical sickness), and IRC section 461(h) (relating to the time of economic performance in determining the taxable year of deduction).


The purpose of IRC section 5891, is to deter the purchasers of payment rights under structured settlements from taking advantage of recipients who are entitled to receive tax free settlement payments, including payments under settlements received by victims of the 9/11 terrorist attack. The tax is basically a penalty tax imposed on purchasers of payment rights under structured settlements. The practical effect of section 5891 is to compel such purchasers to comply with State structured protection acts (“SSPAs”), which require that transfers of structured settlement payment rights receive advance court (or administrative authority) approval. Absent an appropriate court or administrative authority order, a party acquiring structured settlement payment rights must pay, up front, a tax equal to 40% of its expected gross profit on the transaction (i.e., the difference between the total undiscounted amount of the future payments it acquires and the amount that it pays to acquire them). In conjunction with the SSPAs, section 5891 should make structured settlement recipients much less vulnerable to predatory factoring transactions. This new law not only benefits the individual that sells payment rights under his or her structured settlement but also makes clear that insurers involved in structured settlements will suffer no adverse tax consequences as a result of structured settlement factoring transactions. Prior to enactment of section 5891, the tax consequences of these transactions for insurers were uncertain.

See more at IRS.com