Dog Bite Law

Introduction

Structured settlements are often used to resolve the bodily injury claims of both children and adults.

A "structured settlement" is a method of resolving a claim by paying some portion of the victim's compensation at one or more dates in the future, making both the principal and interest exempt from federal tax.

In a typical structured settlement for a child who was bitten by a dog, for example, the settlement funds are used to pay for the past medical treatment, attorneys fee, costs of making the claim, reimbursement of amounts expended by the parents, deposit into a blocked bank account for medical treatment until the child turns 18, and purchase of a special annuity that will make payments to the child when he turns 18 and thereafter. Those payments might cover college tuition, a down payment on a house, and yearly living expenses for some period of time.

If an accident victim is disabled and must permanently rely upon government assistance, the structured settlement may also provide that the victim's proceeds be distributed to a "special needs trust." A supplemental care special needs trust will preserve his eligibility for government assistance, with the trust providing for nonbasic needs and quality of life enhancements.

The reasons for using a structured settlement differ slightly, depending on whether the victim is a minor.

When the victim is a child at the time of settlement

Until the mid-1900s, settlements were paid in cash to all accident victims, resulting in abuses when the victims were children. As a result of those abuses, the courts and legislatures of all states thereafter prevented parents from having access to or control of their children's settlement money.

The involvement of the state is based upon the fact that a minor lacks the legal capacity to enter into a binding contract (with certain exceptions not applicable to injury claims). Because he cannot make a contract, he cannot settle his injury claim -- a settlement is simply an agreement that the victim will give up his claim in exchange for a sum of money and/or possibly other legal consideration.

A minor's claim cannot be settled unless a court confirms the settlement and thereby makes it binding on the minor. This rule applies to all children's settlements which exceed several thousand dollars. The procedure is variously referred to as court approval, court confirmation, guardianship, a friendly suit, or minor's compromise proceeding.

The courts will not approve settlements, however, unless the child's money is protected. Prior to the mid-1980s, the usual method of protection was a bank account containing restrictions. However, the way accident victims received their settlements was changed in the mid-1980s. Because studies established that settlement money was nearly always squandered within several months of being received, Congress provided compelling incentives to take the money periodically as opposed to immediately.

This method is referred to as a "structured settlement" and it requires two things: first, proper documentation and procedures that ensure receipt of favorable tax treatment, and second, a stream of periodic payments that almost always is funded by a "qualified asset."

When it came to minors, the courts jumped in again and set firm requirements for the qualified asset to be used, specifying that it must consist of either a special kind of annuity from a very highly rated life insurance company, or a package of US government obligations.

Between the two, the annuity is the only practical alternative, and therefore the purchase of an annuity to fund a structured settlement is now commonly accepted.

Courts also will approve putting the child's money into a UGMA account, a court-controlled blocked bank account, US Treasury instruments, timed certificates of deposit, and restricted trusts such as special needs trusts and qualified settlement trusts. All of these, however, have significant drawbacks:

• While bank accounts are appropriate for holding money that might be needed for treatment costs to be possibly incurred prior to the child turning 18, such accounts pay almost no interest and any interest is subject to income tax, making this alternative incorrect for a significant settlement.

• US Treasury instruments are theoretically safer than annuities purchased from life insurers, but the "Treasuries" do not pay as well, and they require the use of possibly complicated and costly methods to keep them free of parental mishandling.

• Certificates of deposit pay rates of interest that are less than annuities but the interest is subject to tax and therefore the yield is less.

• Trusts are used only by necessity because they are cumbersome and costly when compared with annuities.

When the victim is an adult at the time of settlement

The reasons for using a structured settlement are slightly different for adult victims. Experience has shown that bodily injury victims almost always have trouble keeping their settlement money. Studies prove that adult victims squander it in just several months. Furthermore, even when the funds are invested, the profits of the investment are subject to income tax.

For these reasons, adults often resolve their claims with a structured settlement, which protects their money and is completely tax-free.

When the victim must rely upon government assistance

When the accident victim is disabled and relies upon government assistance, his funds should be placed in a Special Needs Trust so that they will not make him ineligible. (See below.)

Example

When the victim is a child at the time of the settlement, the amount of the child's net settlement which might be necessary for medical and other treatment costs during minority is deposited into a blocked bank account or its equivalent. The remainder is used to purchase a specialized annuity which will make a series of tax-free payments to the child after age 18. This is referred to as the structured portion of the settlement.

Here's an example of a structured settlement for a 6-year-old boy who was bitten in the face. The insurance company agreed to pay $60,000.00. The attorney received $15,000.00, and there were medical costs of $3,000 and expenditures to prosecute the claim in the amount of an additional $2,000.00. Nevertheless, the child himself shall receive slightly more than $150,000.00, tax free.

How is it that the insurance company paid only $60,000.00, but all of the fees and costs have gotten paid and yet the boy is receiving over $150,000.00? The answer is that this was a "structured settlement." This is a modern way of settling the claims of children and many adults. It keeps the settlement safe and provides tax-free income.

Traditionally, a child-victim's money was deposited into a blocked account because it provides the greatest safety. However, it also pays the least amount of interest, and taxes on the interest must be paid. For those reasons, changes were made to the Internal Revenue Code that enable knowledgeable attorneys to create "structured settlements." 

A structured settlement uses an annuity to "grow" the money, keep it away from the parents (a major concern), and make the interest completely exempt from income tax. 

Structured settlements also can be appropriate for adults, depending on the circumstances. A structured settlement permits the victim to plan for the future, because the periodic payments are locked in when the structure is created. This has the advantage of providing a certain amount of money, guaranteed, pursuant to a financial plan that takes into consideration the victim's specific needs and desires. And as mentioned above, it is completely tax-free.

Another reason for a structured settlement is that it goes a long way to preventing needless, and typical, loss of the settlement money. Studies have shown that most people spend their entire settlement very quickly, no matter how much money they receive. The sad truth is that many people who have suffered injuries and experienced the long ordeal of a lawsuit lose a portion or all of their settlement to bad investments or to taxes that eat away at their good investments. They can fall victim to investment consultants who take commissions and sales charges, and make optimistic promises for their returns, without guaranteeing the results. A structured settlement ensures that the victim will never lose his or her money, will earn high interest rates, and never pay taxes on the interest that is earned.

Children's settlements

Settling a child's case is completely different from settling an adult's case. An adult is legally able to enter into a contract, so he simply signs a "settlement agreement" and instructs his attorney to dismiss the case. Also, an adult is permitted to open a bank account, so he gets the money and deposits it.

Not so with the kids! They can't enter into contracts and they don't have bank accounts. Therefore we have a different process for settling their cases.

While it differs from court to court, the basics are the same. The attorney prepares paperwork that describes the claim, the amount of the settlement, how the settlement will be disbursed, and where the child's money is going to be deposited. That paperwork is given to a judge, who reviews it for the purpose of protecting the rights of the child. If everything meets with approval, the judge issues an order that binds the child to the settlement (like when an adult signs a settlement agreement), permits the bank to open an account to hold the funds that the child will need for medical treatment prior to becoming an adult, and permits the attorney to purchase an annuity for the child if the case resolved with a structured settlement.

The judge does not assist the parents or their attorney with obtaining the most fair settlement for the child. That is an issue that the court cannot get involved in, because of the complexity attending the evaluation of a bodily injury claim. (To read more about that, see How Injuries Are Given Dollar Values.) When the judge reviews the paperwork, he or she is particularly concerned with the disposition of the funds. Emphasis is therefore on the following issues:

Compensation. The victim requires a sum of money to cover past and future losses -- the usual categories of losses include (but are not necessarily limited to) pain and suffering, anxiety, embarrassment, past medical costs and future anticipated medical expenses. Does the overall settlement amount appear reasonable?

Waiver of rights. The insurance company must obtain a legally binding waiver of the all rights of recovery -- in other words, the child will not be able to make another claim against the dog owners at a later time. Has the attorney for the child submitted a proper order? Note that the judge usually gives the attorney and the parents the right to execute any generally acceptable settlement documentation -- which the judge will not see.

Structured settlement. The court will not approve a minor's settlement unless the victim's money is parked in an extremely conservative manner that will assure that the child will receive the entire principal upon attaining majority. When the settlement of a child's or adult's claim involves an annuity, the settlement is referred to as a structured settlement. A structured settlement is one of the safest types of investment for an injured child or adult. To read about payment plans, see below. 

UGMA account. An injured child's settlement money is often put into a Uniform Gifts to Minors Act account. This is appropriate only in cases where the minor should receive the entire amount in one lump sum on the date of attaining majority (usually 18 years old). If future periodic payments are called for because of the size of the settlement, then an annuity should be used or, in rare cases, a restricted trust.

Blocked account. An injured child's settlement money is deposited into a blocked account if (a) the settlement money equals only several thousand dollars, or (b) a portion of the child's settlement cannot be put into a structured settlement because that portion must remain available to cover medical expenses that might be necessary prior to the date that the child attains the age of majority. A blocked account is a bank account that only the court can access. The purpose of a blocked account is to prevent the victim's parents from spending the victim's money. Parents have been heard to request using the victims' money to build swimming pools, add new rooms to the house, even buy a new house -- based on some rationale as to why their plan would be in the best interest of their injured offspring ("She'll really enjoy it if we have a pool!") Sorry mom, but the judge will see through it! You'll have to work harder and save up the money for that new room. You can't make your kid pay for it out of her compensation for being disfigured!

Payments to doctors, the victim's lawyer, the victim's insurance company, the victim's parents. The court reviews the amount of money that the victim owes his or her doctors, lawyer, insurance company and any other people (including parents) who rendered services or advanced money for the victim's benefit. In serious bodily injury cases, health care providers are not fully paid until the settlement money is available.

The victim's attorney almost always is paid from the settlement. In states that permit an attorney to advance the costs of prosecuting the claim, the attorney must receive not only his fee but also reimbursement of his advances.

When the victim's own health insurance company paid the doctors' bills, part of the settlement has to be paid to the insurance company, in states that permit insurance company to have "subrogation" or "reimbursement" rights. The same is true when the victim receives public benefits such as Medicare.

In many cases, the child's parents request reimbursement of amounts that they paid to doctors, and this reimbursement also has to be taken from the victim's share of the settlement.

The courts scrutinize medical charges and all other requests for part of a child's settlement funds, and judges are empowered to reject settlements that propose to pay excessive charges. For example, health care providers in Los Angeles frequently bill $2,000.00 for certain MRI's, but are known to accept as little as $600.00 for them. Similarly, chiropractors frequently bill insurance companies $125.00 per visit, but often accept as little as $50.00 if the patient does not have insurance. Therefore, judges will require the child's attorney to negotiate reductions of all such bills.

Similarly, courts often limit the fees that attorneys charge, and sometimes limit the costs too. It is common, for example, for attorneys to get no more than 25% of the net settlement -- and when the settlement is structured, the fee can total as little as 10% of the amount eventually received by the child.

Concepts, parties and documentation

Sample structured settlements

A 65-year old victim received $10,000.00 at the time of settlement, then $400.00 per month for 10 years. She was interested in the tax-free income, which nicely supplemented her existing retirement income.

Parents of a pre-teen directed the creation of a college fund, in the amount of $2,000.00 per month, for four years, starting at age 18. At age 25 the victim shall receive $25,000.00, and at age 35 she will get $50,000.00.

Parents of a pre-teen asked that all of their son's money be applied to a college fund, because the settlement was somewhat small.

Parents of a pre-teen required that $5,000.00 be placed in a blocked bank account to pay for medical expenses that might occur before their daughter reached age 18. The remainder of the money was used for a college fund and payments of lump sums similar to those described above.

Parents of a toddler directed that the boy receive $3,000.00 per month for his entire life. He was seriously injured when a dog tore off the end of his nose. The nose was reattached to his face. His income will be tax-free, as will the amounts paid under each of the other arrangements mentioned above.

Estimating college costs

Parents frequently request an annuity payout schedule that will pay their child's college costs, among other things. Such expenses can be estimated with the College Cost Calculator or the College Cost Projector.

Determining the number and amount of periodic payments

In number and amount, the future periodic payments will depend on:

The length of time that the annuity issuer retains the victim's settlement money. The longer it remains with the issuer, the more that the issuer will pay to the victim. If the periodic payments are small, and begin many years into the future, the victim's payments will be greater in number and/or amount. 

The number and amount of lump sum payments. If there are lump sum payments, the periodic payments will be smaller or fewer.

The state of the economy when the annuity is purchased. Rates go up and down in relationship to the country's economy.

The arrangements with the broker and the relationship between the liability insurer and the annuity issuer. Brokers have to be paid. Some liability insurers feel that they too have to be paid, in the form of a rebate or an annual fee. Some liability insurers will not cooperate with the victim unless the annuity is purchased through a certain broker or from a certain company. Any practice by which the broker's fees are hidden, or the liability insurer receives a kickback or the annuity business, constitutes a conflict of interest and possible fraud -- and at the present time there is little that most victims can do to prevent it.

The net amount of money that is available to purchase the annuity, after the victim pays for the following: 

An amount that equals the sum of the attorney fee, reimbursement of the attorney's costs, payments to other third parties such as health care providers and insurers who are entitled to reimbursement, and (if the victim is an adult) the victim's "up front" payment (if any).

The amount required to pay for medical bills and other things that will be needed before the first periodic payment under the structured settlement.

How much money the victim or his or her parents have paid out of pocket for medical treatment and other costs, less how much money the insurance company already paid them under the medical payments coverage or as advances against the final settlement.

How much money the attorney (a) paid for recoupable items, (b) incurred for recoupable items that are not yet paid, and (c) shall pay or incur for recoupable items that are required in the future, such as FedEx charges. 

When the victim is a minor, how much the Court will charge for (a) filing fees, (b) certified copies, and (c) a trustee in some jurisdictions. 

The victim's attorney's fee.

Amounts payable to doctors, hospitals and other health care providers for past medical treatment. Many providers will agree to reduce their charges under certain circumstances.

Amounts payable to government agencies such as Medicare. Some agencies will agree to reduce their charges, some have legal limits as to the amount that they can recover from the victim, and others will not reduce their charges under any circumstances.

Amounts payable to insurance companies that paid benefits under health insurance policies which provide such companies a right of reimbursement (also called a lien or subrogation), in states that permit insurance companies to have such rights. Some will agree to reduce their charges, and in certain states they have to do so if the victim retained an attorney and they did not.

The amount to be deposited into a bank account to cover estimated medical bills which will be incurred prior to the first periodic payment to the victim. In minors' settlements, this amount is deposited into a blocked bank account, supervised by the Court, for payment of medical services required before the child turns eighteen.

After doing this breakdown or accounting, the victim will know how much is available for the purchase of the annuity. The victim's representative tells the insurance adjuster or a structured settlement broker the net amount available. They will obtain proposals that conform to the victim's goals.

Evaluating the annuity issuer and surety

Because the settlement payments will come from the annuity issuer at various times in the future, it is important to evaluate the financial strength of the annuity issuer and the surety that might be called upon to make such payments. 

The victim or his or her representative should review either a financial statement or another competent source of financial information about each company. Financial statements often are found on insurance companies' websites.

Start with the Directory of Insurance Companies on the Internet. After finding the company's website, locate the investors' section. Locate the most recent SEC filings, especially the 10-K.

The company that issues the annuity should be of substantial size and have at least $100,000,000.00 of capital and surplus, exclusive of any mandatory security valuation reserve. The victim or representative also should obtain current ratings from any of the following rating companies:

A.M. Best (accept only A+, A+g, A+p, A+r, or A-s). At the home page of their website, enter the name of the life company, and then establish a free account when asked to do so.

Standard & Poor's Corporation Insurer Claims Paying Ability Rating (AA-, AA, AA+ or AAA). At the home page of their website, select Insurer Profiles.

Moodys Investors Service Claims Paying Rating (Aa3, Aa2, Aa1 or Aaa). A very frustrating and difficult website. Click on Ratings.

Duff & Phelps Credit Rating Company Insurance Company Claims Paying Ability Ratings (AA-, AA, AA+ or AAA)

A great website to get ratings and other information about insurance companies and insurance topics is Insure.com.

Details about the tax treatment of structured settlements and the necessary legal documentation

Here are legal details for attorneys and others who would like to know the Internal Revenue Code provisions granting favorable tax treatment of structured settlements, and how such arrangements must be documented.

Generally speaking, compensation received as damages on account of personal injuries is not taxable, per Internal Revenue Code section 104(a)(2):

§ 104. Compensation for injuries or sickness

(a) In general. Except in the case of amounts attributable to (and not in excess of) deductions allowed under section 213 (relating to medical, etc., expenses) for any prior taxable year, gross income does not include—
...
(2) the amount of any damages (other than punitive damages) received (whether by suit or agreement and whether as lump sums or as periodic payments) on account of personal physical injuries or physical sickness....

The exclusion in section 104(a)(2) applies whether the damages are received as a result of a lawsuit or settlement agreement, and whether they are received in a lump sum or periodic payments. The exclusion also extends to the portion of damages received as compensation for lost wages and lost income, even though the same would have been taxable if the plaintiff had earned them. (Burke, Therese A., 504 US 229 (Sup. Ct. 1992).)

However, when such compensation is received and invested, the gain (i.e., the interest or profit) on the same is taxable as ordinary income. (Rozpad, Joseph S., 154 F3d 1 (1st Cir. 1998); Greer, Yancy D., TC Memo 2000-25 (2000).) For example, if an accident victim settles his claim and receives $10,000, invests the $10,000 in a certificate of deposit, and makes $300 in interest after one year, that $300 is taxable even though the $10,000 is not. This same principle is applied to delay damages added to the jury verdict in a personal injury suit. Because such damages essentially compensate the plaintiff for the lost time value of money, they are not considered to be damages received on account of personal injury, and therefore are not excludable from gross income. (Francisco, Charles, 267 F3d 303.)

Congress determined that it would be in the best interest of accident victims if they received their compensation in the form of future periodic payments that had certain restrictions, rather than a single lump sum that could be spent immediately. To encourage victims to agree to do so, the lawmakers provided an incentive in the form of a "tax break." Specifically, Congress passed Public Law 97-473, which made the gain on a personal injury settlement excludable from income (i.e., tax free) if certain conditions are met. (See P.L. 97-473, Jan. 14, 1983 (97th Cong., 2d Sess.))

The most concise summary of these conditions appears in the definition of "structured settlement" contained in Internal Revenue Code section 5891(c)(1):

The term “structured settlement” means an arrangement—

(A) which is established by—

(i) suit or agreement for the periodic payment of damages excludable from the gross income of the recipient under section 104 (a)(2), or

(ii) 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

(B) under which the periodic payments are—

(i) of the character described in subparagraphs (A) and (B) of section 130 (c)(2), and

(ii) 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.

According to the above definition, the structured settlement of a personal injury claim must be an arrangement (a) established by a suit or agreement, (b) for the periodic payment of damages to an accident victim, (c) under which the payments are of the character described in IRC section 130(c)(2)(A) and 130(c)(2)(B), and (d) under which the payor is a party to the suit or agreement, or an assignee of the liability under a "qualified assignment."

A "suit" means a lawsuit. An "agreement" usually means a settlement agreement. A bodily injury claim is resolved by a suit, which leads to a court judgment, or a settlement agreement. Therefore the first requirement of IRC 5891(c)(1) is easily met.

The "periodic payment of damages" refers to the payments to be received in the future. This is generally understood to mean at least two payments. However, in one case, the IRS announced that one payment would meet the second requirement of IRC 5891(c)(1). Nevertheless, in the usual dog bite settlement, there are several or more payments.

"[E]xcludable from the gross income of the recipient under section 104 (a)(2)" means that the money is being paid on account of bodily injuries. Punitive damages do not qualify. The settlement agreement and everything else should therefore say that no part of the settlement is for punitive damages.

Section 5891(c)(1)(B) then refers to payments that meet the conditions of IRC section 130(c)(2)(A) and 130(c)(2)(B):

(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....

In a dog bite case, the victim's periodic payments typically are made through the purchase of an annuity. An annuity is a contract by which a life insurer agrees to make payments at specific times in the future. These payments are "fixed and determinable" by the very nature of the annuity contract itself. A settlement that is funded by an annuity therefore meets this requirement.

The prohibition against accelerating, deferring, increasing or decreasing the payments is intended to ensure that the accident victim does not defeat the purpose of the legislation. The settlement agreement or the annuity contract itself must contain language that satisfies subdivisions (A) and (B).

The last condition has to do with the person or entity that actually will make the payments. The payments have to be made by one of the following: a party to the suit, a party to the settlement agreement, or a person or entity that has assumed the liability under a "qualified assignment."

The party to the suit is the dog owner. Usually he has hoemowners or renters insurance. Therefore he is not going to make the payments himself.

A party to the settlement agreement can make the payments. That would include the homeowners or renters insurance company in the usual case, or a trust if a qualified settlement fund is used (for so-called "QSFs" see Code of Federal Regulations, section 1468(B)(1) (Qualified Settlement Funds)).

As a practical matter, the defendant's liability insurer usually is not the payor. Such companies typically are not set up to make future payments of losses. Remember, these are liability insurers. There are legal restrictions as to how such companies are permitted to invest and make profits; they are not in the business of simply holding funds over many years for eventual payment to victims. Furthermore, from the victim's perspective, liability insurers go out of business from time to time. So the victim would reasonably require more security than a liability insurer can provide. Therefore the payor usually would not be the defendant's liability insurer.

The last category of person or entity is one which has assumed the liability under a "qualified assignment." This can be any person or entity, but cannot be the victim, his attorney, his attorney's trust account, or anyone who is the alter ego of the victim, or is controlled by the victim. Examples include holding companies and trusts. The latter are a variety of "qualified settlement funds." In the usual case, this third party usually is a holding company formed as a corporation and established, maintained and controlled by a life insurance company -- specifically, the company that issues the annuity that provides the future periodic payments. It would be unreasonable for the assignee to be a person, because he would have to be a trustee, he would need to be bonded, he certainly would charge yearly fees, and the funds could be lost if he dies or absconds with them. The assignee could be an institutional trustee, such as a bank, but they too charge fees. The life insurance companies that sell annuities for structured settlements have made it simple and economical to use their assignment companies, because no fees are charged, and the life insurers routinely issue guarantees that these companies will make all payments when due.

Section 5891(c)(1)(B)(ii) refers to "a qualified assignment in accordance with section 130." This refers to an assignment of the underlying obligation to make the future periodic payments. In other words, the holding company assumes the dog owner's tort liability and/or the homeowners or renters insurance company's liability to make the payments to the victim. This performs a neat accounting trick: the liability offsets the value of the annuity contract, so that there is no tax to be paid by the holding company. This becomes a "qualified funding asset" under Internal Revenue Code section 130:

§ 130. Certain personal injury liability assignments

(a) In general

Any amount received for agreeing to a qualified assignment shall not be included in gross income to the extent that such amount does not exceed the aggregate cost of any qualified funding assets.

(b) Treatment of qualified funding asset

In the case of any qualified funding asset—

(1) the basis of such asset shall be reduced by the amount excluded from gross income under subsection (a) by reason of the purchase of such asset, and

(2) any gain recognized on a disposition of such asset shall be treated as ordinary income.

(c) Qualified assignment

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).

The determination for purposes of this chapter of when the recipient is treated as having received any payment with respect to which there has been a qualified assignment shall be made without regard to any provision of such assignment which grants the recipient rights as a creditor greater than those of a general creditor.

(d) Qualified funding asset

For purposes of this section, the term “qualified funding asset” means any annuity contract issued by a company licensed to do business as an insurance company under the laws of any State, or any obligation of the United States, if—

(1) such annuity contract or obligation is used by the assignee to fund periodic payments under any qualified assignment,

(2) the periods of the payments under the annuity contract or obligation are reasonably related to the periodic payments under the qualified assignment, and the amount of any such payment under the contract or obligation does not exceed the periodic payment to which it relates,

(3) such annuity contract or obligation is designated by the taxpayer (in such manner as the Secretary shall by regulations prescribe) as being taken into account under this section with respect to such qualified assignment, and

(4) such annuity contract or obligation is purchased by the taxpayer not more than 60 days before the date of the qualified assignment and not later than 60 days after the date of such assignment.

The Internal Revenue Code section above set forth provides that any amount received for agreeing to assume damage liability shall be excluded from gross income if it is used to purchase an annuity contract issued by any State-licensed insurance company or a U.S. obligation to cover the liability. While it is possible to use U.S. obligations as "qualified funding assets," it is not as practical or advantageous as a special annuity. U.S. obligations such as Treasury bonds still require an assignee, and do not pay as well as annuity contracts.

Special Needs Trusts

When a person is injured seriously, disability may result. A substantially disabled accident victim may require government assistance in the form of Medicaid, Supplemental Security Income and other governmental providers. The settlement of a personal injury lawsuit, however, might produce funds (paid in a lump sum or in periodic payments, as from an annuity) which would disqualify the victim from government assistance. This would be true even if the payments are made in a structured settlement. The solution to this problem is the Special Needs Trust ( "SNT").

An SNT is a professionally managed fund, usually administered by a corporate trustee such as a bank if the amount of the trust is over $200,000; smaller trusts are better served by a professional trustee working on an hourly basis, possibly including a trustee committee consisting of family members. Accident victims would use a Supplemental Care SNT, designed to serve as a secondary source of benefits for the victim after all available government benefits have been exhausted.

The three main advantages of an SNT can be summarized as follows:

• Maintains a disabled individual’s eligibility for critical government benefits
• Supplements treatment, services, and care offered by Medicaid & state programs
• Shelters assets from creditors & protects beneficiaries from financial exploitation

Very generally, a trust is a legal entity which permits one person, the donor, to give something to a second person, the trustee, with qualifications that it must be used for the benefit of someone else, the beneficiary. Assets are owned by the trust. The trustee is usually given the power to manage those assets (e.g., to sell assets, to invest trust funds). In addition, in the case of an SNT, the trustee has the discretion to use trust assets for the benefit of the special needs child. The two main duties of the trustee are:

• Coordinate public benefit programs and use trust assets to enhance lifestyle of beneficiary
• Administer the trust and maintain compliance with all regulations

An SNT may seem appropriate at first, but might not be upon further investigation. Trusts are governed by state laws and should only be drafted by an attorney who is familiar with this area of law. In addition to legal fees, there may be costs associated with transferring assets to, and administration of, a trust. One important consideration is whether some or all of the injured person's settlement should be used to repay government agencies upon his death, or whether it would be more fair under the circumstances for the settlement to pass to the beneficiaries of his estate. Upon death of the child, the SNT will have to repay the benefits previously given by the government to the child, prior to paying any remainder beneficiaries such as the parents of the child.

The legal basis of the SNC is 42 USC 1396(p)(d)(4)(A). For more information about SNTs, click on the following links, which will open in new windows:

• Financial Planning: Special Needs Trusts
• Your Client May Need A Special Needs Trust: Tips For Creating A Special Needs Trust For Disabled Clients
• The expense calculator by MetLife is helpful in estimating how much of your child's needs might be provided by the annuity; be sure to use the 7% rate of return.
• A guide for attorneys, including an admonition against settlement of personal injury cases without considering the necessity of an SNT.
• Choosing the Ideal Trustee of Your Child’s Special Needs Trust.

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