How to Avoid the Constructive Receipt "Hazard"

What is Constructive Receipt?

Trial lawyers should be mindful of not teeing off your client's settlement at the end of mediation or otherwise and ending up in the drink!

If a standard form General Release has been signed and delivered to the defendant's legal representative, the tax benefits of a structured settlement may be lost. The ramifications may be costly for both the plaintiff and his/her/their lawyers. Constructive Receipt is "destructive receipt" from a financial standpoint.

In I.R.S. Rev. Rul. 79-220, the IRS. held that where the plaintiff and defendant had agreed to settle a personal injury claim on the basis of the defendant’s promise to make future periodic payments, the full amount of such payments constituted tax-free damages under Code section 104(a)(2). 1979-2 C.B. 74.

Also see Internal Revenue Bulletin: 2003-46 | Internal Revenue Service (irs.gov) Law and Analysis Issue 1, "Neither § 139(f) nor § 104(a)(2) excludes from gross income amounts that are earned from the investment by the claimant of a lump sum amount received as either payment under section 406 of the Act or damages on account of personal physical injuries or physical sickness, respectively. If such a lump sum payment is invested for the benefit of a claimant who has actual or constructive receipt, or the economic benefit, of the lump sum payment, only the lump sum payment is excluded from gross income, and none of the income from the investment of the lump sum payment is excludable from the claimant's gross income. Rev. Rul. 65-29, 1965-1 C.B. 59"

Why a Standard General Release is Fatal to a Structured Settlement?

A standard general release fails to satisfy the requirements to establish a structured settlement, because of the fatal words "receipt of which is hereby acknowledged". Even though money has not yet changed hands constructive receipt has occurred. Where constructive receipt has occurred in a case involving taxable damages such as an employment or commercial damage case, there is potential for tremendous tax exposure that could have been easily avoided and a potential malpractice exposure for the attorney.

A promise to pay future periodic payments to establish a periodic payment obligation is a critical to establish a structured settlement

Regardless of whether the structured settlement is (1) qualified (medical malpractice, wrongful death, workers compensation, auto, product liability involving damages on account of personal physical injury or physical sickness); or (2) non-qualified structured settlements (wrongful termination, harassment in the workplace, discrimination in workplace, intellectual property and other commercial claims . Even in mass torts where a qualified settlement fund has been established to aggregate settlement money in a big pot for claimants similarly situated, an obligation to pay on the part of the QSF is a critical component of the establishment of a structured settlement.

You may find this video, featuring 4structures.com LLC president John Darer on Constructive Receipt to be helpful.

Last updated September 5, 2024

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