The marketplace for these annuities has evolved to handle a wider range of cases—workers’ compensation claims, employment claims, non-bodily injury property and casualty claims, and other negotiated settlements. SSA arrangements have been used in commercial business transactions as well.
The previous drawback of using SSA arrangements for non-qualified cases was the inability to avoid adverse tax treatment for the assignments. Life insurers have overcome this problem by creating assignment companies in Barbados. Article 18 of the U.S.-Barbados Income Tax Treaty provides for favorable taxation of annuity benefits, overcoming the limitation of section 72(u) dealing with annuities owned by a non-natural person. This adverse tax treatment is not applicable to SSA arrangements that qualify under Section 104 and Section 130.
Attorneys have not widely used SSA arrangements for a variety of reasons. First, the annuity contracts offer very conservative returns, and in the current low-interest-rate environment, these returns have been miniscule. Second, a plaintiff’s firm has tremendous up-front expenses to litigate a case. Third, most SSA brokers do not have the proper licensing with the Financial Industry Regulatory Authority to offer a variable annuity solution to provide investment upside for the deferred contingency fee.
The annuity contracts in the SSA marketplace include both deferred and immediate annuities. However, the annuity contracts used have been fixed annuity contracts where the policy’s crediting rate has been tied to the investment performance of the insurer’s general assets.
The use of a private placement variable deferred annuity (PPVA) as an SSA is something completely new to the SSA marketplace. What is arguably the best solution in terms of costs and investment flexibility is not being offered by SSA brokers.
Tax support for the deferral of attorney’s fees. In Childs v. Commissioner, 103 T.C. 634 (1994), aff’d, 89 F.3d 856 (Table) (11th Cir. 1996), the Tax Court ruled in favor of an attorney fee deferral arrangement. This decision was the first and only case supporting the right of an attorney to defer contingency fee income. The court ruled that the attorney did not have constructive receipt of his fees because the attorney did not have any right to a fee until the settlement agreement was signed. Before signing the agreement, the attorney agreed to receive his fee over time. The attorney also did not have any economic benefit. The life insurer’s guarantee did not meet the definition of property under Section 83. The Service acknowledged the holding in a discussion of construction receipt in FSA 200151003.
Section 409A, which was added to the Code in 2004, deals with the requirements for deferred compensation arrangements. The Service issued a notice entitled “Guidance Under § 409A of the Internal Revenue Code” on December 20, 2004. The notice’s question-and-answer section provides that the limitations of Section 409A do not extend to this type of fee deferral arrangement.
In January 2005 the Supreme Court issued a decision in the consolidated cases of Commissioner v. Banks and Commissioner v. Banaitis, 543 U.S. 426 (2005). The Court ruled that attorneys do not have a property interest in the settlement recovery. This is a critical element enabling an attorney to defer fees.
Tax requirements for deferring contingency fee income. An attorney must avoid the application of the constructive receipt and economic benefit doctrines. An attorney should adhere to the following guidelines in structuring a deferred fee arrangement.
Settlement agreement. The settlement agreement must certify that a contingency fee arrangement between the plaintiff and attorney is in place and that deferred payments are directed to the attorney for the benefit and convenience of the plaintiff to meet the plaintiff’s attorney’s fee obligation. The amount and timing of the payments should be specified in the agreement. This agreement must be made in writing before the fees are earned. The election must be irrevocable. The lawyer’s fee agreement with the client should allow the lawyer to receive all or a portion of contingency fees in the form of periodic payments.
The agreement should contain the attorney’s acknowledgement that the SSA payments “cannot be accelerated, deferred, increased or decreased by the attorney; nor shall the attorney have the ability to sell, mortgage, encumber or anticipate the periodic payments or any part thereof, by assignment or otherwise.”
Assignment. The settlement agreement must require the defendant to assign the settlement obligation to an assignment company. The assignment terminates the defendant’s obligation to make periodic payments. The life insurer issuing the annuity typically owns the assignment company. The agreement should contain a provision that the assignment company maintains all ownership rights and control of the annuity.
Annuity purchase. Under the terms of the assignment agreement, the assignment company purchases an annuity contract from an affiliated life insurance company to fund its obligation. Funds can be held in a qualified settlement fund (QSF) until the annuity is purchased.
PPVA contracts. PPVA contracts are institutionally priced variable deferred annuity contracts for accredited investors and qualified purchasers as defined under federal securities law. Unlike retail variable annuity contracts, these contracts are unbundled and transparent. The contracts have no surrender penalties and are essentially “no load/low load” contracts. The policy assets are not subject to the claims of the life insurer’s creditors. These contracts provide for the ability to customize the investment options of the contract to include alternative investments such as hedge funds, private equity, and commodities.
The investment performance of the PPVA contract is a direct pass-through to the policyholder, the assignment company. The increased account value within the annuity may increase the attorney’s future periodic payments.
The attorney may recommend an investment advisor to the insurance company that may enter into an investment management agreement with the insurer to manage the assets of the annuity contract. The lawyer cannot control the investment decision-making authority of the investment advisor.
Summary. The combination of private placement deferred annuity contracts and structured products provide an exciting solution for plaintiff’s attorneys who wish to defer their legal fees. The deferral in virtually every case crosses the breakeven threshold immediately. The deferral of contingency fees is a powerful alternative to any of the qualified plan benefits available to the lawyer through the law firm’s sponsored benefits.
Law firms may use these arrangements to provide for retention of key employees and attorneys. A law firm may manage the occasional financial insecurity of the law firm’s cash flow by anticipating overhead expenses and structuring payments to meet these obligations.
The use of PPVA contracts with structured investment products provides an opportunity to revolutionize the use of deferred fee arrangements for plaintiff’s attorneys.
ABA SECTION OF TAXATION
This article is an abridged and edited version of one that originally appeared on page 11 of Section of Taxation NewsQuarterly, Summer 2012 (31:4).
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