26 US Code 5891: Tax on Structured Settlement Factoring
Learn how a federal tax on selling future payments is designed to guide these transactions through a court approval process ensuring fairness for the seller.
A structured settlement provides periodic payments, often from a personal injury lawsuit or workers’ compensation claim, for long-term financial support. Individuals may sell their rights to these future payments for an immediate lump sum through a process called structured settlement factoring. To regulate this industry, the Internal Revenue Code imposes a tax on these transactions. This measure discourages transfers unless specific protective conditions are met, ensuring the seller’s financial well-being is considered.
The Excise Tax on Factoring Transactions
Internal Revenue Code Section 5891 imposes a federal excise tax on structured settlement factoring transactions. The tax is set at a 40% rate and is applied to the “factoring discount.” This discount is the difference between the total future payments being acquired and the immediate cash amount paid to the settlement recipient, representing the factoring company’s profit.
The legal responsibility for payment rests entirely with the acquirer of the payment rights, as the individual selling their future payments is not liable for this 40% excise tax. The tax serves to penalize factoring companies for failing to adhere to consumer protection standards. It applies to any person or company that acquires structured settlement payment rights for consideration.
Calculating the Tax Base
The calculation of the tax base, or the factoring discount, begins by determining the total undiscounted value of the future payments being sold. This figure is the sum of all payments the individual is forfeiting, without any reduction for the time value of money. For example, if an individual sells the rights to 15 annual payments of $10,000 each, the aggregate undiscounted amount is $150,000.
The lump-sum payment the factoring company provides is then subtracted from this total. If the company pays $60,000 for the rights to those future payments, the factoring discount is $90,000 ($150,000 – $60,000). The 40% excise tax is then applied to this amount, resulting in a tax liability of $36,000 for the factoring company.
The Qualified Order Exception
The 40% excise tax is rarely paid because the law includes an important exception. The tax does not apply if the transfer of payment rights is approved in advance by a “qualified order” from an applicable state court. This judicial oversight is the primary way the law protects settlement recipients.
To issue a qualified order, a state court must determine that the transfer is in the best interest of the person selling the payments, considering the welfare and support of their dependents. A judge evaluates the seller’s financial situation, the reasons for the sale, and whether the transaction is fair and reasonable.
The law also requires that the seller was advised in writing to seek independent professional advice regarding the transfer. The court must also find that the transaction does not violate any applicable state or federal statute. Since nearly all states have enacted Structured Settlement Protection Acts that mandate this court approval, obtaining a qualified order has become the standard procedure for completing a factoring transaction.
Filing and Reporting Requirements
If a factoring transaction proceeds without a qualified order, the acquiring company becomes liable for the 40% excise tax. The company must report and pay this tax to the IRS using Form 8876, “Excise Tax on Structured Settlement Factoring Transactions.” The responsibility for filing the form and remitting the tax falls solely on the acquirer.
A separate Form 8876 must be filed for each transaction that incurs the tax. The deadline for filing the return and paying the tax is the 90th day after the company receives the structured settlement payment rights. Failure to meet this deadline can result in additional penalties and interest.