World Factoring Industry $3 Trillion Business
What is the history of factoring?
Factoring transactions occur when recipients of structured settlement payments agree to transfer the right to receive future payments to a third party in return for an immediate, discounted lump sum payment.
Structured settlement payment plans are designed to meet the current and future financial needs of physical injury victims and their families. Occasionally, circumstances change, and the claimants believe that the agreed-upon payment plan no longer meets their needs.
Secondary market in the structured settlement industry
Consequently, the 1990s saw the advent of a new, secondary market in the structured settlement industry. This secondary market, known as the factoring market, was born from the need of some claimants to relinquish all or a portion of their agreed-upon structured settlement benefits in return for an immediate, discounted lump sum payment
Congress began regulating the sale of income tax-free structured settlements to third parties in 2001 to help safeguard physical injury victims from jeopardizing their financial future by relinquishing the future value of their benefits for a lesser lump sum.This legislation created Internal Revenue Code section 5891.
Section 5891 requires that an order be acquired from a court of law within the state in which the annuitant resides, in agreement with that state’s Structured Settlement Protection Act. If there is no Structured Settlement Protection Act in the state in which the annuitant lives, then the court order can be obtained in the state where the insurance company is domiciled, in accordance with the Structured Settlement Protection Act in that state. Underscoring the critical need to protect recipients of structured settlement payments,this section imposes a 40% excise tax on purchasers
of structured settlement payment rights factoring companies that fail to obtain a qualified order in compliance with the applicable state Structured Settlement Protection Acts. This excise tax, which is essentially a penalty tax, is charged on the profit earned by the factoring company from said transactions.
Structured Settlement Protection
Nearly all states and the District of Columbia have enacted a Structured Settlement Protection Act. These Acts require the factoring company to provide certain disclosures to the structured settlement payees, prior judicial approval of the transfer of structured settlement payments rights, and transparency of all fees to be charged
Since the structured settlement payee is receiving an amount that may be significantly less than the present value of the future income stream, when considering entering into a factoring transaction, the structured settlement payee should seek the guidance of a financial advisor and/or an attorney of their own choosing. The tax consequences of the transaction should be fully understood, and the firm purchasing the settlement should be fully researched. Its reputation, soundness and history of complying with laws should be confirmed. In addition, other options for obtaining funds should be considered carefully by a structured settlement payee before “selling” their structured settlement payment rights.
The future of structured settlements
Increasing awareness of the value of structured settlements among attorneys, judges, mediators and legislators is critical to ensuring that structured settlements continue to be effective in providing for the long-term financial needs of physical injury victims.
Legal professionals, in particular, are key influencers of the decisions made by physical injury and wrongful death claimants. Expanding the knowledge and appreciation lawyers and judges have of structured settlements is critical to the industry’s future success.
Looking ahead, other factors that could impact the structured settlement marketplace and, more importantly, the financial security of physical injury victims include federal tax reform, tort reform and other regulatory changes.
Federal Tax Reform
As the federal government shifts its focus to federal tax reform, it is important that members of the U.S. Congress are familiar with structured settlements and understand the value these arrangements provide to injury victims and their families.
Recognizing this need, Congressman John Lewis (D-GA) and Congressman Jim Sensenbrenner (R-WI) formed the bipartisan Congressional Structured Settlement Caucus. The focus of the Caucus is to educate members of Congress on the importance of structured settlements to people with serious injuries.
This Caucus and the concerted education and awareness campaigns aimed at members of Congress and facilitated by industry advocates such as the National Structured Settlements Trade Association (NSSTA) and the American Association of People with Disabilities (AAPD) will be central to safeguarding the tax preference of structured settlements.