What is Constructive Receipt?
When setting up a structured settlement annuity, one of the most important tax rules attorneys and clients must understand is the concept of constructive receipt. Constructive receipt determines when settlement funds are considered received for tax purposes, and it plays a critical role in preserving the tax-free status of a qualified structured settlement.
Under the doctrine of constructive receipt, a client may be treated as having received settlement money even if they never physically touch the funds. For example, if the settlement proceeds are deposited into the attorney’s trust account and are available for the client to access, the IRS can view this as the client having control over the funds. When that happens, the client can lose the ability to fund a structured settlement annuity and forfeit the significant tax-free growth and tax-free future payments that these annuities provide.
Because constructive receipt is triggered by how settlement funds are handled—not just who touches them—attorneys must ensure the portion of the settlement intended for the annuity never becomes available to the client. Understanding this rule is essential to protecting the structured settlement’s tax advantages, preventing avoidable tax consequences, and ensuring clients receive the full long-term financial benefits of a structured settlement annuity.
Receiving Funds into an Attorney’s Trust Account
Annuity companies don't want the structured settlement annuity funds to be sent to an attorney’s trust account because they believe it may jeopardize the income tax exclusion on those annuities. If settlement funds hit the attorney’s trust account, the life insurance companies treat the client as though he or she has received the funds personally. As a result, the client then loses the ability to place those funds into a qualified structured settlement annuity and benefit from the tax exclusion on the interest that the annuity earns. Learn more about structured settlement annuity rates.
So, if a client wants to place all or a portion of their settlement into a structured settlement annuity, the attorney must ensure that the part of the settlement that will be used to fund the structured settlement annuity goes directly from the defendant’s insurer to the annuity company’s assignment company — without those funds ever being sent to the attorney.
Of course, the cash portion of the settlement that will be used for expenses (legal fees, costs, liens, etc.) can be paid to the attorney’s trust account. The funds at issue are only the amount that will be placed into the annuity.
If you have a case where a client wants to place a portion of the settlement into a structured settlement annuity, we are happy to walk through all of these steps with you and your client. It's not something attorneys necessarily need to worry about. However, attorneys do need to understand what constructive receipt is and why it's important in a structured settlement annuity context.
Does Constructive Receipt Apply When Setting Up a Special Needs Trust?
We often receive questions about whether constructive receipt applies if a client wishes to set up a special needs trust. The answer, in most states, is no. Attorneys can receive funds into their trust account without affecting the tax-free nature of the settlement and without jeopardizing the ability to place the funds in the special needs trust.
Settlement funds can then be transferred from the attorney trust account directly to the special needs trust.
Conclusion
If clients want to set up structured settlement annuity, attorneys need to ensure that the funds are sent directly from the defendant to the life insurance company (and not to their trust account). By doing so, the client can enjoy the tax exclusion benefits of the annuity (read our guide on taxation of structured settlements for more insights).
If you have any questions about how constructive receipt in situations involving structured settlement annuities, please feel free to give us a call.
Through Amicus Settlement Planners, we assist clients and personal injury attorneys with structured settlements, asset management, and strategic financial planning.
