Structured settlement payments are typically received tax free by the original annuitant, per 26 U.S. Code § 104. Therefore, carriers do not issue IRS Forms 1099 to the original payees.
U.S. Code § 5891 and IRS audit guidelines outline how a new assignee may obtain an existing payment stream from an original payee without incurring an excise tax – most importantly, a qualified court must determine that the purchase is in the original annuitant’s “best interests.”
This is the path followed by DCF Exchange on all transfers of structured settlement payments and is documented in our closing book.
DCF Income Payment Taxation:
While the sale proceeds are not taxable for the original payee, the portion of a DCF Income Payment that is income (vs principal) is subject to tax for the purchaser. Carriers do not issue IRS Forms 1099 to the purchaser, but the taxable income portion of each payment is the taxpayer’s responsibility.
Income from assigned payment streams are typically considered ordinary income and recognized for tax purposes only when it is received, leaving unrealized income to defer, accrue, and compound.
The portion of a payment that is reportable as income (and not principal) is ultimately determined by the taxpayer. However, DCF Exchange obtained guidance confirming favorable deferral treatment of DCF Income Payments from a well-recognized nationwide accounting firm, which we make available to our clients. This guidance states that the income portion of a payment is (1) the amount received minus (2) the price of purchase for that payment. That allows for substantial deferral as early payments have proportionally less taxable income, and later payments have more.
DCF Exchange performs the calculations following this reporting method and displays the taxable portion of each DCF Income Payment on the Payments Schedule.
Some purchasers choose to compute taxes based on an “exclusion ratio” applied to the whole payment stream so as to obtain a consistent ratio of income vs. principal across all payments. For purchasers who use this less favorable tax deferral method, DCF computes the exclusion ratio on the Payments Schedule. While DCF has not obtained tax advice regarding this method, we understand that many purchasers of structured settlement payments use this method of tax reporting.
Taxation of DCF Income Payments in IRAs
Please note, if a DCF Income Payment is owned by your IRA then the tax treatment above does not apply, as IRA distributions trigger taxes for IRA holders, not the income from IRA owned assets.
DCF Exchange, LLC does not offer tax advice, and this page is for general information only, so please be sure to consult your own tax adviser for more information.