In a series of twelve Private Letter Rulings (which cannot be cited as precident) the IRS has ruled that the sale of settlement rights received by the survivors and/or decedents estates will be considered non-taxable.
In the case, the estates of those killed sued and received a financial award for the wrongful death and intentional infliction of emotional distress. The estates were granted summary judgement by the palintiffs and awarded an unstated aggregate recovery of compensatory damages, interest, and putnative damages.
The defendent appealed the summary judgement, and while on appeal, the estates/beneficiaries sold the rights to the award to an investor for an immediate cash payment. The estates/beneficiaries looked to the IRS for guidance concening the taxability of this transaction.
The IRS looked at §104(a)(2) and Regulation §1.104-1(c) which governs that awards received on account of personal physical injury or sickness are non-taxable. Additionally, §1605 of the Small Business Job Protection Act of 1996 expands the definition to include those pertaining to the wrongful death and emotional distress attributable to a physical injury.
In general, if you are trading the rights to a future payment, the lump-sum payment will maintain the same tax characteristics as the future payment. In the case of a lottery winner, the trade of annuity rights for a lump-sum causes ordinary income. This has been taken through the courts, as many lottery winners attempted to modify the tax characteristics by claiming that it shoudl be a capital gain transaction.
Citations: PLR200942007 (Jul. 06, 2009)
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