Structured settlements are tax free awards to the original annuitant, per U.S. Code § 130, and carriers therefore do not issue IRS form 1099-INT for the the payments to the original payees.
U.S. Code § 5891 and IRS audit guidelines outline how a new assignee obtains an existing payment stream by means of qualified order in compliance with § IRS Section 5891. This is the path followed by DCF Exchange on all transfers of structured settlement payments and is documented in the closing book. These assigned payments are what we call ‘secondary market annuities’.
In an IRS § 5891 compliant transfer, the tax free treatment of income is preserved for the original annuitant, and the parties do not face a risk of an excise penalty tax. But just because the payments are tax free to the original annuitant and no 1099-INT is issued, this does not mean it’s tax-free to the purchaser of an assigned payment stream.
As with any type of income, the tax treatment of income from assigned structured settlement payments is ultimately determined by the taxpayer and their tax adviser. Income from assigned payment streams is typically considered ordinary income and is recognized when received.
The proportion of income vs principal in any given payment is determined by the taxpayer using either an amortization schedule, or an exclusion ratio applied to the whole payment stream. The exclusion ratio is shown on the amortization schedule for all payment streams sold by DCF Exchange. Please note, if the payment is in an IRA then all IRA distributions will be taxed when they are taken, not when payments are received into your IRA.
How To Calculate Interest Using The Exclusion Ratio
The exclusion ratio works like this: say you paid $100,000 and will receive $200,000 over 100 payments of $2000 each. Exactly 50% of each payment would be income, and 50% is return of principal. Consult your adviser, but generally, this income is “ordinary income” for IRS purposes.
The exclusion ratio therefore is 50%- 1/2 of each payment is taxable income. This article explains it well, but consult your tax adviser for specific questions.
To be fair, there may be alternative ways to reflect the principal and interest in your payment stream by using an amortization schedule, which can be downloaded from the inventory page and will be provided with your closing book.
This method treats the payment stream in the same manner you would treat a loan or other receivable, where you are the lender, and recognizes interest income predominately in early years, and principal in latter years. This may or may not be beneficial for you.
At this time, it’s our understanding you can use either the amortization method, or the exclusion ratio method, to calculate your taxes. But be sure to consult your own tax adviser.
Summary of Taxes and Secondary Market Annuities
So even though will not be receiving a 1099 for the payments from the carriers based on current tax law, what happens in the future to tax law is anyone’s guess. Some now use an amortization schedule to allocate principal and interest, while others use the exclusion ratio.
DCFAnnuities.com and DCF Exchange, LLC do not offer tax advice, and this page is for general information only, so please be sure to consult your own tax adviser for more info.