The Office of Chief Counsel of the Internal Revenue Service (IRS) recently issued a memorandum addressing the excise tax imposed by §5891(a) of the Internal Revenue Code related to various scenarios where a factoring company obtains a court order, pursuant to a Structured Settlement Protection Act (SSPA), from a state other than the state of the payee’s domicile.

The memorandum focused on the following scenarios:

  • Under scenario 1, payee and factoring company enter into an agreement pursuant to which factoring company will acquire payee’s structured settlement payment rights in exchange for a lump sum. State A, where payee is domiciled, has a SSPA. Factoring company does not file the petition in State A, but rather filed in State B and represented in its petition that the payee is domiciled in State B. State B approved the petition and factoring company begins to receive payment pursuant to the court order issued by State B. The IRS concluded the §5891(a) excise tax applies against factoring company. Since payee is domiciled in a state that has a SSPA, in order to qualify for the exception in §5891(b) from the 40 percent tax imposed by §5891(a), factoring company must obtain a “qualified order” that complies with §5891(b)(2) from the state where payee is domiciled, approving, in advance, the transfer of payee’s payment rights to the factoring company.
  • Under scenario 2, the facts remain the same as in Scenario 1, except that subsequent to the order issued by the court in State B, the IRS initiates an examination of factoring company records and proposes asserting the tax on the transaction described in Scenario 1, arguing the factoring company did not obtain a “qualified order” under §5891(b)(2). Factoring company attempts to remedy the situation by filing a petition in State A to approve the transfer pursuant to the original State B order. The court in State A subsequently approves the transfer and issues an order. The IRS concluded the §5891(a) excise tax applies against factoring company. Section 5891(b)(1) states the tax imposed under §5891(a) shall not apply to a structured settlement factoring transaction in which the “transfer of structured settlement payment rights is approved in advance in a qualified order.” Since the court order from State A was obtained after the transfer of the payment rights from payee to the factoring company pursuant to the State B court order, the requirements of §5891(b)(1) have not been met.
  • Under Scenario 3, the facts are the same as the facts in Scenario 1, except that payee decides to sell the future payment rights to a parent of the factoring company. The parent brings its petition to the court in State B and requests that the court approve and order the assignment of the payments to the subsidiary, which is wholly-owned and finances the parent’s transactions. The court in State B approves the transfer and issues an order directing payments to the subsidiary. The IRS concluded an excise tax can be asserted against the parent for the same reasons as in Scenario 1. In addition, based on the “directly or indirectly” language in §5891(a), the tax may be asserted against the subsidiary if the IRS finds that the parent is a shell company or straw man; or that the substance of the transaction is that the subsidiary indirectly acquired the structured settlement payment rights.

It appears the IRS is sending a message to factoring companies in light of the increasing forum shopping issues and aggressive tactics employed by certain factoring companies to obtain court approvals. Insurers’ practices and responsibilities related to transfer petitions are not directly implicated by the issuance of this memorandum; however, the memorandum could be a useful tool when dealing with factoring companies and related venue issues.

View the entire memorandum here