Constructive Receipt Doctrine

The Internal Revenue Code (IRC) governs the taxation of income by way of doctrines which determine the conditions under which income is subject to taxation. The "constructive receipt" doctrine taxes income before the income is actually received. Two other doctrines, the "actual receipt" doctrine and the "economic benefit" doctrine also govern taxation, however, the latter doctrine does not normally apply to tort case recoveries.

Actual receipt or "triggering" the constructive receipt doctrine will subject income to taxation. Elements or actions which do not trigger the constructive receipt doctrine include:

. Negotiating the structure funding amount

. Knowledge of the annuity cost

. Negotiating a split-funded structure

. Countering structure plan design

. Establishing a court-ordered structured settlement

Q. Where can I find the doctrine in the law?

A. the constructive receipt doctrine is in the Treasury's regulations as follows: "(a) General Rule. Income, although not actually reduced to a taxpayer's possession is constructively received by him in the taxable year during which it is credited to his account, set apart for him, or otherwise made available so that he may draw upon it at any time, or so that he could have drawn upon it during the taxable year if notice of intention to withdraw had been given. However, income is not constructively received if the taxpayer's control of its receipt is subject to substantial limitations or restrictions." Treas. Reg.d 451-2(a).

Q. What is an example of how the constructive receipt doctrine applies?

A. Savings account interest is one example. Such interest is taxed to you even if you haven't gone to the bank to pick it up. Such interest is constructively received by you, because there is no limitation on receiving it, such as a penalty if you pick it up. You are not in constructive receipt of the interest until the limitations is removed.

Q.How does the constructive receipt doctrine affect negotiations and settlement of personal injury claims?

A. The general rule is that the plaintiff cannot be in constructive receipt of the defendant's lump sum offer if the plaintiff has not agreed to provide a release. As with a penalty imposed on receiving savings account interest, the requirement that the plaintiff agree to release the claim is a "substantial limitation" that prevents the constructive receipt doctrine from operating. If the plaintiff has agreed to give a release or drop an appeal, then the plaintiff is in constructive receipt of the offered money, assuming the money is collectible and no other limitations are imposed on its receipt.

Pre-verdict examples

Q. Lump-sum offer: The defense has offered a lump sum to settle the claim, which the plaintiff is considering, Does the plaintiff have a constructive receipt problem?

A. No. Mere negotiations do not trigger the constructive receipt doctrine. A Structured settlement can be used to settle the claim.

Q.Lump sum conditioned on structure: The plaintiff has agreed to settle the Claim for a specified amount, conditioned on agreeing to a structured settlement plan of payments. Is there a constructive receipt problem yet?

A. No. Discussing the amount the defendant will spend on the structured settlement will not cause the plaintiff to be in constructive receipt of that amount. Priv. Ltr. Rul. 833-33-035 (May 16, 1983) ("disclosure by defendant of the existence, cost, or present value of the annuity will not cause you to be in constructive receipt of the present value of the amount invested in the annuity"); Priv. Ltr. Rul. 90-17-011 (Jan. 24, 1990) ("knowledge of the existence, cost, and present value of the annuity contract used to fund the settlement offer. will not cause the family to be in constructive receipt of the amount payable under the annuity contract or the amount invested in the annuity contract")

Q. Discussion of periodic payment:The plaintiff has rejected the amount that was offered. The plaintiff has countered with a higher amount, condition on agreeing to a structured settlement. The defendant has agreed to the higher amount. You are discussing the timing and amount of the periodic payments. Any problem yet?

A. No As long as the plaintiff has not agreed to release the claim, the negotiations can continue without a constructive receipt problem.

Q. Conditioned on a settlement agreement: The parties have agreed or the amount the defendant will spend. They have also agreed on the timing and amount of each periodic payment. The plaintiff has agreed to release the claim if a mutually acceptable settlement agreement can be drafted. Can the structured settlement still be modified?

A. Yes. Conditioning the release on a mutually acceptable settlement agreement will prevent the constructive-receipt doctrine from operating. Until the settlement is final, the parties can continue to negotiate.

Post-verdict examples

Q. Verdict reached. A verdict has been reached. Is the plaintiff in constructive receipt of the verdict amount?

A. No. Verdict finding cannot be reduced to the plaintiff's possession and the doctrine therefore does not operate. A structured settlement can still be used.

Q. Judgment entered. The judgment has been entered in the amounts found by the jury. Is the plaintiff in constructive receipt of the judgment amounts?

A. Yes. If the defendant is willing and able to pay the amount of the judgment, then the plaintiff is in constructive receipt of the judgment amount. A structured settlement cannot be used in those circumstances.

Q. Effect of appeal. How does an appeal effect the constructive receipt doctrine?

A. A good-faith appeal that puts the amount of the judgment in doubt prevents the constructive receipt doctrine from operating. A structured settlement can be used to settle the case during such an appeal.

Q. Appeal to negotiate. Can the parties file an appeal solely to allow more time to negotiate a structured settlement?

A. No. A tax-motivated appeal will probably be ignored by the Internal Revenue Service. The appeal must be a good-faith appeal that puts the amount of the judgment in doubt.

Q. Offer to pay judgment. The defendant has offered to pay the judgment if the appeal is dropped. Is the plaintiff in constructive receipt of either the judgment amount or the offered amount?

A. No. Conditioning the payment on dropping the appeal prevents the constructive receipt doctrine from operating, in the same way that a pre-verdict settlement offer conditioned on a release prevents it from operating. A structured settlement can still be sued to settle the appeal.