Constructive Receipt Doctrine - Questions and Answers
- by Broberck Phleger & Harrison
Q. What is “Constructive Receipt?”
A. It’s a doctrine that taxes income before the income is actually received. The two other doctrine tax income are the “actual receipt” doctrine (i.e., you really receive it) and the “economic benefit” doctrine (not applicable to structured settlements).
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. S 1.451-2(a).
Q. Is it often a problem in litigation?
A. No. The two situations where the constructive receipt doctrine usually applies are (i) completed settlement negotiations and (ii) final judgments.
Q. How can it affect structured settlements?
A. If the settlement is complete or the judgment is final, then a structured settlement can’t be used. The constructive-receipt doctrine would cause the present value of the settlement to be treated as the nontaxable compensation for the personal injury. Any interest earned on the annuity or bond that funded the settlement would be taxed to the plaintiff. Rev. Rul. 76-133, 1976-1 C.B. 34 (settlement deposited in court was tax free but interest earned was taxable to plaintiff); Rev. Rul. 65-29, 1965-1 C.B. 59 (actual receipt of present value of future damages is not taxable, but earnings are taxable).
Q. Where does it operate in daily life?
A. Savings account interest is an 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 your ability to get it. On the other hand, if there is a substantial limitation on your ability to receive it (a penalty if you pick it up, for example), then you are not in constructive receipt of the interest until the limitation is removed.
Q. What’s the general rule that governs each of the following examples?
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. Like a penalty imposed on receiving savings-accounts interest, the requirement that the plaintiff agree to release her 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 limitation are present 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 the amount, conditioned on agreeing to a structured settlement using that amount. 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. Pric. Ltr. Rul. 83-33-035 (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, or 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 of the amount invested in the annuity contract”).
Q. Discussion of periodic payments. The plaintiff has rejected the amount that was offered. The plaintiff has countered with a higher amount, conditioned on agreeing to a structured settlement. The defendant has agreed to the higher amount. We are now 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. We have agreed on the amount the defendant will spend. We have also agreed on the timing and amount of each periodic payment. The plaintiff has agreed to release the claim if a mutually acceptable 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 amounts?
A. No. verdict findings 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. No. The judgment must be final and non-appealable. A structured settlement can still be used if good faith appellate issues exist that would put the amount of the judgment in doubt.
Q. Judgment is final. The judgment has been entered and the time within which to seek reconsideration of the judgment or to appeal the judgment has expired. 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 affect 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 used to settle the appeal.
Q. No-strings offer to pay. What if the defendant offers to pay part of the judgment with no strings attached while the appeal is pending?
A. If the plaintiff refuses a no-strings offer to pay, then the plaintiff will be in constructive receipt of the amount offered. Such offers are rare, however. Normally, a defendant will condition such an offer on dropping further appeals. Where no such condition is present, however, the amount offered will trigger the constructive-receipt doctrine. See, e.g., Howard A. Fromson v. U.S., No. 92-98T (Cl. Ct. Aug. 11, 1994) (check received in 1986 from the judgment debtor, with no strings attached, was taxable in 1986, even though cashed by the plaintiff in 1987).
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