Tax the PAYOR of wrongful death settlement?

About 15 years ago, guy kills his wife. He pleads guilty to voluntary manslaughter, serves 10 years and gets out. Had some money. Wife's estate obtains a $124 million judgment against husband (wrongful death, I assume). Agreement is reached for him to settle that judgment for 75% of his investment and pension fund assets.

How the family recipients are taxed, if at all, is interesting, but is not my main question. How is he taxed? A lot, I hope.

He can transfer stocks and bonds directly from taxable accounts and avoid paying tax on the unrealized gains. With the pension fund assets, he's going to have to pay taxes and any penalties that may apply. Those can't be transferred directly unless the entire account is transferred to a beneficiary.

Why would the direct transfer of stocks and bonds from taxable accounts not be considered a sale?

Right, I forgot about the payment-in-kind / barter transaction rules. I was thinking in terms of a gift, but it clearly isn't a gift.

Although gain is realized, this is a payment rather than a literal sale. For tax purposes, are there any differences between the two types of transactions?

Transfer of appreciated assets from regular (i.e., not pension or other accounts) would, I think, be satisfaction of a liability with appreciated property, a taxable exchange that, I think, is not different from a "literal" sale. I hope the answer to this next one is "no". If the investments have declined in value, does he get to claim the loss? (I think the only heir is a daughter).

I've since learned that the pension fund assets are IRAs. I'm certain he's well over 55 years old. Not sure whether they are Roths.

With the pension fund assets, he's going to have to pay taxes and any penalties that may apply. Those can't be transferred directly unless the entire account is transferred to a beneficiary.. I did not know that. So he can't just direct the custodian or trustee to send a check to the estate or heirs and have it treated as a constructive distribution to him, with a 1099R, and a tax due? Instead, he has to pull out the entire account and pay tax on all of it? Good! Not looking to help him in any way; don't even know him, but I remember reading about the murder years ago and it still disgusts me. But could he do a rollover on the 25% he's allowed to keep?

Surely the heir(s) (only a daughter, I think), don't get taxed on any of the $2.25 million settlement, right? Like, for instance, as a taxable distribution from the IRAs?

Now a really way out question. Did the $124 million judgment that got settled at about $2.25 million create COD income to the killer? I hope so.

And one more. Is there any way section 1041 enters the picture here? I assume not.

If the investments have declined in value, does he get to claim the loss? (I think the only heir is a daughter).

If, as you say, a direct transfer of the property is no different from a sale, then no matter how he decides to use the assets, I think there will be a capital loss on property held for investment, deductible above the line.

I've since learned that the pension fund assets are IRAs. I'm certain he's well over 55 years old. Not sure whether they are Roths.

The age 55 exception applies to plans taken out with an employer. For IRA's, the relevant age is 59½. But that may not matter for our facts.

With the pension fund assets, he's going to have to pay taxes and any penalties that may apply. Those can't be transferred directly unless the entire account is transferred to a beneficiary.. I did not know that. So he can't just direct the custodian or trustee to send a check to the estate or heirs and have it treated as a constructive distribution to him, with a 1099R, and a tax due?

You misunderstand me. While the assets can't be transferred directly, I don't see anything stopping him from selling the assets and transferring cash. Whether a check could be cut directly to a third party might depend on who the custodian is.

Surely the heir(s) (only a daughter, I think), don't get taxed on any of the $2.25 million settlement, right? Like, for instance, as a taxable distribution from the IRAs?

The settlement is clearly income. To avoid tax, there would have to be an exclusion provided for in the Code. In reviewing §§  101-140, I don't see anything that seems to apply. Since the death was 15 years ago, § 104(c) is out.

Now a really way out question. Did the $124 million judgment that got settled at about $2.25 million create COD income to the killer? I hope so.

I think the contested liability doctrine would apply. See Zarin v. Commissioner, 916 F.2d 110.

And one more. Is there any way section 1041 enters the picture here? I assume not.

I also assume not. He's not transferring anything to the wife or to a trust for the benefit of the wife.

If, as you say, a direct transfer of the property is no different from a sale, then no matter how he decides to use the assets, I think there will be a capital loss on property held for investment, deductible above the line.. How about section 267?

For IRA's, the relevant age is 59½. But that may not matter for our facts.
. I should have said 59-1/2. He's over that.

How about section 267?

I think you might have something there, assuming the settlement is for the assets themselves and not just an amount equal to 75% of their value. Even if he sells the assets first and then provides cash, we might employ the step transaction doctrine or something like it.

But if the plaintiff in the settlement receives cash, it seems dubious that she could ever benefit from the provisions of section 267(d). That's either an argument against your section 267 theory or a reason for her to request a direct transfer of the assets.

I looked at some old news articles on the case, and it seems the $124 million award was (mostly) for punitive damages. I'm not sure "wrongful death" was a term used in the lawsuit, but it probably does not matter. Punitive damages are taxable.

I'll throw this against the wall and see if anyone thinks it sticks. The big award was to the wife's estate. If she had been injured, not killed, one would assume it would have been an award to her. It was an award to punish him for what he did to her while she was alive, that killed her. So it's income in respect of a decedent, treated however it would have been treated had she received it in her lifetime. That treatment would have been, under 1041, as a gift to her, with his basis carrying over. Good for her in that there is no current income to her, but bad because she'd take his (lower, we think) basis. Unfortunately, it'd also be good for him. Unless he sells the investments first and pays the proceeds to the estate, which would be good for the estate and bad for him.

Chay, in #6 you said Since the death was 15 years ago, § 104(c) is out.. Later, I said Punitive damages are taxable.. Do we need to re-consider this? What is the relevance of the 15 years? Don't we need to look at the applicable state law that was in effect in Sept 1995, without any changes that may have occurred since that date? If said law provides that only punitive damages may be awarded for wrongful death, then don't we need to see if that law no longer provides that (or is so construed)? If it still provides that, then don't we still have an exclusion?

You're right. I misread the section, thinking that the decision that must take place on or before September 13, 1995 was a decision with respect to a specific wrongful death suit.

Here is the PA statute on wrongful death.

42 Pa. C.S. § 8301
Section 8301 - Death action

(a) General rule An action may be brought, under procedures prescribed by general rules, to recover damages for the death of an individual caused by the wrongful act or neglect or unlawful violence or negligence of another if no recovery for the same damages claimed in the wrongful death action was obtained by the injured individual during his lifetime and any prior actions for the same injuries are consolidated with the wrongful death claim so as to avoid a duplicate recovery.
(b) Beneficiaries Except as provided in subsection (d), the right of action created by this section shall exist only for the benefit of the spouse, children or parents of the deceased, whether or not citizens or residents of this Commonwealth or elsewhere. The damages recovered shall be distributed to the beneficiaries in the proportion they would take the personal estate of the decedent in the case of intestacy and without liability to creditors of the deceased person under the statutes of this Commonwealth.
(c) Special damages In an action brought under subsection (a), the plaintiff shall be entitled to recover, in addition to other damages, damages for reasonable hospital, nursing, medical, funeral expenses and expenses of administration necessitated by reason of injuries causing death.
(d) Action by personal representativeIf no person is eligible to recover damages under subsection (b), the personal representative of the deceased may bring an action to recover damages for reasonable hospital, nursing, medical, funeral expenses and expenses of administration necessitated by reason of injuries causing death.
42 Pa.C.S. § 8301. - 1976, July 9, P.L. 586, No. 142, § 2, effective June 27, 1978. Amended 1982, Dec. 20, P.L. 1409, No. 326, art. II, § 201, imd. effective; 1995, July 6, P.L. 309, No. 46, § 1, effective in 60 days.

. So it seems that the law's last amendment was effective early in September, 1995, before that magic date in 104(c)(2). I am not a lawyer, so I have no idea whether that law

... provides, or has been construed to provide by a court of competent jurisdiction pursuant to a decision issued on or before September 13, 1995, that only punitive damages may be awarded in such an action.

. I'd love to know that answer. I fervently hope the outcome is that the killer gets taxed and the surviving daughter doesn't.

In an action brought under subsection (a), the plaintiff shall be entitled to recover, in addition to other damages, damages for reasonable hospital, nursing, medical, funeral expenses and expenses of administration necessitated by reason of injuries causing death.

Based on the above, it sounds like more than just punitive damages may be awarded.

for whatever is worth in a discussion like this you can actually have a posthumous QDRO.

The Finance Committee Report gives these

Reasons for change
Punitive damages are intended to punish the wrongdoer and are not intended to compensate the claimant (e.g., for lost wages or pain and suffering). Thus, they are a windfall to the taxpayer and appropriately should be included in taxable income.

. https://www.finance.senate.gov/imo/medi ... 04-281.pdf

And yes, Chay, that PA law as in effect on the magic date does provide for damages other than punitive damages, so therefore if some or all of the damages are punitive, that much is not excludible under 104. But it doesn't necessarily follow that some or all of the $2.25 million is (or is construed as) punitive. We'd need to read the actual settlement to figure that out. But unfortunately for the desired outcome, it probably is, so let's go with that assumption.

But how about her deferral until she sells the securities, as I suggest in paragraph 2 of #16?

" How is he taxed? A lot, I hope."

"Did the $124 million judgment that got settled at about $2.25 million create COD income to the killer? I hope so."

"Unfortunately, it'd also be good for him."

" I fervently hope the outcome is that the killer gets taxed and the surviving daughter doesn't."

"But unfortunately for the desired outcome, it probably is, so let's go with that assumption."

" Instead, he has to pull out the entire account and pay tax on all of it? Good! Not looking to help him in any way; don't even know him, but I remember reading about the murder years ago and it still disgusts me."

So you think that even after both the criminal and civil justice systems have determined appropriate penalties, that somehow the tax code should be used to impose further punishment, to satisfy your moral indignation? How opposite that is from your normal position in this forum.

And for someone who takes the legal meaning of terms quite seriously, maybe you should figure out the difference between murder and manslaughter before you go casually tossing such terms around.

"Manslaughter is typically treated as a much less severe crime than murder. Manslaughter can be broken up into degrees, or categorized as voluntary and involuntary manslaughter. Voluntary manslaughter is the killing of another person under extreme provocation or while under the heat of passion. Typically, it does not require an intent to kill, but rather [...] the intent to do something else." https://murphylawoffice.org/john-murphy ... ghter.html

I confess to all that stuff, makbo, unapologetically. It's my honest feelings. As to murder v. manslaughter, I'm well aware of the differences, but I'm also aware of what happens in plea bargaining.

Now, back to the tax aspects, I'd really appreciate the input of any and all TPT members on the technical tax aspects raised in this thread. Some of them are not clear.

Now a really way out question. Did the $124 million judgment that got settled at about $2.25 million create COD income to the killer? I hope so.

I've looked at §1.61-12 and §108, etc, and although I can't find a clear definition of "indebtedness", it appears to involve at minimum a debtor and a creditor. I cannot see any reasonable interpretation that would consider a reduced civil penalty as "cancellation of debt" under the tax code -- there is no accession to wealth involved, which is the usual justification for treating COD as income.

"The leading explanation of why COD income should be taxed in the first place is the ‘‘loan proceeds’’ theory now found in every casebook and treatise. Borrowed money (loan proceeds) is not taxed when received because it does not belong to the borrower. Loan proceeds are supposed to be returned to the lender and so do not increase the borrower’s net worth. If that supposition is later contradicted by forgiveness of the debt, the original reason for tax-free receipt is negated, so the theory goes, and the forgiveness should be taxed, if not by reopening the loan year, then in the year of forgiveness nunc pro tunc. This justification for taxing COD is generally accepted and I have never seen it challenged."

You probably agree, as you consider it a "way out question" in the first place.

I see two issues that are still not clear. Maybe we need to see the charges, the plea agreement and the later settlement documents.

First issue, whether section 1041 is applicable. Is there a transfer of property, both for the investments and also the IRAs? If so, is it within 1041 given that wife is dead?

Second issue, COD income. The Zarin case linked earlier involved a compulsive gambler who won on the tax issue of COD income, i.e., there was none. THe Third Circuit stated the issue here:

Initially, we find that sections 108 and 61(a)(12) are inapplicable to the Zarin/Resorts transaction. Section 61 does not define indebtedness. On the other hand, section 108(d)(1), which repeats and further elaborates on the rule in section 61(a)(12), defines the term as any indebtedness "(A) for which the taxpayer is liable, or (B) subject to which the taxpayer holds property." I.R.C. Sec. 108(d)(1). In order to bring the taxpayer within the sweep of the discharge of indebtedness rules, then, the IRS must sholevant to our factsw that one of the two prongs in the section 108(d)(1) test is satisfied. It has not been demonstrated that Zarin satisfies either.

. There was no "debt" because the liability was not enforceable under the gambling laws of the state. There was also no "debt" because the casino's chips are not property. Those points are not particularly relevant to our facts. (Nor, by the way, is the reasoning in CCA 200039037/TAM 200039038, which posited nthat in Zarin-type facts, the reduction in "debt" was really a purchase price adjustment).

This excerpt is important. It summarizes what a contested liability is in our context.

Instead of analyzing the transaction at issue as cancelled debt, we believe the proper approach is to view it as disputed debt or contested liability. Under the contested liability doctrine, if a taxpayer, in good faith, disputed the amount of a debt, a subsequent settlement of the dispute would be treated as the amount of debt cognizable for tax purposes. The excess of the original debt over the amount determined to have been due is disregarded for both loss and debt accounting purposes. Thus, if a taxpayer took out a loan for $10,000, refused in good faith to pay the full $10,000 back, and then reached an agreement with the lendor that he would pay back only $7000 in full satisfaction of the debt, the transaction would be treated as if the initial loan was $7000. When the taxpayer tenders the $7000 payment, he will have been deemed to have paid the full amount of the initially disputed debt. Accordingly, there is no tax consequence to the taxpayer upon payment.

.

Why I think the actual documents would help is this. We can't be sure whether, in our facts, the debt is contested. A court approved a plea agreement. Husband disputed his murder charge, but agreed to manslaughter, and the $124 million was (we think) for damages, including punitive damages. We don't know for sure, but I'd guess the Court approved the damages as well. Then, maybe, negotiations ensued that ended up with a settlement at the $3 million plus number. I'm not aware there was an appeal, but maybe there was, and that would matter. Does all that amount to a disputed/contested liability, or is it merely a negotiated settlement of an adjudged liability, a settlement made because the husband did not have that kind of money and therefore the creditor settled for what they could get. If so, i.e., if it's not a contested debt, the only other exclusion I see in section 108 is insolvency. Measuring that insolvency immedIately before the settlement, husband is clearly insolvent. Not after the settlenet though.

You seem to missing the point that a penalty or fine is not at all the same thing as indebtedness from a loan. If he did not receive any loan proceeds at any point, where is the potential income?

Your tentative position is like saying that if someone kidnaps your relative (or the data on your computer, if you prefer) and demands a ransom, and then later reduces the ransom demand (that you end up paying), you have received CODI.

If simply having a fine or penalty reduced was CODI, there would be plenty of examples in the literature. Have you found any?