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11 Reasons an Attorney Should Utilize a Qualified Settlement Fund for Small Settlements

July 23, 2024

Attorneys, maximize your client's peace of mind with Qualified Settlement Funds (QSFs). Preserve tax benefits, earn interest for clients, and more. QSFs offer a flexible, efficient, and state BAR-approved solution for managing even small settlements.

Qualified Settlement Funds (QSF) - (sometimes called 468B trusts, qualified settlement trusts, qualified settlement accounts, QSF accounts, or even QSF trusts) - this powerful tool allows attorneys to reduce risks and efficiently manage the distribution of settlement proceeds – even for smaller settlements.

Here are the reasons why attorneys should consider using a Qualified Settlement Fund, even for smaller settlements:

1. Preservation of Tax Benefits - QSFs offer significant tax advantages. By placing settlement funds in a QSF, the defendant can take a current-year tax deduction, and plaintiffs can defer income recognition until they receive their settlement.

2. Earned Interest for Clients - Unlike IOLTA accounts, where interest benefits the state, funds in a qualified settlement fund earn interest for the client, maximizing their financial benefits from the settlement.

3. Time to Plan Financial Decisions - A QSF provides clients valuable time to make informed financial decisions, such as opting for structured settlement annuities or setting up special needs trusts, without the pressure of immediate fund distribution.

4. Efficient Lien Resolution - QSFs allow time to resolve liens, bankruptcy, and probate issues, ensuring clients receive their settlement funds free from potential disruptions and financial penalties.

5. Avoiding Constructive Receipt - By using a QSF, attorneys can avoid the constructive receipt of funds, which can have tax implications for plaintiffs.

6. Avoiding Economic Benefit - By using a QSF, attorneys can avoid triggering the economic benefit of funds, which otherwise would result in taxation for plaintiffs.

7. Protection Against Defendant Insolvency - A QSF protects plaintiffs from the risk of defendant insolvency by securing settlement funds in advance and ensures that clients receive due compensation regardless of the defendant's financial status.

8. Flexibility - QSFs offer a flexible framework for distributing settlement proceeds, accommodating various client needs and preferences for financial planning.

9. Enhanced Compliance with Legal and Ethical Standards - By utilizing a QSF, attorneys can ensure compliance with legal and ethical standards, particularly in handling significant settlement amounts, which helps to safeguard client interests.

10. Streamlined Settlement Process - QSFs streamline the settlement process by allowing for the efficient allocation and management of settlement funds, reducing administrative burdens on attorneys, and ensuring a smoother experience for clients.

11. Online Quick, Easy, and Low Cost – Online solutions like QSF 360 provide accessible and low-cost qualified settlement fund solutions in as little as one day.

In summary, qualified settlement funds provide numerous benefits that can significantly enhance the settlement management process for attorneys and their clients, even in cases involving smaller settlements. By leveraging the advantages of QSFs, attorneys can offer their clients better financial outcomes and peace of mind.

For a comprehensive overview of tax minimization strategies, see our guide on minimizing tax liability on lawsuit settlements.

Learn how the Plaintiff Recovery Trust addresses the attorney fee double tax created by Commissioner v. Banks.

Frequently Asked Questions

Under IRC § 61, all income from whatever source derived is taxable unless a specific exclusion applies. Lawsuit settlements are included in gross income by default. The key exceptions are physical injury and physical sickness recoveries under IRC § 104(a)(2), which are excluded from gross income when received as compensation for a physical injury or physical sickness claim.

IRC § 104(a)(2) excludes from gross income damages received on account of personal physical injuries or physical sickness. The exclusion applies to compensatory damages only. The injury or sickness must be physical — emotional distress damages, employment discrimination recoveries, breach of contract proceeds, and punitive damages do not qualify for the exclusion and are taxable.

Yes. Punitive damages are taxable as ordinary income regardless of whether the underlying claim involves a physical injury. IRC § 104(a)(2) does not exclude punitive damages. Even in a physical injury case where compensatory damages are excluded, any punitive damages awarded are included in the plaintiff's gross income and subject to federal income tax.

For most plaintiffs, no. The Tax Cuts and Jobs Act of 2017 suspended miscellaneous itemized deductions under IRC § 67(g) for tax years 2018 through 2025, eliminating the attorney fee deduction for most civil litigation recoveries. IRC § 62(a)(20) provides an above-the-line deduction only for qualifying discrimination and whistleblower cases. Plaintiffs in personal injury, breach of contract, and most tort cases cannot deduct attorney fees under current law.

A Qualified Settlement Fund (QSF) under IRC § 468B separates the timing of the defendant's payment from the plaintiff's taxable receipt of funds. The defendant transfers proceeds to the QSF and takes an immediate tax deduction. The plaintiff does not recognize taxable income until distribution from the QSF, preserving a planning window to implement structured settlements, Plaintiff Recovery Trusts, Special Needs Trusts, or other tax-minimization strategies before receiving taxable income.

A Plaintiff Recovery Trust (PRT), administered by Eastern Point Trust Company, addresses the attorney fee double tax created by Commissioner v. Banks, 543 U.S. 426 (2005), and worsened by TCJA 2017. The PRT separates the attorney fee portion of the settlement from the plaintiff's taxable recovery, allowing each party to recognize income only on their respective portion. Eastern Point Trust Company has saved plaintiffs $30 million or more through PRT structures. The PRT is implemented during the QSF administration window before taxable distributions occur.

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Qualified Settlement Fund

Plaintiff Recovery Trust

Qualified Settlement Fund

Plaintiff Recovery Trust

11 Reasons an Attorney Should Utilize a Qualified Settlement Fund for Small Settlements

Frequently Asked Questions

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