From time to time, Eastern Point Trust Company (EPTC) receives requests to create and administer a Qualified Settlement Fund (“QSF”) pursuant to 26 CFR §1.468B-1 et. seq to fund current or future liabilities (by way of example, future response or remediation requirements) arising from Comprehensive Environmental Response, Compensation and Liability Act (“CERCLA”) claims (and violations of state and local environmental law).
This White Paper summarizes via a FAQ format the utilization of a QSF established and operated pursuant to 26 CFR §1.468B-1 related to funding CERCLA environmental claims (and violations of state and local environmental law) and the key advantages of a QSF over an Environmental Remediation Trust (“ERT”) established under IRC §301.7701.
The author assumes for this paper that the reader is familiar with CERLA, ERTs, the associated federal, state, and local environmental law, and the related environmental remediation liability aspects and processes.
Answer: On December 23, 1993, the IRS issued a final regulation regarding Qualified Settlement Funds, which went into effect on January 1 as 26 CFR §1.468B-1 et seq., establishing the qualification and operational requirements for a QSF.
26 CFR §1.468B-1 included torts, breach of contract, violation of law, and environmental claims under CERLA as qualifying events.
According to 26 CFR §1.468B-1(c), a QSF must meet the following criteria:
“(c) Requirements. A fund, account, or trust satisfies the requirements of this paragraph (c) if -
(1) It is established pursuant to an order of, or is approved by, the United States, any state (including the District of Columbia), territory, possession, or political subdivision thereof, or any agency or instrumentality (including a court of law) of any of the foregoing and is subject to the continuing jurisdiction of that governmental authority;
(2) It is established to resolve or satisfy one or more contested or uncontested claims that have resulted or may result from an event (or related series of events) that has occurred and that has given rise to at least one claim asserting liability -
(i) Under the Comprehensive Environmental Response, Compensation and Liability Act of 1980 (hereinafter referred to as CERCLA), as amended, 42 USC 9601 et seq.; or
(ii) Arising out of a tort, breach of contract, or violation of law; or
(iii) Designated by the Commissioner in a revenue ruling or revenue procedure; and
(3) The fund, account, or trust is a trust under applicable state law, or its assets are otherwise segregated from other assets of the transferor (and related persons).”
Answer: Yes, a QSF, pursuant to 26 CFR §1.468B-1(c)(2)(i), qualifies to fund the associated liabilities under CERCLA if:
“it is established to “resolve or satisfy one or more contested or uncontested claims that have resulted or may result from an event (or related series of events) that has occurred and that has given rise to at least one claim asserting liability -
(i) Under the Comprehensive Environmental Response, Compensation and Liability Act of 1980 (hereinafter referred to as CERCLA), as amended, 42 USC 9601 et seq.
(ii) Arising out of a tort, breach of contract, or violation of law; or”…
As noted, 26 CFR §1.468B-1(c)(2)(i) implicitly provides for liabilities under CERCLA as eligible for QSF treatment if (pursuant 26 CFR §1.468B-1(f)(2)) the transferor’s sole remaining liability to the Environmental Protection Agency (“EPA”) upon transfer to the QSF “is a remote, future obligation to provide services or property.”
“(2) CERCLA liabilities. A transferor’s liability under CERCLA to provide services or property is described in paragraph (c)(2) of this section if following its transfer to a fund, account, or trust the transferor’s only remaining liability to the Environmental Protection Agency (if any) is a remote, future obligation to provide services or property.”
Notwithstanding the foregoing, and pursuant to 26 CFR §1.468b-1(c)(2), if, on a facts and circumstances basis, a QSF established in good faith on the then known facts would remain qualified if reopener claims arose as new claims arising from “claims that have resulted or may result from an event (or related series of events).”
Practice Note: It is common to have multiple QSFs associated with the same event. Nothing in 26 CFR §1.468B-1 et seq. prohibits the bifurcation of liabilities into multiple QSFs, each addressing different elements of the claims, different transferors, or other administrative-related segmentation. However, a QSF may not hold claims arising from an unrelated series of events.
Practice Note: As clarified in 26 CFR §1.468B-1 - Example 7 (regarding a landfill operator), there must be at least one claim asserting a liability. General business obligations are not a claim, such as a future cost to perform, even if the law nominally requires the obligation.
PLR Number: 200821019 Release Date: 5/23/2008 clarifies that the funds in the QSF must “resolve or satisfy claims described in section 1.468B-1(c)(2)” and Example 7 considered the following scenario: “There a corporation owned and operated a landfill in a state that required the corporation to transfer money to a trust annually based on the total tonnage of material placed in the landfill during the year. Under the law, the corporation is required to perform (either itself or through contractors) specified closure activities when the landfill is full, and the trust assets would be used to reimburse the corporation for these closure costs. The trust in that example is not a qualified settlement fund because it is established to secure the liability of the corporation to perform such closure activities.”
Additionally, 26 CFR §1.468B-1(c)(2)(ii) provides that claims “Arising out of a tort, breach of contract, or violation of law” qualify under the regulation. Thus, those liabilities arising from violations of state law and other environmental laws comparable to the federal CERCLA, to the extent they satisfy 26 CFR §1.468B-1(c)(2)(ii), qualify for transfer into a QSF.
Practice Note: QSFs have unique qualifications and operational requirements; the best practice is to have an independent, institutional trustee with well-established experience appointed to administer a QSF and act as the trustee. The trustee shall act on behalf of the QSF, established as a trust under state law, to enter into a Settlement Agreement between the QSF and the EPA (or other applicable state agency). The associated Settlement Agreement, incorporated into the terms of the QSF, formalizes the agreement between the trustee acting on behalf of a QSF and EPA (or other applicable state agency), defining the obligations under the QSF.
Answer: Yes, unlike ERTs, which provide for no Economic Performance at the time of funding, a QSF pursuant to 26 CFR 26IRC §1.468B-3(c)(1) provides for the “Economic Performance” of the “transferor” at the time of the irrevocable funding of the QSF. Accordingly, a QSF, which is properly qualified, allows a current-year tax deduction of the irrevocable funding amount(s).i
“In general. Except as otherwise provided in this paragraph (c), for purposes of section 461(h), economic performance occurs with respect to a liability described in 26 CFR §1.468B-1(c)(2) (determined with regard to 26 CFR §1.468b-1(f) and (g)) to the extent the transferor makes a transfer to a qualified settlement fund to resolve or satisfy the liability.”
By contrast, an ERT is a Grantor Trust, and each respected funder of an ERT is a “Grantor,” which retains ownership and control of the funds in the ERT, for tax purposes, and the Grantor Trust rules apply. Under the Grantor Trust rules, the funder of an ERT is the owner of the portion of the ERT contributed by that respective Grantor, as the funding does not constitute Economic Performance. Only when the ERT makes payments for the remediation project are the corresponding amounts deductible by the Grantor(s), and only in the current tax year in which the payments occur.
As such, the Grantor is not allowed to claim a deduction based solely upon the funding of the ERT.
Answer: Yes, funding transferred from an existing ERT into QSF would constitute Economic Performance and allow the “transferor” a corresponding tax deduction for the funding amount in the current tax year.
Answer: Yes, 26 CFR §1.468B-1 et seq. establishes no limit on the number of funding events within the lifetime of a QSF, and each funding of a QSF shall constitute Economic Performance at the time of funding. The deduction of multiple fundings within the current year tax is likewise afforded to the transferor.
Answer: No, there is no statutory or regulatory time limit on the duration of a QSF. A QSF may operate for so long as potential liabilities are outstanding.
Answer: No, unlike an ERT, upon establishing a QSF, the transferor irrevocably transfers the funding and the associated value of the liability to the QSF. Therefore, the transferor no longer carries on their Balance Sheet the transferred portion of the environmental remediation liability or the assets held within the QSF.
Practice Note: Transferors report that the ability to remove liabilities from their Balance Sheet irrevocably provides secondary benefits of isolating liabilities and improving their reportable financial condition.
Answer: No, unlike an ERT (whose assets and investment gains are the transferor’s property), a QSF is responsible for its tax liability and files its own IRS Form 1120-SF (https://www.irs.gov/pub/irs-pdf/f1120sf.pdf).
Accordingly, a QSF is a separate entity, and the transferor has no ongoing accounting, tax liability, or reporting requirements related to the operation of a QSF.
Pursuant to 26 CFR §1.468B-2, a QSF is subject to taxation on its modified gross income. A QSF must file IRS form 1120-SF each tax year it exists (even if it has no assets) until terminated. The trustee/administrator of a QSF typically prepares and files the IRS Form 1120-SF along with any necessary 1099 reporting requirements that may arise from distributions made during the operation of a QSF.
Practice Note: A QSF’s tax treatment of income, distributions, deductions, and income differs materially from the rules generally governing trust taxation via IRS Form 1041. Seek the advice of an experienced QSF tax professional.
Answer: No, if excess funds remain in a QSF upon satisfying all environmental remediation obligations and claims and the pending termination of a QSF, there is no option to revert the funds to the transferor without compromising the transferor’s original deduction of the funding. Reverting the funds to the transferor would nullify the deductibility of the original transfer in the year of funding, thereby necessitating the transferor to file an amended tax return(s) for the year(s) corresponding to the original deduction(s).
Excess funds may offset trustee/administrator expenses, tax liabilities of the QSF, accounting and legal services of the QSF, notification of claimants and claim processing expenses, or other deductions.
Practice Note: One should be conservative in funding a future liability as additional funding may be added to the QSF at any time, but generally, excess funds may not revert without impacting the qualification of the QSF (some exceptions may apply as noted in PLR Number: 200821019 Release Date: 5/23/2008). If excess funds exist, it is not uncommon for a QSF to make a charitable contribution to distribute them or transfer / escheat them to an appropriate government entity.
Answer: No, a transferor may choose to fund all or any portion of the potential or actual liability for environmental remediation, into a QSF, at their discretion. The corresponding liabilities are transferred into a QSF, and Economic Performance occurs as the funding occurs.
Practice Note: When applicable, transferors have conducted studies to determine the Net Present Value of funding required to offset the liabilities. Utilizing actuarial studies and or an appropriate funding vehicle, the transferor funds the associated QSF with the Net Present Value of the liabilities. In such a circumstance, transferors have transferred the entire liability to the associated QSF. However, the transferor may only claim a tax deduction for the actual funding, not the future value of the entire transferred liability. Further, depending on the investment performance of the assets within a QSF, additional funding into a QSF may be required to fulfill the potential or actual liability for environmental remediation liabilities if they exceed the associated QSF’s available funds. A fixed-income investment vehicle such as an annuity can pre-fund and match the long-term stewardship obligations. With an appropriate inflation factor, some cleanup companies shall agree to a guaranteed fixed-price contract. (The details of such arrangements are not within this White Paper’s scope.)
Answer: No, pursuant to 26 CFR §1.468B-1(c)(1), a QSF must meet the following criteria regarding governmental approval:
“(c) Requirements. A fund, account, or trust satisfies the requirements of this paragraph (c) if -
(1) It is established pursuant to an order of, or is approved by, the United States, any state (including the District of Columbia), territory, possession, or political subdivision thereof, or any agency or instrumentality (including a court of law) of any of the foregoing and is subject to the continuing jurisdiction of that governmental authority;”
Eastern Point’s online turnkey QSF platform allows you to design a QSF in as quickly as 15 minutes and create a QSF in as little as a single day, including the necessary governmental authority approvals and the IRS granting an EIN.
Answer: Yes, pursuant to 26 CFR §1.468B-1(d), a transferor may transfer (fund) “money or property to a qualified settlement fund to resolve or satisfy claims”
“Definitions. For purposes of this section -
(1) Transferor. A “transferor” is a person that transfers (or on behalf of whom an insurer or other person transfers) money or property to a qualified settlement fund to resolve or satisfy claims described in paragraph (c)(2) of this section against that person.”
Property such as real estate may be contributed to a QSF to fund claims settlement, but not as an income-producing property. IRS regulations prescribe the method to value property transfers to a QSF properly. The initial basis for the property a QSF receives is the property’s fair market value on the date of transfer to the fund.
Practice Note: Exercise caution to ensure a fair market valuation of the transferred property, which establishes the property’s initial basis.
QSFs provide material tax and financial advantages over an ERT.
QSF Advantages:
Today’s QSF industry provides quick, inexpensive, and easy solutions to implement a QSF to fund environmental remediation liabilities with material tax and financial advantages.
ABOUT EASTERN POINT TRUST COMPANY
Eastern Point Trust Company is a global leader in trust innovation, providing technology-empowered services to individuals, courts, and institutional clients around the world.
Eastern Point is the only “end-to-end” turnkey QSF escrow solution., As an experienced provider, Eastern Point allows for QSF creation, approval, and operation in as little as one business day for QSF of all types.
i The existence of an unrestricted or illusory reversion/refund provision within a QSF is addressed within IRC §1.468B-3(c)(2) in which unused QSF assets maybe returned to the transferor. For the purpose of this paper the use of a reversion/refund provision is not contemplated as such a provision may neuter Economic Performance and thus compromise the ability to qualify for the current year tax deduction in which the QSF is funded.
26 CFR §1.468B-3(c)(2)
Right to a refund or reversion -
(i) In general. Economic performance does not occur to the extent -
(A) The transferor (or a related person) has a right to a refund or reversion of a transfer if that right is exercisable currently and without the agreement of an unrelated person that is independent or has an adverse interest (e.g., the court or agency that approved the fund, or the fund claimants); or
(B) Money or property is transferred under conditions that allow its refund or reversion by reason of the occurrence of an event that is certain to occur, such as the passage of time, or if restrictions on its refund or reversion are illusory.
(ii) Right extinguished. With respect to a transfer described in paragraph (c)(2)(i) of this section, economic performance is deemed to occur on the date, and to the extent, the transferor's right to a refund or reversion is extinguished.
ii If excess funds remain in the QSF upon the satisfaction of the environmental remediation obligations there is no reversion of the excess funds back to the transferor.
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