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Misconceptions Regarding Qualified Settlement Funds

May 9, 2023

Uncover the truth about QSFs and their benefits, including tax advantages, flexibility, and protection for all parties involved in a legal settlement. Learn how QSFs can be used in cases of any size and by all parties and how they offer cost-effective solutions for managing settlement funds.

A Qualified Settlement Fund (QSF) is a legal and financial vehicle for managing settlement funds in certain legal cases. QSFs are created under §1.468B-1 et seq. of the Internal Revenue Code and allow parties to a legal settlement to defer receipt of settlement funds. At the same time, settlement funds are allocated and distributed to the intended recipients. QSFs can provide several benefits, including tax advantages, flexibility, and protection for all parties involved in a settlement.

Despite the potential benefits of QSFs, several common misconceptions may prevent parties from considering this option. This article will explore these misconceptions and provide a more accurate understanding of QSFs and how to use them.

Misconception #1: QSFs Are Only for Large Settlements

One of the most common misconceptions about QSFs is that they are only suitable for large settlements. In reality, there is no minimum or maximum settlement amount or number of plaintiffs required to use a QSF. While it’s true that QSFs are often utilized in cases involving significant sums of money, they can be helpful in any case where a settlement or judgment requires allocation and distribution to plaintiffs.

QSFs can be particularly useful in cases where the settlement amount is uncertain or where there are multiple plaintiffs with varying claims. With a QSF, parties can defer receipt of the settlement funds until the distribution plan is finalized and agreed upon. This feature can help ensure that each party receives an appropriate settlement share based on their circumstances and claims.

Misconception #2: QSFs Are Only for Plaintiffs

Another common misconception about QSFs is that plaintiffs only use them in a legal dispute. While it’s true that QSFs typically hold settlement funds for plaintiffs, they are also used by defendants or other parties involved in a legal dispute.

For example, a defendant may use a QSF to hold settlement funds while negotiating with multiple plaintiffs. This can help simplify the settlement process and ensure each plaintiff receives an appropriate share of the settlement funds. QSFs can also be used when multiple defendants or other parties are involved, such as in a class action lawsuit.

Misconception #3: QSFs Are Expensive

Another common misconception about QSFs is that they are expensive to set up and administer. While some costs may be associated with setting up and managing a QSF, typically, the benefits of using a QSF outweigh the costs. Solutions like QSF 360 offer turnkey QSF solutions starting at $500.

For example, QSFs can provide tax benefits that significantly reduce the overall tax liability for all parties involved in the settlement. QSFs can also help streamline the settlement process, potentially saving time and money in the long run. Additionally, many QSFs are set up with the assistance of experienced providers, which can help ensure that the process runs smoothly and that all parties’ legal interests are protected.

Misconception #4: QSFs Are Complicated

Another common misconception about QSFs is that they are complicated to understand. While QSFs can involve some complex legal and financial issues, experienced professionals can help guide the parties through the process.

By working with experienced professionals, parties can ensure that they fully understand the benefits and risks of using a QSF and make informed decisions about managing settlement funds.

Conclusion

In conclusion, QSFs are valuable for managing settlement funds in various legal cases – from single-plaintiff cases to larger and more complex cases. Unlike in the past, affordable, quick, and straightforward solutions (QSF 360) provide access to QSFs for even small single-claimant cases.

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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