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Qualified Settlement Fund Trusts and When Should a Corporate Defendant Use One?

Settlement Contract and Gavel - When Should a Corporate Defendant Use a QSF

Qualified Settlement Funds (QSFs), sometimes referred to as 468B trusts or settlement trusts, earn their title from the qualification requirements stipulated in IRC §1.468B-1. Through the relevant regulations, the Internal Revenue Service (IRS) allows QSFs an accelerated method for deducting the expenses associated with settling legal claims. As outlined in IRC §1.468B-1, three conditions must be fulfilled for a fund to qualify as a QSF.

QSF Steps

First, a QSF is established through an order or approval issued by a Governmental Authority. Unless transferred, a QSF must remain within the jurisdiction of the approving Governmental Authority. Note that a QSF is not valid without oversight from the Governmental Authority.

Second, the trust must be used to address allowable claims against the defendant. Allowable claims are outlined in §1.468B-1, and include actions based on torts and breaches of contract.

Third and finally, the QSF must adhere to state laws governing the creation of trusts in the state where the QSF is sitused (i.e., where the QSF is “domiciled”).

QSFs are commonly employed to settle tort, breach of contract, and other claims allowed under §1.468B-1. When a company requires a QSF, it has determined that future settlement or judicial award payments will be necessary. If correctly executed, any transfers or payments made to the fund can be considered expenses incurred in the course of business and thus eligible for a tax deduction in the same year as the transfer.

Generally speaking, once the company transfers funds into the Qualified Settlement Fund, the funds cannot be returned to the company. To claim a deduction for funds transferred to the QSF, the company must relinquish any right to demand a refund. However, if all claims are satisfied, the Trustee may return unused portions to the company in certain circumstances.

One might question why a business should permanently transfer funds if there is a chance that there may be no financial obligations following a trial or appeal. In some situations, establishing an escrow account could be a more practical choice until the dispute resolution is final. Nonetheless, there are many reasons why a business may opt for a QSF.

The Benefits of Establishing a Qualified Settlement Fund Trust

When confronted with legal claims, businesses must explore avenues for paying judgment holders. Creating a QSF as an avenue for payments is worth considering for several reasons.

A QSF offers immediate tax deductions for all funds moved into the trust – To qualify for tax deductions, businesses must satisfy the “all events test” outlined in § 461. According to this test, there needs to be “economic performance.” Section 1.468B 3(c) of the Treasury Regulations (26 C.F.R. § 1.468B 3(c)) specifies that transferring funds to a Qualified Settlement Fund with the intention of settling a liability meets the economic performance test, making it eligible for deduction as a business expense.

A QSF effectively relieves the defendant from liabilities by taking over the responsibility for payments and judgment holders related to claims related to the QSF. When a defendant transfers the payment obligations to a QSF, the Trust Agreement governing the QSF stipulates “the release” of the defendant from all liability for those claims.

Upon establishment, a QSF frees the defendant from the administrative burden of dealing directly with claimants by shifting that responsibility to the QSF, which now deals directly with the claimants. The Trustee overseeing the QSF would manage these matters accordingly. The QSF and its Trustee are responsible for distributing payments among claimants regardless of differences in owed amounts or uncertainties surrounding these amounts.

QSFs enable companies to streamline management following the resolution of disputes, which can often drag on for extended periods. By utilizing QSFs, businesses can efficiently allocate funds to judgment holders without delay.

When dealing with the expenses of compensating individuals, there are concerns about budget and logistics. How many claimants will there be in the end? What amounts need to be paid to them? How will the company handle this uncertainty? The establishment of a QSF can address these concerns.

Once a QSF trust is set up and funded, the company can categorize any transfers as an expense. Decision-makers no longer need to worry about identifying all recipients or determining individual payment amounts. What matters for the company is the sum transferred to the fund irrespective of each claim value or judgment award.

By implementing a QSF, companies show goodwill. Moreover, once payments are disbursed to plaintiffs, the QSF can donate any remaining funds to a charity chosen by the company, should the company choose to do so. Opting for this, the company may enhance its reputation if presented and communicated effectively.

Conclusion

The noted benefits of a QSF collectively make a case for defendants to utilize QSF trusts to settle claims.

If your company is dealing with a dispute and considering setting up a QSF trust to settle matters, it’s advisable to seek advice from a tax and accounting specialist like Eastern Point Trust Company and learn how QSF 360 can resolve your settlement administration and dilemma in as little as one business day.


For more content on QSFs visit Eastern Point Trust’s – YouTube Channel.

Rachel McCrocklin
Rachel McCrocklin
Author

Rachel McCrocklin

Ms. Rachel McCrocklin, MBA is a settlement industry and trust professional specializing in creating, operating, and administering 468B Qualified Settlement Funds (QSFs). Additionally, she provides insights on advanced settlement optimization solutions such as the Plaintiff Recovery Trust (PRT) while working with litigants, plaintiff counsel, and defendants to implement tax-efficient solutions and maximize settlement outcomes for all stakeholders.

Ms. McCrocklin oversees Eastern Point's QSF and PRT client services operations and communications while participating in developing new and innovative advantaged tax structures.

She is a prolific author of articles, including for the American Bar Association; she regularly presents at the Federal Bar Association, Practicing Law Institute, and settlement industry events and is frequently cited in financial industry publications such as USAToday, Finance Digest.

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