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Qualified Settlement Fund Administration: Myths vs. Reality

A set of scales of justice with Reality written on both sides and various objects stacked with it

Qualified Settlement Funds (QSFs) are qualified tax entities established under the legal framework of 26 U.S.C. § 468B, regulated under 26 C.F.R. § 1.468B-1, and operate as statutory trusts. These QSFs or Section 468B trusts are settlement funds created upon the approval of a “government authority.” Critical to a successful QSF implementation is the Qualified Settlement Fund Administrator and associated QSF Administration, which streamlines the settlement process for efficient distribution to the involved parties. This consolidation simplifies the fund’s administration and introduces tax benefits designed to empower the plaintiffs financially.

In this article, we will explore the common myths regarding Qualified Settlement Funds and Qualified Settlement Fund Administration.

Myth 1: QSFs Are Exclusively for Mass Tort and Class Action Settlements

One common misconception about Qualified Settlement Funds is that they are exclusively utilized for mass tort and class action settlements. However, the versatility and application of QSFs extend far beyond these areas.

Broad Application: QSFs are designed to resolve and satisfy claims, including those made before the QSF is established and funded. This broad application makes them suitable for most types of torts, breach of contract, and environmental liability cases.

Diverse Case Types: The use of QSFs spans a wide range of cases. They are not only applicable in scenarios with large numbers of plaintiffs, such as product-liability cases, drug cases, and sexual abuse cases, but also in single claimant cases.
Ethics and Compliance: Particularly in cases with multiple plaintiffs, QSFs play a crucial role in ensuring compliance with ethics rules.
Uncooperative Defendants: QSFs support structured settlement solutions even when a defendant or insurer is unwilling to enter directly. Moreover, QSFs can effectively pay adverse parties with and without liens and address lien resolutions.

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Myth 2: Only Plaintiffs Benefit From QSFs

The myth that only plaintiffs benefit from QSFs overlooks the multiple advantages these funds offer to all parties involved in litigation. The following outlines the benefits for both plaintiffs and defendants, showcasing the unique utility of QSFs:

For Plaintiffs

Deferred Taxation: Plaintiffs benefit from deferring taxes on their settlement amounts until the funds are distributed, providing significant financial planning flexibility.
Flexibility: Plaintiffs gain financial planning and tax benefits by avoiding immediate access to income from the settlement and having ample time for negotiations to address liens and choose distribution methods.
Conflict Resolution: QSFs facilitate the resolution of disputes among multiple plaintiffs and their attorneys, contributing to a more efficient and equitable settlement process.
Settlement Planning: Plaintiff attorneys can secure the settlement proceeds in a QSF, providing a safe space to work out a comprehensive settlement plan, address liens, and engage in probate proceedings without the pressure of immediate distribution.

For Defendants

Immediate Tax Deductions: Defendants can immediately claim tax deductions for their contributions to a QSF, even if the funds have not yet been distributed among the plaintiffs. This benefit to the defendant is particularly significant because it allows for deductions when the settlement is paid into the QSF rather than upon distribution to each plaintiff.
Litigation Closure: By contributing to a QSF, defendants can remove themselves from the ongoing settlement administration process, often receiving a permanent release upon their contribution. Thus, QSFs simplify the settlement process and provide financial and legal closure.
Streamlined Process: Forming a QSF can bridge difficulties when plaintiffs and defendants cannot agree on tax language or reporting, ensuring that all tax, legal fee, and payout issues are managed strictly between plaintiffs and their lawyers outside the influence of defendants.

Myth 3: Establishing a QSF Is an Expensive Process

Contrary to the prevalent belief that establishing a Qualified Settlement Fund (QSF) is a costly affair, platforms like QSF 360 offer the creation of a QSF for a setup fee of only $500. The process and costs associated with setting up and maintaining a QSF are as follows:

1. Initial Setup and Maintenance Costs

  • Drafting of Trust Document: Essential for the legal establishment of the QSF.
  • Ancillary Services: These may include legal advice, fund management, and other services necessary for the operation of the QSF.
  • Government Filing Fees: Required for the legal establishment of the fund.
  • QSF Administration and Trustee Fees: For the day-to-day management and oversight of the QSF.
  • Tax Preparation Fees: Preparing tax returns is crucial for maintaining the fund’s compliance with tax laws.
  • Technology and Support Services: Platforms like QSF 360 offer cost-effective solutions for creating and administering a QSF, bypassing traditional expenses and court delays.

2. Process of Establishment

  • Petitioning Governmental Authority: Involves submitting the QSF agreement for approval, ensuring compliance with qualification requirements.
  • Obtaining Federal Tax ID Number: A mandatory step for the fund’s operation.
  • Approval: QSFs can be approved by any “governmental authority” irrespective of whether the litigation is a federal or state matter, providing flexibility in establishment.

3. Comprehensive Services at a Glance

  • QSF 360: Offers a same-day* online solution that includes document preparation, disbursement of payments, UCC and bankruptcy lien management, and tax filings, among others, providing a holistic approach to QSF administration.
  • Licensed QSF Administrator Selection: The best outcomes typically result from using a specialized fiduciary or individual to ensure proper service.
  • Simplified Account Management: A QSF creation can be as straightforward as spending only 15 minutes online.

Myth 4: Qualified Settlement Fund Administration Is Overwhelmingly Complex

The myth surrounding the overwhelming complexity of Qualified Settlement Fund (QSF) administration can deter parties from considering this efficient settlement solution. However, understanding the structured roles and responsibilities can demystify the process:

Role of the QSF Administrator

  • Comprehensive Management and Coordination: Ensures the smooth operation and administration of a Qualified Settlement Fund, including asset custody and oversight.
  • Documentation Preparation: Involves drafting necessary legal and financial documents to maintain compliance and facilitate settlement.
  • Disbursements Management: Handles disbursements to claimants, managing both gross payments to individual claimants and distributions on behalf of claimants with accuracy.
  • Post-Distribution Activities: Conducts audits, oversees funds, and oversees post-distribution tasks, ensuring the fund’s closure aligns with all legal requirements.

Expertise and Compliance

  • Knowledge and Experience: A licensed fiduciary serving as a QSF Administrator brings a wealth of knowledge, ensuring compliance with regulations and guidelines for the QSF.
  • Tax Regulation Proficiency: Proficiency in managing tax-related requirements outlined in the U.S. Tax Code is crucial, with administrators handling the fund’s EIN application and annual tax returns.
  • Selection Criteria: When selecting a QSF Administrator, their experience in tax regulations related to QSFs and management capabilities is paramount.

Qualified Settlement Fund Taxation

  • Taxation and EIN: QSFs are taxed separately on the income they earn, with the need for their own EIN, simplifying tax reporting and compliance.
a man in a shirt and tie points to graphs demonstrating the taxation of qualified settlement funds

Myth 5: QSFs Offer Limited Tax Advantages

Dispelling the myth that Qualified Settlement Funds (QSFs) offer limited tax advantages requires an in-depth exploration of the tax benefits they present for defendants and plaintiffs. Here is a concise breakdown:

Tax Benefits for Defendants and Plaintiffs

Immediate Tax Deduction for Defendants: Upon contributing to a QSF, defendants are eligible for an immediate tax deduction, even if the funds have yet to be distributed to the plaintiffs. The upfront deduction can significantly reduce the defendant’s taxable income in the fiscal year of the contribution.

Income Deferral for Plaintiffs: Plaintiffs can defer taxation on their settlement amounts until distribution. The benefit of deferral can offer substantial financial planning advantages, allowing plaintiffs to potentially lower their tax obligations by receiving funds in years when they may be in a lower tax bracket.

Structured Settlements and Legal Fees: Both structured settlements and structured legal fees are available post-defendant involvement, providing plaintiffs and their attorneys the flexibility to plan for future financial needs. Notably, structures, including the attorney fees portion of the claimant proceeds, can circumvent constructive receipt and economic benefit doctrines, taxing plaintiffs and their attorneys only upon receiving each payment.

Operational and Taxation Aspects of QSFs

Separate Tax Entity Status: As a separate tax entity, QSFs are subject to taxation on interest and dividend income at the maximum rate of 39.6% (as of 2024). Despite the taxation, QSFs benefit from deductions for administrative costs, incidental expenses, and losses sustained in property transactions.

Accrual Accounting and Corporate Treatment: QSFs must employ an accrual method of accounting and are treated as corporations for subtitle F of the Internal Revenue Code. This corporate treatment simplifies tax reporting and compliance, ensuring that the tax imposed on the QSF’s modified gross income is treated consistently with corporate tax obligations.

Flexibility and Longevity of QSFs

No Explicit Time Limit: The absence of a strict time limit for the existence of a QSF provides flexibility in managing complex cases that may span several years. This enduring nature ensures that all controversies can be resolved without rushing the process, benefiting all parties involved.

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The myths surrounding QSFs, QSF Administration, their applicability, costs, tax advantages, and administrative complexity are unfounded. Additionally, the critical element to ensure a seamless QSF is the QSF Administrator.

Particularly noteworthy is the capacity of QSFs to extend beyond limited use scenarios, provide benefits to plaintiffs and defendants, and offer significant tax advantages that can profoundly impact financial planning and legal strategy.

In navigating the complexities and ensuring optimal outcomes within the QSF framework, engaging a skilled and experienced administrator is vital. Use only a licensed fiduciary for QSF Administration to ensure compliance, maximize tax benefits, and streamline the settlement process for all parties involved. This professional insight and management are pivotal in harnessing the full potential of QSFs, transforming them from a misunderstood financial instrument into a powerful solution for dispute resolution and settlement planning.

* Same-day service is dependent on a variety of factors such as the time of day when the QSF creation request was received. This also excludes non-business days if said QSF creation request was received outside normal business days.

Disclosure: This content is an overview. It is not a detailed analysis and offers no legal or tax opinion on which you should solely rely. Always seek the advice of competent legal and tax advisors to review your specific facts and circumstances before making any decisions or relying on the content herein.
Any opinions, views, findings, conclusions, or recommendations expressed in the content contained herein are those of the author(s) and do not necessarily reflect the view of the Eastern Point Trust Company, its Affiliates, or their clients. The mere appearance of content does not constitute an endorsement by Eastern Point Trust Company (“EPTC”) or its Affiliates. The author’s opinions are based upon information they consider reliable, but neither EPTC nor its Affiliates, nor the company with which such author(s) are affiliated, warrant completeness, accuracy or disclosure of opposing interpretations.

EPTC and its Affiliates disclaim all liability to any party for any direct, indirect, implied, special, incidental, or other consequential damages arising directly or indirectly from any use of the content herein, which is expressly provided as is, without warranties.
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