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What to Do When Family Members (And Even the Lawyers) Are Fighting Over the Settlement Proceeds

May 28, 2024

Qualified Settlement Funds (QSF) streamline post-settlement disputes and ensure tax compliance, with tax benefits for defendants and plaintiffs.

Navigating Post-Settlement Complexities with a Qualified Settlement Fund

Great! You have won the case but now face secondary claims and litigation.

No, you are not the first to encounter these issues, and it is not uncommon for post-settlement secondary disputes to occur. For example, families argue over their “Fair Share,” lawyers dispute fee splits, plaintiffs dispute attorney fees, 3rd party lien holders come out of the woodwork to make claims against the litigation proceeds, and more.

Navigating the post-settlement challenges can be overwhelming for lawyers and their clients. But, there is a simple solution - a Qualified Settlement Fund, also referred to as a 468B trust, presents an option to simplify the post-settlement process and handle the hurdles that emerge. By setting up a QSF, the parties can resolve the secondary issues, effectively preserve the settlement funds, ensure tax compliance, and allow time for making informed decisions by deferring taxation.

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Here, we delve into the details of QSF and its valuable role in post-settlement planning and administration.

Understanding Qualified Settlement Funds (QSFs)

A Qualified Settlement Fund, sometimes shorthanded as a “QSF,” is an entity created according to IRC Section 468B and its associated regulations to settle various legal disputes. Defendants can place funds into a QSF and receive a release from liability while allowing time for the other parties to resolve secondary disputes and carefully consider their settlement proceeds options.

QSFs trace back to the Tax Reform Act of 1986, which incorporated Section 468B into the Internal Revenue Code. Initially utilized in class action lawsuits, QSFs have since extended to the broad breadth of legal conflicts such as single events, single claimant personal injury claims, and contract breaches.

To establish a QSF, specific requirements must be met:

Be approved by a “governmental authority” defined by 26 C.F.R. §1.468B-1(c)
Be under the continuing jurisdiction of the approving governmental authority
Be set up to resolve one or more legal claims
Qualify as a trust under applicable state law if established as a trust

PRO TIP: Online QSF platforms like QSF 360 can fully establish a QSF in as little as one business day.

Advantages of Using QSFs for Post-Settlement Resolution

Qualified Settlement Funds offer numerous advantages for all parties involved in post-settlement dispute resolution. By establishing a QSF, defendants can claim immediate tax deductions and extricate themselves from ongoing litigation. At the same time, plaintiffs gain tax deferral, which provides them valuable time to make informed decisions regarding the allocation of settlement funds, aiding in the negotiation of competing claims and liens, and implementation of financial and tax planning strategies.

Avoiding Conflicts of Interest and Ensuring Fair Distribution

Conflicts arise when plaintiffs and their family members are suing each other, and sometimes even when the lawyers get into the act by suing one another or their clients over the allocation of the settlement. Qualified Settlement Funds offer a way to handle these disputes by allowing tax-deferred time to resolve the conflict and preserving the core settlement. The QSF administrator administers the distribution depending on each case’s details and implements the court’s final instructions.

qualified settlement fund documents sitting on a desk next to books and a scale

Conclusion

The use of QSFs has transformed how lawyers and their clients navigate the realm of post-settlement disputes and allocation affairs. By offering a streamlined approach to settlement fund management, addressing liens and conflicts, and facilitating settlements, QSFs bring numerous advantages to all parties involved.

By staying up to date, collaborating with experienced QSF professionals, and adapting to the requirements of each case, attorneys and plaintiffs can harness the full potential of QSFs and secure optimal outcomes in the post-settlement stage.

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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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