Qualified Settlement Funds

In 1993, the Treasury Secretary introduced regulations governing the treatment of designated settlement funds (DSF) (26 C.F.R. §§1.468B-1 through 1.468B-5). Under these regulations, the Secretary provided for the creation and use of “qualified settlement funds” (QSF). Although QSF’s are not specifically mentioned in the IRC §1.468B-1, they are clearly intended to meet the definition of a DSF.

The QSF was originally enacted to simplify the settlement of mass tort cases, but has also found popularity as a vehicle to settle cases involving the multiple claims of a single claimant. When a QSF is established, it assumes the tort liability from the defendant before the settlement is made, at which time the defendant is dismissed with prejudice. The QSF then stands in the shoes of the defendant with the plaintiff until all negotiations are concluded with the plaintiff(s), their healthcare providers with enforceable liens, their legal (and other) experts’ fees and costs, and any others, including government entities with a possible claim on the potential proceeds. Moreover, it is also at this time that the negotiations and design for the structured settlement (for both the plaintiffs and attorney fees) and special needs trust are concluded, if applicable.

The proceeds of a personal injury settlement used to fund a QSF continue to receive favorable tax treatment under IRC §104(a)(2), but income earned on the proceeds are taxable to the QSF for so long as the QSF continues to hold the funds.  Under 26 C.F.R. §1.468B-2, QSF’s are taxed at the maximum rate applicable to trusts, but are otherwise treated as corporations under the IRC.

Plaintiff Attorneys Favor the QSF

  • The plaintiff attorney can have greater control of the settlement funds while determining appropriate distribution amounts to their clients;
  • Plaintiffs have more flexibility in making appropriate choices for distribution of the settlement in cash, in structured settlements that can provide a secure income stream, or in special (supplemental) needs trusts to preserve Medicaid and Supplemental Security Income (SSI);
  • A QSF provides more time to resolve Medicare and Medicaid liens, as well as any subrogation;
  • Plaintiffs can benefit from interest accumulation of funds if the distributions are not timely; and
  • Obtaining the settlement award early eliminates risk of insolvency of the defendant or its insurer and allows time for an agreement on allocation when more than one plaintiff is involved.

Best Cases for QSF or DSF

  • Mass tort and class action cases (breast implant cases, Zyprexa, Vioxx, and many others);
  • Environmental (CERCLA) lawsuits; and
  • Cases involving one or more claims when there is a dispute over the allocation of the settlement among the plaintiffs, and the insurance carrier is willing to comply in exchange for a complete release from the plaintiffs.

The Sequence of the QSF

The QSF process begins at the moment when the plaintiff(s) have extracted maximum value from the defendant(s) and both parties are ready to settle all claims for one settlement amount. The processing of the qualified settlement fund can appear to require more work and documents than the average settlement. While this is a typical sequence of events, facts and circumstances of a particular case may dictate otherwise:

  • Determine Settlement Fund Administrator
  • Agreement to Establish the QSF or DSF
  • Establishment of the QSF Trust Agreement
  • Petition or Motion to Establish the QSF
  • Order Establishing the QSF
  • Petition or Motion to Approve the Settlement Between Defendant(s) and Plaintiff(s)
  • Order to Approve Settlement Between Defendant(s) and Plaintiff(s)
  • Application for Federal Tax ID Number (EIN)
  • Establish QSF Bank Account
  • Settlement Agreement & Release Between Defendant(s) and Plaintiff(s)
  • Defendant(s) Fund the Settlement Award to the QSF
  • Dismissal of Prejudice
  • Conclude the negotiations with the plaintiff(s), lien holders, experts, co-counsel, and any other interested parties. It is at this time that all matters also be concluded for the structured settlements (for both the plaintiffs and attorney fees) and special needs trust, if applicable.
  • Settlement Agreement & Release Between the QSF (Releasee) and Plaintiffs (Releasor)
  • Qualified Assignment & Release
  • Petition or Motion for Order Approving the Settlement (i.e., minor, protected adult, wrongful death estate, etc.), Order Distribution of QSF Assets, Releasing QSF, Dismissing Cause and Administrator, and Terminating the QSF.
  • Order Approving the Settlement (if estate, minor, or protected adult), Order Distribution of QSF Assets, Releasing QSF, Dismissing Cause and Administrator, and Terminating the QSF.
  • The final duty of the QSF Administrator is to have a fiduciary tax return prepared. Typically, there is enough interest generated on the funds in the QSF to cover the cost of a CPA to prepare this simple return, as well as for fees for consulting with a tax attorney throughout this process. Any money left in the fund once all disbursements are made can be paid to the plaintiff(s) or given to charity.