Pitfalls of the Improper Election of Qualified Settlement Funds

The qualified settlement fund (QSF) – a common vehicle used by plaintiff and defense attorneys – is governed by section 468B of the Internal Revenue Code (IRC). The Tax Reform Act of 1986 created the qualified settlement fund in response to questions surrounding the income tax treatment of settlement funds, and defendant’s issues related to when a tax deduction for payments made into a settlement fund could be taken. 

A QSF operates as a tax-free holding point used when determining who receives what amount from the settlement. It’s also a vehicle from which distributions are made. 

IRC Section 468B makes it clear that settlement funds are taxed on a current basis, and provided guidance as to when tax deductions could be taken by defendants. The regulations supporting this code section; however, took almost five years to draft. 

For a settlement fund to qualify as a QSF, the tax administrator must make an election after three criteria are met: 

  1. The fund must be under the jurisdiction of a Court
  2. The funds must be segregated
  3. The purpose of the fund is to be in settlement of a tort

Once the fund has been established as a QSF, there are certain requirements that must be met: 

  1. The fund must apply for its own tax ID number 
  2.  The fund has an annual tax filing requirement 
  3. The fund must pay quarterly estimates, if required 
  4. The fund may have to make a relation-back election in certain situations to allow defendants to get a timely deduction 
  5. The fund may be required to file informational returns when the fund is liquidated (i.e. 1099s) 

If any step is missed, the IR) will (and has in the past) impose substantial penalties on the fund. A common pitfall is that if the fund does not meet all the criteria, it may revert to grantor trust treatment with no current deduction for defendants and more importantly, an unintended tax liability for the defendants.  

Another common pitfall is not realizing that each state has its own unique tax treatment of qualified settlement funds. Therefore, it is critical for parties to consider where the fund is established and be mindful of the state’s specific qualified settlement fund requirements. 

Heffler Claims Group’s certified public accountants (CPAs) have unparalleled expertise in managing the many issues surrounding the taxation of Qualified Settlement Funds under IRC section 468B, having been involved since the law was first enacted. Heffler participated in focus group sessions with the United States Treasury that assisted in the drafting of the regulations that accompany IRC code section 468B. 

Today, we have a dedicated team of highly-trained tax professionals specializing on IRC section 468B tax issues who are committed to keeping up-to-date on all tax developments related to qualified settlement funds and 468B at both the state and federal level. Heffler Claims Group was hired to provide these services for over 1,000 matters in Antitrust, Securities, Corporate, Government, Mass Tort and Wage & Hour settlements. On an annual basis, our team prepares 100 tax returns and has obtained successful results in numerous IRS audits. 

IRC Section 468B is just one line in the tax code but there are many pitfalls that can prove to be embarrassing and costly if not handled properly. Our team is happy to work with you to ensure you are in compliance. 

Contact Heffler Claims for all class action settlement distribution needs.

Edward Radetich
Edward J. Radetich, Jr., CPA (Ed), oversees management and operation of the firm. Having participated in the administration of hundreds of class action matters, Ed has been instrumental in developing the policies and practices of the claims administration group over the last 35 years and has established Heffler Claims Group as a leading provider of class action services for antitrust, securities, employment and labor, consumer and government enforcement matters.

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