Benefits of Qualified Settlement Funds in Complex Situations

Key Takeaways:

• Qualified Settlement Funds are holding vehicles that help streamline legal settlements by allowing time for proper fund allocation, lien resolution, and administrative tasks to be completed before disbursement.
• Both parties in the settlement benefit from the use of Qualified Settlement Funds. Plaintiffs have delayed receipt of funds, which allow for tax planning, while defendants can still claim tax deductions immediately.
• Qualified Settlement Funds give attorneys and clients more control over settlement timing and structure, which helps to maximize recovery and reduce financial risks.

During the final stages of any large legal settlement, both parties should consider using Qualified Settlement Funds (QSFs). QSFs are effective holding vehicles for settlement proceeds, and plaintiffs’ lawyers can use them to both maximize their clients’ recoveries and ease burdens on their back office.

Created by federal statute, QSFs are regulated by IRC §1.468(b). Most importantly, while settlement proceeds remain in an account associated with the QSF, neither the plaintiff nor the attorney are in constructive receipt — as defined by IRC §1.451-2 — of the settlement proceeds. To be a valid QSF, the following three requirements must be met:

• Created via a federal, state, or local court order capable of exerting continuing jurisdiction.
• Created for the purpose of holding settlement proceeds from tort, breach of contract, or other violations of laws.
• That the settlement proceeds must be segregated from all other assets of the defendant or other transferor.

This flexibility makes the use of QSFs practical and necessary in complex legal situations.

Complex Settlement Administration

Not every settlement is simple, and in cases involving hundreds or thousands of plaintiffs there are claims matrices, review and allocation procedures that need to take place before final disbursement of settlement funds. When depositing into a QSF, defendants receive the benefit of a tax a write-off in the year payment is made, while plaintiffs have additional time to wait for these processes to be completed. The avoidance of immediate constructive receipt allows plaintiffs' attorneys to meet their individual obligations to their collective group of clients.

Post-Resolution Considerations

At the end of litigation, other interests may need to be satisfied before a plaintiff can be paid. If a plaintiff has medical liens, negotiations with public and private health insurers often take a long time and can materially affect the plaintiff’s net recovery. An entity may have previously declared bankruptcy, and final clearance from the trustee must be obtained. There can also be succession disputes between heirs or successor entities that need to be resolved. By keeping funds in a QSF while waiting for final disposition, plaintiffs have time to determine how their situation may change before receiving their money. Taxability of Settlement Proceeds

Not every settlement agreement is the same, and there may be ambiguity regarding how funds are to be treated for tax purposes. Disputes might arise on whether the settlement proceeds are for physical or emotional damages, resulting in outside advice being needed. For non-personal injury cases, it may be important to consult an accountant to determine if deductions are available to offset taxes. The use of a QSFs allows all parties time to make informed decisions before tax season.

Qualified settlement funds can be an important tool during settlements. These are a few of the benefits QSFs provide at the time of a settlement. Whether for a breach of contract claim or an environmental contamination case, plaintiffs’ attorneys should be aware of how a QSF can help their clients after a final settlement.