1 Qualified Settlement Funds Richard B. Risk, JD, CSSC
2 Introduction The QSF is the most powerful tool available to the plaintiff for taking control of how the plaintiff s damage recovery funds will be distributed and determining who will handle the transaction.
3 Endorsement of the QSF Edwin W. Ash, Esq. American College of Trial Lawyers
4 Topics of Discussion Reasons for taking control Technical tax issues The need for formal guidance The political climate Overcoming defense opposition
5 Qualified Settlement Funds Can agree to future periodic payment obligations as part of settlement terms Can stand in the shoes of original person having liability, to make a qualified assignment under I.R.C. 130 of payments excluded under I.R.C. 104(a)(2) Taxable distributions can also be structured by QSF using offshore obligor
6 Reasons for Taking Control Preserving the plaintiff s damage recovery Avoiding fraud and other abuses Protecting privacy of personal financial data and medical history of plaintiff and attorney Maximizing benefits with available funds Allowing adequate time for proper planning Providing immediate release for defendants
7 Technical Tax Issues Economic benefit argument is used most by opponents Structures specifically carved out of economic benefit rule: 1982 Act codifying Rev. Rul TAMRA codifying right to security interest 2001 Act codifying right to sell payments Childs v. Comm r affirming attorney fees Reasons for establishing are clearly stated Allocation theories create absurdity, conflict with canons of professional conduct Unavoidable single-claimant situations Section 468B not created exclusively for mass tort cases
8 Economic Benefit Doctrine ARGUMENT: Some claim that a QSF established for just one claimant will trigger the doctrine of current economic benefit and cause loss of tax-free growth. Note that one or more language of Treas. Reg B-1(c) does not make the argument for a qualified assignment from a single-claimant QSF. Legislative history of the Periodic Payment Settlement Tax Act of 1982 says periodic payments from qualified assignment are excludable only if the recipient taxpayer is not in constructive receipt of or does not have the current economic benefit of the sum required to produce the periodic payments. H.R. Rep. No. 832, 97th Cong. 2d Sess. 4 (1982); S. Rep. No. 646, 97th Cong., 2d Sess. 4 (1982)
9 Economic Benefit Doctrine EXPLANATION: Under this doctrine, the creation by an obligor of a fund in which taxpayer has vested rights will result in immediate inclusion by taxpayer of the amount funded. A fund is created when an amount is irrevocably placed with a third party, and a taxpayer s interest in such fund is vested if it is nonforfeitable. This is a common-law doctrine. See Sproull v. Comm r, 16 T.C. 244 (1951), aff d per curiam, 195 F.2d 541 (6th Cir. 1952); Rev. Rul 60-31, 1960 C.B. 174 (Situation 4).
10 Economic Benefit Doctrine RESPONSE: This doctrine is not meant to apply to a QSF involving a single claimant: It is well-established that judge-made law is overridden when a statute (including legislative history or legislative regulation, which has effect of statute) is more specific and more recent than the doctrine. At least three instances of congressional intent through lawmaking demonstrate a carve-out from this rule.
11 Economic Benefit Doctrine RESPONSE (continued): This doctrine is not meant to apply to QSF involving a single claimant: The IRS found in the underlying facts of Revenue Ruling , where tortfeasor purchased and retained exclusive ownership of annuity to fund specified payments. Taxpayer s only right was to receive monthly benefits. Taxpayer (a single claimant to the annuity benefits) did not have actual or constructive receipt or economic benefit of the amount invested.
12 Economic Benefit Doctrine RESPONSE (continued): This doctrine is not meant to apply to QSF involving a single claimant: Periodic Payment Settlement Tax Act of 1982 legislative history confirms Congress intent that Revenue Ruling was the existing law (along with Rev. Rul and ) and that the new statutory provision was intended to codify rather than change present law. H.R. Rep. No ; 97th Cong. 2d Sess. H.R. 5470, II, n2; pertinent text identical in Senate Report No
13 Economic Benefit Doctrine RESPONSE (continued): This doctrine is not meant to apply to QSF involving a single claimant: Under facts of a QSF, the plaintiff is even further removed from the funds than in those facts underlying Revenue Ruling because the plaintiff still has a cause of action against the QSF (transferred from the original defendant) and no agreement has been signed between the plaintiff and the QSF giving the plaintiff any rights to the funds whatsoever.
14 Economic Benefit Doctrine RESPONSE (continued): This doctrine is not meant to apply to QSF involving a single claimant: When Code 130 was amended by TAMRA in 1988 to allow security interest in the annuity or Treasury obligation funding asset in a qualified assignment, repealing a previous section, this would normally constitute economic benefit. IRS acknowledged in Private Ruling : The amendment was intended to allow assignments of periodic payment obligations without regard to whether the recipient has the current economic benefit of the sum required to produce payments.
15 Economic Benefit Doctrine RESPONSE (continued): This doctrine is not meant to apply to QSF involving a single claimant: When Code 5891 was added effective January 23, 2002, by the Victims of Terrorism Tax Relief Act of 2001, confirming the taxpayer s right to sell, assign, pledge or otherwise encumber or alienate for consideration the periodic payments, which constitutes a property right that normally triggers economic benefit, Congress clearly made another exception or carve out to the economic benefit rule.
16 Economic Benefit Doctrine RESPONSE (continued): This doctrine is not meant to apply to QSF involving a single claimant: Tax Court in Childs v. Comm r rejected the IRS position that the right of the attorneys to receive periodic payments on behalf of their clients, in satisfaction of clients debt for attorney fees, was funded or secured. Tax Court held that structured fees were mere unfunded promises and did not constitute property under Code 83. This is consistent with three statutory indications. See Childs v. Comm r, 103 T.C. 634 (1994), aff d 89 F.3d 865 (11th Cir. 1996).
17 Economic Benefit Doctrine RESPONSE (continued): An absurdity results under the theory that a single claimant QSF or pre-allocation of funds triggers economic benefit: All QSFs must be allocated before final distribution can be made. At the instant allocation is made, economic benefit would occur under this theory. Obviously, this is not intended.
18 Economic Benefit Doctrine RESPONSE (continued): The allocation theory of economic benefit conflicts with canons of professional conduct: A lawyer who represents two or more clients shall not participate in making an aggregate settlement unless each client consents after consultation, including disclosure of the participation of each person in the settlement. ABA Model Rule of Professional Conduct 1.8(g); ABA Disciplinary Rule 5-106(A) reads essentially the same. See also Burrow v. Arce, 997 S.W.2d 229 (Tex. 1999) (adopting fee forfeiture as a remedy)
19 Economic Benefit Doctrine RESPONSE (continued): Unavoidable single-claimant situations should not cause economic benefit: When a settlement by a defendant to a QSF based on probable multiple casualties, such as in an explosion, but it is later discovered that there was only one casualty. When state probate law requires that all claims in wrongful death cases must be brought on behalf of the estate by its personal representative.
20 Purpose of Creating a QSF Nothing in legislative history of IRC 468B suggests that settlement funds: Are to be used exclusively for multiple-claim cases (see one or more language in Treasury Regulations); Need to be created for a specific reason other than those stated in the statute; Must be in existence for some minimum duration period Note: QSFs may not be used in workers compensation cases.
21 36 Tulsa L.J. 865 (2001) Resources Skadden Arps request for formal guidance Essay on 130 and 468B tax arguments Virginia Tax Review, Spring 2004 A Case for the Urgent Need for Treasury to Clarify Tax Treatment of a Code Section 468B Qualified Settlement Fund Created for a Single Claimant to Facilitate a Section 130 Qualified Assignment
22 Resources Fax from Terrance McWhorter, Office of Associate Chief Counsel (Income Tax and Accounting), IRS, 05/30/2003, to Jody Brewster of Skadden Arps: Jody, here are the articles we re referred to in the past. The last page is just the first page of a 46 page law review article by Richard Risk. I trust these are helpful, and we look forward to your comments regarding the 130/singleclaimant QSF soon. The articles cited included one by Bill Winslow from 1993, two Structured Settlements newsletter articles and the 2001 Tulsa Law Journal article.
23 Need for Formal Guidance Treasury Secretary has a duty under IRC 7805(d) to provide needful rules and regulations for enforcement of IRC. Much of the doubt as to tax treatment of single-claimant QSF assignments has been created by offhand comments from IRS staffers that get repeated.
24 Political Climate Disinformation campaign by opponents Internal tension at IRS over economic benefit providing ammunition (offhand comments being repeated) Request by Skadden Arps for formal guidance Liability insurers, their life affiliates and defense brokers (through auspices of NSSTA) lobbying against ruling Defense brokers know that the QSF is changing the power to control the structured settlement transaction Intimidation of SSP members by insurers, brokers Intellectually dishonest tax opinion letters
25 Political Climate NSSTA notice of 2004 Administrative Staff Seminar, listing topics: The 468b Controversy. IRC 468b was intended to solve a problem involving funds set aside to resolve mass tort cases. It has evolved into something quite different in our industry. We ll tell you what it all means, and how it is likely to be decided.
26 TIP IRC 467 Certain payments for the use of property or services IRC 468 Special rules for mining and solid waste reclamation and closing costs IRC 468A Special rules for nuclear decommissioning costs IRC 468B Special rules for designated settlement funds IRC 469 Passive activity losses and credits limited
27 TIP Title 26, United States Code Internal Revenue Code of 1986 Internal Revenue Code aka 26 U.S.C. or 26 USC aka I.R.C. or IRC aka Tax Code aka Code (among tax professionals) not IRS Code
28 TIP Title 26, Code of Federal Regulations Treasury Regulations aka 26 C.F.R. or 26 CFR aka Income Tax Regulations
29 Two Distinct Parts to a QSF QSF is established by agency or court: Administrator appointed and agreement approved Funds deposited Transferor gets economic performance under I.R.C. 461(h) Original defendants are released and dismissed with prejudice Liability is transferred to QSF through a novation QSF settles with claimant(s): Individual settlement agreements entered into Periodic payment liabilities are assigned per Rev. Proc Court approves settlements and orders distribution of QSF assets Funds are distributed QSF terminates existence Administrator files tax return
30 Novation Has the effect of adding a new party as substitute obligor which was not a party to the original duty, and discharging the original defendants by the agreement of all parties, completely extinguishing any alleged liability of the defendants See generally Rev. Proc , C.B. 470, also Restatement (Second) of Contracts 280 (1981).
31 Revenue Procedure This revenue procedure provides rules under which a designated settlement fund described in section 468B(d)(2) of the Internal Revenue Code or a qualified settlement fund described in section 1.468B-1 of the Income Tax Regulations will be considered a party to the suit or agreement for purposes of section 130. In general, section 130 provides that an assignee may exclude from gross income amounts it receives for assuming the liability of a party to a suit or agreement to make described periodic payments of damages to a claimant.
32 Overcoming Defense Opposition Create [Surname] Settlement Trust No mention of 468B, QSF, DSF, etc. To resolve post-settlement issues of no concern to defendants, their attorneys, their insurers Order approves Settlement Trust Agreement Settlement Trust Agreement is not filed Order to distribute refers to Settlement Agreement for details of payments Settlement Agreement incorporates Qualified Assignment by reference and is not filed
33 TIP The defendants or their insurers will pay the combined sum of $0,000, to the [Surname] Settlement Trust for the benefit of the plaintiff(s). Its federal tax identification number will be provided. The check will be delivered to [Attorney], the attorney for the plaintiff(s), or wire transfer of funds made not later than [agreed date]. Upon collection of the funds, the plaintiff(s) will file a Dismissal with Prejudice naming the defendant(s). Suggested language to be included in mediation summary, letter to defense counsel, court order establishing settlement trust
34 TIP There are some post-settlement issues that need to be resolved which do not involve the defendant, the defendant s attorney or insurer. These issues involve personal financial and personal medical information, which are meant to be protected under an individual s right to privacy, as a matter of public policy. Those issues subject to privacy rights might include: allocation among claimants, establishing or preserving eligibility for Medicaid or Medicare, unresolved liens for which the defendants will be indemnified, beneficiary designations, etc.
35 TIP It is tempting to tell the defense, if they refuse to cooperate in allowing the plaintiff to have periodic payments (a structured settlement), we ll just take this into a 468B. It is better not to let them know at all that the plaintiff is interested in a structured settlement. Several liability insurers have adopted a policy of not cooperating with plaintiffs who create QSFs because the insurers know they will lose their ability to reclaim some defense costs and profit at the expense of the injury victims.
36 TIP Consider putting language in the court order establishing the [Surname] Settlement Trust that authorizes the trustee/administrator to deposit all proceeds from the defendant or its insurer into the trust account, regardless of payee(s), without the endorsement of any other payee.
37 Availability of Markets Resistance generally seems to be a mixture of true (but unwarranted) concern and political reasons Defense factions within industry are known to boycott or threaten boycott Defense factions have staged an all-out campaign to discredit the single-claimant QSF by misstatements and intimidation
38 What This Means Remember, the employment of a QSF is not all about taking control so that the plaintiff broker is not left without compensation or has to share with a defense broker This issue is about preserving the plaintiff s damage recovery, each side paying their respective costs, avoiding schemes to benefit the defense, and protecting privacy
39 Next Steps Resolve to use the QSF every time you have a case of a size that warrants it (with multiple layers of coverage, you can bet on other brokers seeking to be involved) Every time the plaintiff takes control of the process of distributing money paid as damages, it is a victory for plaintiffs everywhere Plaintiffs have already been victimized by the tortfeasor prevent a second occurrence
40 Endorsement of the QSF James E. Frasier, Esq. Past President, Oklahoma Trial Lawyers Association
41 Conclusion The QSF is the most powerful tool available to the plaintiff for taking control of how the plaintiff s damage recovery funds will be distributed and determining who will handle the transaction.