What Is a Qualified Settlement Fund in a Mass Tort Settlement?

Most mass tort settlements are not paid as a single cheque. The money goes into a vehicle created for the purpose, and that vehicle is what actually holds the funds, pays the administrators and lawyers, resolves the medical liens that follow an injury claim, and eventually pays the claimants. That vehicle is usually a qualified settlement fund: a fund, account or trust, established by or with the approval of a court, that holds money to satisfy tort claims and exists to avoid the tax problem that a multi-defendant, multi-claimant pot would otherwise create.

The rules are not case law and they are not litigation procedure. They are tax regulations, sitting in Title 26 of the Code of Federal Regulations, and they are unusually specific: which money is excluded from income, which costs are deductible, who counts as the administrator, what the fund must file, and when it stops existing. A person waiting on a settlement payment usually meets the fund long before they meet the regulations, but the rules explain almost everything about why the money behaves as it does.

What makes a fund a qualified settlement fund

The definition is in 26 C.F.R. § 1.468B-1(c), and it has three requirements. A fund qualifies only if all three are met.

It is created by a governmental authority and stays under that authority’s continuing jurisdiction. Section 1.468B-1(c)(1) requires establishment by order of, or approval by, the United States, a state, a territory or possession, a political subdivision, or an agency or instrumentality of any of them — a court included. § 1.468B-1(e) explains what “ordered by” or “approved by” means: it is enough that the authority issues its initial or preliminary order or approval, even if that order is subject to review or revision.

It exists to resolve claims from an event or related series of events that has already occurred and has already produced at least one claim asserting liability. Under § 1.468B-1(c)(2), those claims must arise out of a tort, a breach of contract, or a violation of law. CERCLA liabilities and anything the Commissioner designates by revenue ruling or revenue procedure are also covered. A fund cannot be qualified if its purpose is prospective — money set aside for claims not yet asserted against a future event does not fit.

It is a trust under applicable state law, or its assets are otherwise segregated from the transferor’s other assets. That is § 1.468B-1(c)(3), and it is the requirement that stops a company from holding claimant money in an account it can reach.

Requirement	Source	What it rules out
Established by or approved by a court or other governmental authority, subject to its continuing jurisdiction	26 C.F.R. § 1.468B-1(c)(1), (e)	A purely contractual fund no court has blessed
Set up to satisfy claims from an event that has occurred and produced at least one liability claim	26 C.F.R. § 1.468B-1(c)(2)	Money reserved for future, unasserted liabilities
Trust under state law, or assets segregated from the transferor	26 C.F.R. § 1.468B-1(c)(3)	A fund the paying company can reach back into

Two consequences follow from the structure. Because the fund is not a grantor trust, a corporation’s own tax position in its product-liability case does not follow the fund’s treatment of its payments — the two are deliberately kept apart. And because the definition is condition-based rather than elected, a fund that fails any one of the three requirements simply is not a qualified settlement fund, whatever the parties called it.

Who administers the fund, and in what order

The regulations do not let the parties pick whoever is convenient. 26 C.F.R. § 1.468B-2(k)(3) sets out a priority order for who the administrator is, and a trustee can hold that role:

1. The person designated or approved by the governmental authority that ordered or approved the fund under § 1.468B-1(c)(1).
2. The person designated in the escrow agreement, settlement agreement, or other similar agreement governing the fund.
3. The escrow agent, custodian, or other person in possession or control of the fund’s assets.
4. The transferor, or all the transferors jointly, unless an agreement signed by all of them designates a single transferor.

In practice a mass tort settlement names its claims administrator in the first place, so the court-appointed or court-approved administrator is usually also the party handling claims. That administrator then does what any fund administrator does: validates claim forms, applies the settlement’s own schedule of benefits, resolves disputes over entitlement and amount, and reports distributions to the court and to the taxing authorities.

Courts appoint these administrators by order. In In re Pelvic Repair Systems Products Liability Litigation, MDL No. 2187, Pretrial Order No. 286 (S.D.W. Va. July 13, 2018), for example, the court appointed a named administrator as qualified settlement fund administrator, named the financial institution holding the fund, and authorized the administrator to segregate settlement funds, distribute attorney fees and litigation expenses, invest the fund as the motion described, and take steps to wind the fund down after the final distribution. The order is worth reading as a template: it is what the court’s continuing jurisdiction over a fund looks like when exercised.

Which money is taxed, and which is not

This is the part of the regime that surprises people, because the fund is taxable and the settlement is not.

Money paid into the fund is excluded from its income. Under § 1.468B-2(b)(1), amounts transferred by or on behalf of the transferor to resolve or satisfy the liability the fund was established for are excluded from gross income. § 1.468B-2(b)(1) then names three things that are not excluded: dividends on stock of the transferor or a related person, interest on debt of the transferor, and payments in compensation for a late or delayed transfer. Those are earnings on the transferor’s own assets, not settlement proceeds, so they stay in the fund’s taxable base.

What the fund is taxed on. § 1.468B-2(a) imposes a tax on the fund’s modified gross income at a rate equal to the maximum rate in effect for the taxable year under section 1(e) of the Internal Revenue Code, and (b) defines modified gross income as gross income with those exclusions and deductions applied. The fund’s taxable year is the calendar year and it must use an accrual method of accounting (§ 1.468B-2(j)).

What it may deduct. Section 1.468B-2(b)(2) allows a deduction for administrative costs and other incidental expenses of operating the fund — state and local taxes, legal, accounting and actuarial fees relating to the fund’s operation, and the expenses of notifying claimants and processing their claims. The same paragraph draws a hard line: those costs “do not include legal fees incurred by, or on behalf of, claimants.” A deduction is also allowed for losses on the sale, exchange or worthlessness of fund property, and for net operating losses, each on the same terms a corporation would get under sections 165, 1211 and 172.

What the tax replaces. Under § 1.468B-2(g), the fund’s tax is in lieu of other taxation of its income under subtitle A. A qualified settlement fund is not subject to the alternative minimum tax of section 55, the accumulated earnings tax of section 531, the personal holding company tax of section 541, or the section 1(h) maximum capital gains rate. It remains subject to taxes that are not imposed on its income. Section 1.468B-2(h) also denies the fund any credits against the tax.

A worked example from the regulations shows how the exclusion and its exception divide. In Example 1 under § 1.468B-2(n), a settlement of $10,833,000 was approved, comprising $10 million of damages and $833,000 of interest calculated at 10 percent annually from October 1, 1992 to August 1, 1993. Because none of the $10,833,000 was due until August 1, 1993, the interest was not a payment compensating for a late transfer. In Example 2, the settlement instead accrued 12 percent interest on any amount not transferred by August 1, 1993, and the transferor paid $11,374,650 on January 1, 1994. The extra $541,650 was compensation for the late transfer and therefore stayed in the fund’s gross income. The same distinction decides a whole category of questions a claimant never sees: whether late payment is a return of the settlement or earnings on the transferor’s delay.

Item	Treatment	Authority
Settlement proceeds transferred in to satisfy the claims	Excluded from gross income	26 C.F.R. § 1.468B-2(b)(1)
Interest on the transferor’s own debt; dividends on its stock	Not excluded — taxable	26 C.F.R. § 1.468B-2(b)(1)
Payment compensating for a late or delayed transfer	Not excluded — taxable	26 C.F.R. § 1.468B-2(b)(1)
Administrative, legal, accounting and actuarial costs of running the fund	Deductible	26 C.F.R. § 1.468B-2(b)(2)
Legal fees paid for claimants	Not a fund administrative cost	26 C.F.R. § 1.468B-2(b)(2)
Distributions to claimants and transferors	Not deductible by the fund	26 C.F.R. § 1.468B-2(d)
Foundation of fund property	Initial basis is fair market value on the transfer date	26 C.F.R. § 1.468B-2(e)

How the money reaches the claimant

The fund’s own accounting follows the settlement document, not the tax code. Inside the fund, payments to claimants are not a deductible expense of the fund at all: § 1.468B-2(d) states that amounts distributed to a transferor or a claimant are not deductible by the fund. The payments come out of principal, and the fund’s job with them is distribution rather than accounting.

That is where a claimant meets the machinery. The administrator applies the settlement’s own schedule — the defined-amount or grid-based payout the parties agreed — to a validated claim, resolves any disputes about entitlement or the amount, and issues the payment. Distributions to claimants are reported to the claimants themselves, and the fund must make a return for, or withhold tax on, a distribution to a claimant if the transferor would have been required to do that had it paid the claimant directly (§ 1.468B-2(l)(2)(ii)(A)).

Two related mechanisms sit alongside it. A common fund arrangement, usually in a class or group settlement, shares the common expenses of administration and attorney compensation across the group rather than charging each claimant alone. And liens are the other deduction a claimant should expect to see: amounts a state Medicaid agency or a Medicare plan paid for medical care on a claimant’s behalf have to be accounted for before a claimant keeps the net. Those are statutory recovery rights, not settlement terms, which is why they follow the money rather than being negotiated away. For how the underlying claims get filed and tracked, see how a mass tort claim moves; for the differences between a class action and a mass tort, see why mass torts are not class actions.

The filing obligations, which run for years

A fund that exists for a decade has a decade of filing obligations. 26 C.F.R. § 1.468B-2(k)(3) requires an income tax return for each taxable year the fund is in existence, whether or not it had gross income that year, filed on or before March 15 of the following calendar year unless extended. The administrator must obtain an employer identification number for the fund (§ 1.468B-2(k)(4)), deposit tax payments with an authorized government depositary (§ 1.468B-2(k)(5)), and is exposed to the section 6655 addition to tax on an underpayment of estimated tax (§ 1.468B-2(k)(6)).

Reporting runs both ways. Payments to the fund are treated as payments to a corporation for information-reporting purposes (§ 1.468B-2(l)(1)). Payments out of it are subject to the information-reporting requirements of Code part III of subchapter A of chapter 61, and to the withholding requirements of chapter 3, with the special rules in § 1.468B-2(l)(2).

The transferor keeps its own obligations too. 26 C.F.R. § 1.468B-3(a)(1) requires a transferor to treat a transfer of property to the fund as a sale or exchange for purposes of section 1001(a). § 1.468B-3(a)(2) is the anti-abuse provision: the Commissioner may disallow a loss where a principal purpose of the transfer was to claim it and the transferor placed significant restrictions on the fund’s use of the property, or the property (or substantially similar property) was distributed back to the transferor or a related person. Transfers of certain property carry a qualified appraisal requirement under § 1.468B-3(b), with a copy due to the administrator no later than February 15 of the year following the year of the transfer.

Obligation	Deadline or rule	Authority
Fund income tax return	March 15 of the year after close of the taxable year	26 C.F.R. § 1.468B-2(k)(3)
Employer identification number	Obtained by the administrator for the fund	26 C.F.R. § 1.468B-2(k)(4)
Qualified appraisal copy to administrator	February 15 of the year after the transfer	26 C.F.R. § 1.468B-3(b)(2)
Fund taxable year	Calendar year, accrual method accounting	26 C.F.R. § 1.468B-2(j)
Return or withholding on claimant payments	If the transferor would have been required to report or withhold	26 C.F.R. § 1.468B-2(l)(2)(ii)(A)

When the fund stops existing

A fund has a defined life. 26 C.F.R. § 1.468B-2(k)(2) says it is in existence from the first date it is treated as a qualified settlement fund until the earlier of the date it no longer satisfies § 1.468B-1 and the date it no longer has any assets and will receive no more transfers. The practical effect is that the fund’s existence is measured to its asset and requirement status, not to the settlement’s timetable.

§ 1.468B-2(m) adds the closing mechanism: a fund may request a prompt assessment of tax under section 6501(d), and for that purpose it is treated as dissolving on the date it no longer has assets other than a reasonable reserve for potential tax liabilities and related professional fees and will receive no more transfers. The Covidien order in MDL No. 2187 describes the parallel court step — after the final distribution the administrator must take appropriate steps to wind the fund down and discharge itself from further responsibility.

How the two statutory routes differ

Congress has provided two distinct routes for holding settlement money, and they are easy to confuse because they sit four subsections apart in the same Code section.

A designated settlement fund under 26 U.S.C. § 468B is the taxpayer-side mechanism. It must be established pursuant to a court order that completely extinguishes the taxpayer’s tort liability with respect to the claims; no amounts may be transferred out of it other than as qualified payments; it must be administered by persons a majority of whom are independent of the taxpayer; it must be established for the principal purpose of resolving and satisfying present and future claims for personal injury, death or property damage; the taxpayer may hold no beneficial interest in its income or corpus; and the taxpayer must make the election, which can be revoked only with the Secretary’s consent. Section 468B(a) treats economic performance as occurring as qualified payments are made to the fund, which is what lets a taxpayer deduct before it has actually spent the cash.

A qualified settlement fund under the regulations is the vehicle itself. Congress’s conclusion in § 468B(g)(1) is explicit: “Except as provided in paragraph (2), nothing in any provision of law shall be construed as providing that an escrow account, settlement fund, or similar fund is not subject to current income tax.” The regulations then set the conditions under which a settlement fund is a QSF and how it is taxed. The single exception in § 468B(g)(2) is narrow: a fund established by consent decree for CERCLA claims, under the direction of a government entity, and turned over to that entity on termination.

That is the practical reason the settlement money in a mass tort does not flow through the company’s books. The company’s tax problem is solved by the § 468B election; the money is parked in a vehicle that qualifies under the regulations, and the vehicle is a separate taxpayer with its own taxpayer identification number and its own calendar-year returns.

Frequently asked questions

What is a qualified settlement fund?

A qualified settlement fund is a fund, account or trust that holds money to resolve tort claims and is established by, or with the approval of, a court or other governmental authority. It gets special federal tax treatment: the settlement money itself is not taxed as income to the fund, administrative costs are deductible, and the fund pays a single entity-level tax on what it earns. The rules are in 26 U.S.C. § 468B and 26 C.F.R. §§ 1.468B-1 through 1.468B-5.

Why do mass tort settlements use one?

Because a mass tort fund is not one plaintiff with one judgment. It is money held for a large group of claimants, often over several years, by an administrator acting under court supervision. Without a defined tax regime the fund would have to work out for itself how to be taxed and how long it exists, and each transferor would have to characterize its own payment. The qualified settlement fund rules supply that structure: when the fund exists, who is its administrator, what it may deduct, and what it must file.

Who runs a qualified settlement fund?

An administrator, which is often the claims administrator the settlement appointed and can be a trustee. 26 C.F.R. § 1.468B-2(k)(3) sets out a priority order for who the administrator is: first the person designated or approved by the governmental authority that ordered the fund, then the person designated in the escrow or settlement agreement, then the escrow agent or custodian holding the assets, and finally the transferor. The administrator must obtain an employer identification number for the fund and file its returns.

Is settlement money taxed?

No. Amounts transferred to the fund to satisfy the claims it was established to resolve are excluded from the fund’s gross income under 26 C.F.R. § 1.468B-2(b)(1). The fund is instead taxed on modified gross income, which is what remains after its exclusions and deductions. One exception is explicit in the regulation: interest on debt of the transferor, dividends on the transferor’s stock, and payments compensating for a late or delayed transfer into the fund are not excluded, because those are earnings on the transferor’s own assets rather than settlement proceeds.

Can a qualified settlement fund deduct anything?

Administrative costs and other incidental expenses of running the fund, including state and local taxes, legal, accounting and actuarial fees relating to the fund’s operation, and the costs of notifying claimants and processing their claims. 26 C.F.R. § 1.468B-2(b)(2) also draws the line explicitly: legal fees incurred by or on behalf of claimants are not an administrative cost of the fund and are not deductible under that provision.

How long does a qualified settlement fund exist?

From the first date it is treated as a qualified settlement fund until the earlier of the date it stops meeting the requirements of 26 C.F.R. § 1.468B-1 or the date it has no assets and will receive no more transfers. Its taxable year is the calendar year and it must use an accrual method of accounting under § 1.468B-2(j). A fund that runs past its claimants is still a fund with filing obligations until it winds down.

Where the primary sources are

• 26 U.S.C. § 468B — Special rules for designated settlement funds, including the requirements for a designated settlement fund in subsection (d)(2) and the clarification in subsection (g) that a settlement fund is subject to current income tax
• 26 C.F.R. § 1.468B-1 — Qualified settlement funds, the three requirements and the governmental-order rule
• 26 C.F.R. § 1.468B-2 — Taxation of qualified settlement funds and related administrative requirements, including the administrator priority order, filing obligations and worked examples
• 26 C.F.R. § 1.468B-3 — Rules applicable to the transferor, including the section 1001(a) sale-and-exchange treatment and the anti-abuse rule
• 26 C.F.R. § 1.468B-5 — Effective dates and transition rules
• 26 U.S.C. § 1001(a) — gain or loss on the disposition of property, applied to a transfer to the fund by the transferor
• 26 U.S.C. § 6501(d) — prompt assessment of tax, for which a fund is treated as dissolving when it is wound down
• In re Pelvic Repair Systems Products Liability Litigation, MDL No. 2187, Pretrial Order No. 286 (S.D.W. Va. July 13, 2018) — a court order establishing a qualified settlement fund, appointing an administrator and a financial institution, and authorizing distributions and wind-down
• 42 U.S.C. § 1396p(a)–(b) — the Medicaid lien and recovery provisions that a state may assert against a claimant’s recovery

Fund administration practice varies by settlement and by state, and the regulations are amended over time. Read the governing court order and the settlement’s own plan of distribution before relying on any figure or deadline.

This is not legal advice

This describes how a settlement fund is structured and taxed. It cannot tell you what you are owed under any particular settlement, how your claim will be valued, or what a lien will take from your recovery. Only a lawyer reviewing your records and the governing documents can do that.