644 / What are the tax consequences of using a designated settlement fund or qualified settlement fund to satisfy a defendant’s obligations under a structured settlement?

Because of the economic performance requirement of IRC Section 461, payments made to a designated settlement fund (DSF) arguably may not be deductible by the defendant because the plaintiff has not actually received the funds transferred into the account. Despite this, IRC Section 468B provides an exception and allows a defendant to deduct “qualified payments” made to a DSF.¹ Qualified settlement funds (QSFs) receive the same tax treatment as DSFs pursuant to the regulations under Section 468B.

A “qualified payment” is a payment made to a DSF or QSF pursuant to a court order other than payments that (1) may be transferred back to the defendant (or a related person), meaning that the transfer must be irrevocable, or (2) are transfers of stock or indebtedness of the defendant (or any related person).²

If the fund is a DSF or QSF that meets the requirements of Section 468B, the economic performance requirement will be considered met upon transfer to the DSF or QSF so that the defendant will be entitled to a deduction as payments are transferred into the fund regardless of when they are eventually paid to the plaintiff.

The gross income of DSFs and QSFs is taxed at the maximum tax rate applicable to trusts.³ Qualified payments (see above) made to the fund are not considered income to the fund.⁴ DSFs and QSFs are not subject to additional taxes, such as the alternative minimum tax, the accumulated earnings tax, the personal holding company tax or the capital gains tax.⁵

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1. IRC 468B(a).