What Is a Qualified Settlement Fund (QSF)?

The three IRC § 468B requirements

1. Court order or governmental authority. The fund must be established under the supervision of a court or government agency.
2. Resolve or satisfy claims. It must exist to resolve one or more claims arising out of a tort, breach of contract, violation of law, or similar legal action.
3. Qualifies as a trust or segregated account. It must be a trust under applicable state law or a separately identifiable account.

How a QSF is established

Counsel drafts a QSF trust agreement and submits it to the presiding court for approval. Once the court signs the establishing order, the fund obtains an EIN, opens a trust bank account, and is ready to receive the defendants' settlement payment. The defendants take their tax deduction at the moment of transfer, even though distributions to plaintiffs may be months away.

The administrator's role

The court appoints a QSF administrator — typically a corporate trustee, settlement-fund administration firm, or qualified attorney — to manage the fund as a fiduciary. Core duties:

• Hold and invest fund assets in conservative, court-approved vehicles.
• File the fund's annual tax return on Form 1120-SF and pay tax on modified gross income (primarily investment earnings).
• Coordinate lien resolution with Medicare, Medicaid, ERISA plans, and private insurers before any claimant payment.
• Process individual allocation decisions made by a special master or claims administrator.
• Disburse net proceeds to claimants, attorneys, and structured-settlement assignees.
• Maintain books and records and report distributions to the IRS.

Tax treatment in plain English

A QSF is a separate taxable entity, not a pass-through. It pays federal tax on its modified gross income — generally limited to investment returns earned while funds are held — at the maximum trust rate. The original settlement principal is not taxed at the QSF level because the defendant already took the deduction when it funded the trust.

Plaintiffs are taxed under the normal settlement rules when they receive their distributions: physical-injury recoveries under IRC § 104(a)(2) remain tax-free, while non-physical and punitive components are taxable. Attorneys' fees are taxable to counsel as ordinary income.

Typical QSF lifecycle

1. Settlement agreement signed; parties petition the court to establish the QSF.
2. Court enters the establishing order; trustee opens accounts and obtains EIN.
3. Defendants transfer the gross settlement amount and take their tax deduction.
4. Special master or claims administrator allocates the fund among claimants.
5. Lien holders are notified, negotiated with, and paid from each allocation.
6. Net amounts are disbursed as immediate cash or routed into structured-settlement annuities (often tax-free for physical-injury recoveries).
7. Administrator files final Form 1120-SF and the court closes the fund.

Why plaintiffs benefit

• Time to evaluate Medicare set-aside obligations without holding up the entire settlement.
• Ability to design tax-advantaged structured-settlement annuities before constructive receipt.
• Coordinated lien resolution that often reduces net lien repayment.
• Funds earn interest in trust rather than sitting in defendant escrow.