Taxation of Qualified Settlement Funds

Taxation of qualified settlement funds is a complex area, demanding precision, accuracy, and timely action. No facet of QSF administration requires more planning, patience, and persistence. Administrators and trustees of QSFs face a demanding mix of tax and regulatory requirements.

A qualified settlement fund is a distinct tax-paying entity. A QSF is required to file an annual tax return, to make timely tax payments, and to prepare and distribute the appropriate tax forms to employees and asset recipients.

Compliance is essential, as the mission and integrity of the QSF depend on close adherence to the rules. Noncompliance can cause the trust to incur heavy penalties, and at the worst may partially or entirely invalidate the trust. It is very important to have an experienced QSF accountant involved to avoid these potential traps.

Timely and accurate income reporting is the most basic issue of QSF taxation. For QSF income taxation, Treasury Regulation 1.468B-2 provides a detailed and complex definition of net income. QSF income is taxed at  35 percent on the Federal level; state taxation varies widely.

The fund must precisely manage federal and state tax filings, payment of estimated taxes, and compliance with every aspect of the law; failure to do so may jeopardize the legal standing of the trust.

Beyond QSF income taxation, other tax liabilities require careful attention. If the fund pays wages or makes a beneficiary payment that represents a wage, it is considered an employer. As an employer, the fund acquires numerous responsibilities, driving the need for timely and accurate tax withholding and liability deposits, reporting of new hires, and compliance with unemployment tax requirements.

Distributions that are not wages—attorney payments, for example—still must be reported on Form 1099 to all recipients.

Beneficiary distributions have other tax implications. For some distributions, the trust must report income on Form 1099 to each recipient. If a recipient is subject to backup withholding, the QSF has the additional burden of withholding and depositing the funds and completing a Form 945.

These are only a few of the many issues of qualified settlement fund taxation. A detailed analysis is beyond the scope of this post, but Lordan CPA stands ready to assist with the most complicated aspects of QSF taxation.

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