The QSF regs. - a double-edged sword.

• Author: Goodarz, Agahi
• Position: Qualified settlement fund

Generally, the treatment of a settlement fund as a qualified settlement fund (QSF) benefits the transferor, because a transferor who contributes funds to a QSF may be able to take a deduction that would otherwise not be allowed (under the economic performance rules) until the funds are distributed to claimants; see Kegs. Sec. 1.468B-3(c). However, QSF treatment is not elective, in contrast to the QSF's progenitor, the designated settlement fund (DSF); sec Sec. 468B(d)(2)(F). This distraction is a trap for the unwary, as evidenced by the Tenth Circuit's decision in Brown, 334 F3d 1197 (10th Cir. 2003).

Background

In Brown, the issue before the Tenth Circuit was whether a trust established to provide restitution to foreign investors (Investors) was a QSF liable for income taxes on its earnings. The Investors were defrauded when they attempted to invest in U.S. securities sold by a domestic company (Transferors) that had misrepresented the securities. The Transferors entered into stipulations with the U.S. under which they released their claims to certain property and placed it in a fund (Fund) designed to provide the Investors with restitution. The total Fund assets, however, were worth less than one-fourth of the total claims filed against the Fund.

Nearly two years after the Fund was established, the IRS identified it as a QSF, submitting a proof of claim stating that the Fund owed taxes. The tax erect on the Investors was considerable; under a treaty, they would not otherwise have been subject to U.S. taxes on Fund distributions. The Investors raised several arguments against QSF treatment, including challenging (1) the statutory authorization for the QSF regulations as an unconstitutional delegation of authority under the "nondelegation doctrine"; and (2) the QSF regulations as a misuse of delegated power.

Regulations

Regs. Sec. 1.468B-1(c) defines a QSF as a fund, account or trust if:

(1) It is established pursuant to an order of, or is approved by, the United States, any state (including the District of Columbia), territory, possession, or political subdivision thereof, or any agency or instrumentality (including a court of law) of any of the foregoing and is subject to the continuing jurisdiction of that governmental authority;

(2) It is established to resolve or satisfy one or more contested or uncontested claims that have resulted or may result from an event (or related series of events) that has occurred and that has given rise to...