Taxation of Distributions From Qualified Settlement Fund

Qualified settlement funds can help you get the tax treatment you want.

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When you win a settlement from a lawsuit, the tax on the payout depends on the type of damages. Certain damages, such as medical bills, are exempt from tax. Others, such as lost wages, are taxable. When any part of the settlement is taxable, timing issues could result in you winding up with a tax bill before you have the cash in hand to pay it. Qualified settlement funds help simplify tax issues and speed up the settlement process.

Basics of Qualified Settlement Funds

Qualified settlement funds, also called 468B funds, are trusts that are subject to court supervision and exist to resolve a legal claim. You or the defendant can suggest using a qualified settlement fund to facilitate the payment. You can have any court approve and supervise the trust. While qualified settlement funds are typically used in class action cases, there’s no established minimum number of claims required to be able to create a qualified settlement fund.

Settlement Language

The legal language of the settlement dictates the tax treatment of the distributions you receive. Qualified settlement funds give you time to work out with your attorney how to take the money out and what form it should take for your needs. Because you negotiate the final settlement agreement with the fund, rather than the defendant, you’re likely to get the tax language you want. You can enter into a structured settlement with the qualified settlement fund after the lawsuit has been decided that pays your award out over time and might offer tax advantages.

Interest and Dividend Income

Money placed in a qualified settlement fund might stay there for a long time as you work out with your attorney and any other plaintiffs who gets how much and what form the distributions will take. While the fund holds onto the payout from the defendant, the trustee will likely invest the funds in a secure, interest-bearing account. Because qualified settlement funds are separate tax entities they pay tax on any interest or dividend income. The after-tax income then becomes part of the settlement fund.

Defendant's Tax Treatment

The defendant must irrevocably hand the money over to the qualified settlement fund. The only exception is that the fund can automatically return the money to the defendant upon successful appeal and does not distribute money to plaintiffs while the case is in appeal. This requirement allows the defendant to get any tax deduction for the loss immediately.