Qualified Settlement Funds

A Response: State of Idaho Department of

Recently, in Idaho Department of Health and Welfare v. Jona- delson (Hudelson), the Court reversed and remanded a dis-
thon L. Hudelson, the Idaho State Supreme Court presumed trict court decision to affirm the judgment of the original
that the establishment of a qualified settlement fund (QSF) magistrate. In making this decision, the Court presumed
under IRC § 468B was a benefit to the claimant in the form of the establishment of a qualified settlement fund (QSF) un-
a “receipt” of settlement proceeds. This enabled the Department der IRC § 468B was a benefit to the claimant in the form
of Health and Welfare to seek reim- of a “receipt” of settlement. Not only does this interpreta-
bursement from a Medicaid recipient’s tion threaten the effectiveness of a QSF as a settlement
personal injury settlement immediately tool for personal injury attorneys, but it also threatens the
upon the defendant’s transfer of pro- ability of their clients to properly plan for their receipt of
ceeds to a qualified settlement fund. This settlement money, which possesses a profound effect on
Court’s interpretation of “receipt” has their future health and welfare. QSFs have in the past and
national implications for both single continue to be an excellent resource for personal injury
event and mass tort matters, involv- attorneys in dealing with cases that involve various post-
ing how and when settlement funds are settlement related issues, such as lien resolution, govern-
received and how a claimant’s financial ment benefit preservation, and the tax consequences that
needs are affected by a QSF. This in result from the financial plan adopted to protect the future
turn affects a claimant’s willingness to interests of their injured client.
By Michael
settle and everyone’s ability to receive Under the Treasury Regulations and Revenue Rulings
Russell Peter
satisfaction. We believe it is important that set forth the legal basis for QSFs, the Court’s interpre-
that we bring this case to the atten- tation of “receipt” appears to be misguided. While assets
tion of the attorneys that comprise are placed in a QSF, there is no actual or constructive
the Kentucky Justice Association, receipt, via the economic benefit or constructive receipt
because similar arguments may be doctrines on the part of a claimant. “Receipt” occurs only
made in Kentucky QSF cases, espe- upon the release of funds from the QSF through distri-
cially in light of the recent statutory bution. QSFs present unique and complex legal and tax
developments in favor of health care issues, such that a cursory analysis of “receipt” by a court,
providers’ subrogated interests. while understandable, may lead to an improper conclusion.
A proper analysis of “receipt” based upon the Treasury
This article is in response to a deci- Regulations and their Congressional intent render QSFs
sion by the Supreme Court of Idaho, useful tools that provide valuable breathing space to claim-
which was filed on October 16, ants and their attorneys, which in turn helps ensure that
and Peter H.
2008. In State of Idaho Department of proper client counseling can occur after settlement.
Wayne IV
Health and Welfare v. Jonathon L. Hu-
The Issue: When is a Settlement “Received?”
The issue of “receipt” and its impact upon QSFs is
vital to settlements of all sizes and circumstances. In small
Michael Russell provides qualified settlement fund
settlements where there is a primarily injured claimant and
services for The Garretson Firm. He may be reached at
derivatively injured parent, child or spouse, the QSF can
mrussell@garretsonfirm.com.
be utilized to help properly allocate the funds among all
the claimants who possess their own individual or deriva-
Peter Wayne is general counsel for the Settlement
tive claims under state law. In mass torts where there are
Services Group. Peter may be reached at pwayne@
numerous claimants with individual claims, the QSF can
garretsonfirm.com. be used to provide each individual with the appropriate

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Qualified Settlement Funds

amount of time to address government benefits verifica- of constructive receipt is set forth in Treas. Reg. §1.451-2,
tion, preservation and lien resolution. Hence the interpre- which states that income, although not actually reduced
tation of “receipt” is essential to QSF utilization for both to a taxpayer’s possession, is constructively received in the
small and large mass tort settlements. taxable year during which it is credited to his account, set
In Hudelson, the Idaho Supreme Court ruled in favor apart for him, or otherwise made available so that he may
of the Department of Health and Welfare (Department) draw upon it any time, or so that he could have drawn
in its attempt to seek reimbursement from a Medicaid upon it during the taxable year if notice of intention to
recipient’s personal injury settlement. The individual withdraw had been given. The Treasury Regulation further
became eligible for Medicaid benefits as a result of injuries asserts that there is no constructive receipt if the taxpayer’s
sustained in a car accident. A QSF was established to hold control of its receipt is subject to substantial limitations or
the tortfeasor’s payment and resolve the claims of both the restrictions.
injured individual (claimant) and Medicaid. It is important When a QSF is established, a fund administrator is
to note that this article does not take issue with the Court’s appointed to control and make distributions from the QSF.
decision in favor of the Department but rather with the While money is in the QSF it is not credited to, set apart
Court’s holding with respect to “receipt.” The Court ap- for, or otherwise made available to an individual claimant.
plied the presumption of I.C. §56-209b(6), which states In actuality, a novation occurs whereby the liable party is
the following: released from present and future liability despite the cause
If a settlement or judgment is received by the of action remaining alive to permit the court to maintain
[Medicaid] recipient without delineating what its jurisdiction over the case. The novation that occurs
portion of the settlement or judgment is in pay- adds a new party as substitute obligor (the settlement
ment of medical expenses, it will be presumed fund administrator) who was not previously a party to the
that the settlement or judgment applies first to action, and discharges the original defendant. Upon pay-
the medical expenses incurred by the recipient in ment into the QSF, the liability on the underlying cause of
an amount equal to the expenditure for medical action transfers from the original defendant to the settle-
assistance benefits paid by the department as a ment fund and its administrator. Therefore, the claimant
result of the occurrence giving rise to the payment and the fund administrator must come to an agreement
or payments to the recipient. on the final distribution and only after executing a fund
settlement agreement and release of liability, are the settle-
In its application of I.C. §56-209b(6), the Court held ment proceeds released. When the settlement proceeds
that the settlement was “received” under the statute, and are released, receipt takes place. The operation of the fund
that the presumption therefore applied. However, it ap- administrator as substitute obligor places a substantial
pears the Court based its finding of receipt by the claim- limitation on the claimant’s ability to control receipt of
ant solely upon the lower court’s simultaneous approval the settlement proceeds. Furthermore, a QSF is created
of the settlement allocation and establishment of the QSF to resolve the claims of multiple parties to a single settle-
in this case. Despite the fact that the settlement proceeds ment fund. The fund is not simply set aside specifically
were being held in the QSF and that none of the money for the claimant’s benefit but serves as a vehicle to resolve
was directly payable to the claimant, the Court surprisingly the claims of various involved parties. In Hudelson, both
found that the money was applied to the claimant’s benefit the claimant and the Department possessed claims to the
and was, thus, constructively received. In sum, the Court settlement proceeds. Therefore, the settlement proceeds
held that for purposes of I.C. § 56-209b(6) a settlement is were not specifically set aside or available to any particular
received upon the establishment of a QSF and subsequent person, party or organization.
payment into it by a liable party. This appears to contradict Additionally, a QSF is a separate taxable entity, which
the Treasury Regulations concerning QSFs, and indeed the is distinct and totally divorced from the claimant. Regs.
very purpose of their creation by Congress in the tax code. §1.468B-2(k)(4) requires that a QSF must obtain its own
individual employer identification number (EIN). The
Constructive Receipt fund is responsible for quarterly taxes and these tax pay-
QSFs were expressly designed by Congress to avoid ments are reported using the EIN and showing the fund
constructive receipt issues in the settlement process. Thus, as payer as required by Regs. §1.468B-2(1)(2)(ii)(D).
a judicial ruling that a QSF actually creates constructive The fund administrator is responsible for adhering to the
receipt runs afoul of their declared purpose. The doctrine income tax compliance measures. The claimant is not

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credited with an account and he possesses no tax responsi- ments. As mentioned with respect to constructive receipt
bilities with respect to the QSF. Only after a disbursement above, a QSF is established to resolve multiple claims - one
is made from the QSF to the claimant, does the claimant of the three requirements for a QSF under Regs. §1.468B-
need to report the receipt of settlement money to the IRS 1(c). In Hudelson, the settlement proceeds in the QSF
and be subject to taxation as if the defendant paid the were subject to the claims of both the claimant and the
claimant directly. The scheme created for the taxation of Department; the settlement proceeds were not solely for
QSFs is further support that settlement proceeds in a QSF the benefit of the claimant. Additionally, this case included
are not actually or constructively received until they are more uncertainty and the possibility of partial forfeiture.
released from the fund. Even after the allocation was approved by the trial judge,
The court in Hudelson correctly noted that a QSF was it was noted that this decision was not binding on the
established and an order for settlement was approved. Department. Thus, because the allocation was not final
However, it appears from these facts alone that the Court and binding, the economic benefit was not unconditional.
assumed receipt on the part of the claimant. In coming to A final, unconditional, allocation does not occur until the
this conclusion, they omitted an analysis of the mechan- money is released from the fund.
ics of the QSF, specifically the tax scheme laid out by the Furthermore, while the settlement proceeds are in the
Treasury Regulations, the role of the fund administrator QSF, the claimant does not possess an unconditional right
and the purpose of QSFs. When taking the aforementioned to them and their receipt is restricted. The claimant must
aspects into account, it is clear that the money is not ap- come to an agreement with the fund administrator and
plied to the claimant’s benefit until release from the fund execute a release before he gains a vested right in and sub-
and, thus, there is no constructive receipt by him until sequent access to his allocated portion of the settlement
then. proceeds. Thus, there is no economic benefit or uncondi-
tional use of the settlement proceeds until an agreement
Economic Benefit Doctrine is executed and the settlement proceeds are released from
The economic benefit doctrine does not apply to the the fund. In Hudelson, the settlement money was still in the
establishment of a QSF because while money is in a QSF fund and no fund settlement agreement was yet executed.
there is neither the actual receipt of property nor the right Thus, the claimant did not receive the settlement and there
to receive property in the future by any particular claim- was no economic benefit.
ant to the fund. This receipt is required to confer a current We believe that the Court in Hudelson presumed re-
economic benefit upon the claimant. This common law ceipt by the claimant without an adequate discussion and
doctrine applies when assets are paid into a trust or fund analysis of the essential elements of a qualified settlement
for the unconditional use and sole benefit of the recipient. fund.
In Sproull v. Commissioner, 16 T.C. 244 (1951), aff’d., 194 Moreover, this presumption from the Court directly
F.2d 541 (6th Cir. 1952), the court found an economic conflicts with the Treasury Regulations and Revenue
benefit when a trust was established by an employer to Rulings that stand as the legal authority for QSF estab-
compensate an individual for past services. These settle- lishment and administration. A claimant does not receive
ment proceeds were solely for the individual and receipt assets held within a QSF in any form, thus, there is no
was unconditional and irrevocable. While this doctrine constructive receipt and the economic benefit doctrine
exists, it is important to note that not all such payments does not apply. Receipt takes place only at the time of the
trigger the economic benefit doctrine. In Rev. Rul. 79-220, execution of any paperwork between the claimant and the
1979-2 C.B. 74, there was no economic benefit where a fund administrator acknowledging allocation and trigger-
taxpayer did not receive the lump sum amount to be used ing disbursement from the QSF. In conclusion, the QSF
to fund an annuity. When there are future conditions or remains an effective tool to create breathing space after a
the possibility of forfeiture, the economic benefit doctrine settlement due to its prevention of actual or constructive
does not apply. Therefore, determining whether or not receipt by any claimant.
the doctrine applies to a QSF requires another look at the
mechanics of this settlement vehicle.
Published in The Advocate, Volume 37, Number 2, 2009 by the
Settlement proceeds placed in a QSF do not trigger
Kentucky Justice Association. Reproduced with permission.
the economic benefit doctrine because the funds are not
solely held for the benefit of one claimant and payment is
conditioned upon the execution of fund settlement agree-