U.S. Income Tax Return for Settlement Funds

Definitions

Administrator. An administrator, which may include a trustee if the qualified settlement fund is a trust, is (in order of priority):

• The person designated or approved by the governmental authority that ordered or approved the fund.
• The person designated in the escrow agreement, settlement agreement, or other similar agreement governing the fund.
• The escrow agent, custodian, or other person in possession of the fund's assets.
• The transferor or, if there are multiple transferors, all of the transferors unless an agreement is signed by all of the transferors that designates a single transferor as the administrator.

Transferor. A transferor is a person who transfers (or on whose behalf an insurer or other person transfers) money or property to a settlement fund to resolve or satisfy claims against that person.

Related person. A related person is any person who is related to the transferor within the meaning of section 267(b) or section 707(b)(1).

Qualified Settlement Fund

A fund, account, or trust (a fund) is a qualified settlement fund if it meets the governmental order or approval requirement, the resolve or satisfy requirement, and the segregation requirement. These requirements are discussed below.

Governmental order or approval requirement. To meet this requirement, the fund must be established under an order of, or must be 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.

A fund is ordered by or approved by a governmental authority when the authority issues its initial or preliminary order to establish, or grants its initial or preliminary approval of, the fund even if that order or approval may be subject to review or revision. Generally, a governmental authority's order or approval has no retroactive effect and does not permit a fund to be a qualified settlement fund prior to the date the order is issued or the approval is granted. However, see Relation-back rule below.

Arbitration panels. An arbitration award that orders the establishment of, or approves, a fund is an order or approval of a governmental authority if:

• The arbitration award is judicially enforceable.
• The arbitration award is issued following a bona fide arbitration proceeding in accordance with rules approved by a governmental authority (such as self-regulatory organization-administered arbitration proceedings in the securities industry).
• The fund is subject to the continuing jurisdiction of the arbitration panel, the court of law that has jurisdiction to enforce the arbitration award, or the governmental authority that approved the rules of the arbitration proceedings.

Resolve or satisfy requirement. To meet this requirement, a fund must be established to resolve or satisfy one or more contested or uncontested claims that have resulted, or may result, from an event (or a series of related events) that has occurred and that has given rise to at least one claim asserting liability:

• Under the Comprehensive Environmental Response, Compensation and Liability Act of 1980 (CERCLA), as amended,
• Arising out of a tort, breach of contract, or violation of law, or
• Designated by the IRS in a revenue ruling or revenue procedure.

Generally, a fund does not meet the resolve or satisfy requirement if it is established to resolve or satisfy a liability to provide property or services unless the transferor's obligation to provide property or services is extinguished by a transfer or transfers to the fund. An exception exists for liabilities to provide property or services if the liabilities are under CERCLA.

Segregation requirement. To meet this requirement, the fund must (a) be a trust under applicable state law or (b) keep its assets segregated from other assets of the transferor (and related persons). For example, cash held by a transferor in a separate bank account satisfies the segregation requirement.

Classification of fund prior to meeting all three requirements. If a fund meets the resolve or satisfy requirement, the assets of the fund are treated as owned by the transferor of those assets until the fund also meets the governmental order and the segregation requirements. On the day the fund meets all three requirements, the transferor is treated as transferring the assets to a qualified settlement fund.

Relation-back rule. If a fund meets the resolve or satisfy requirement and the segregation requirement before it meets the governmental order or approval requirement, the transferor and the administrator (defined on page 2) may jointly elect the relation-back election (defined below) to treat the fund as coming into existence as a qualified settlement fund on the later of (a) the date the fund meets the resolve or satisfy requirement and the segregation requirement or (b) January 1 of the calendar year in which all three requirements are satisfied.

If a relation-back election is made, the assets held by the fund on the date the qualified settlement fund is treated as coming into existence are treated as transferred to the qualified settlement fund on that date.

Relation-back election. Make the relation-back election by attaching a copy of the election statement to Form 1120-SF for the tax year in which the qualified settlement fund is treated as coming into existence. The statement must be signed by each transferor and the administrator. File Form 1120-SF and the election statement by the due date of Form 1120-SF, including extensions. The election statement must contain the following:

• The words Regulations section 1.468B-1 Relation-Back Election at the top of the first page.
• The name, address, and identifying number of each transferor.
• The name, address, and EIN of the qualified settlement fund.
• The date on which the qualified settlement fund is treated as coming into existence.
• A schedule describing each asset treated as transferred to the fund on the date the fund is treated as coming into existence. The schedule of assets does not have to identify the amount of cash or the property transferred by a particular transferor.

Qualified settlement fund treated as a corporation. Except as otherwise provided in Regulations section 1.468B-5(b), for purposes of subtitle F of the Internal Revenue Code, a qualified settlement fund is treated as a corporation and any tax imposed under Regulations section 1.468B-2(a) is treated as a tax imposed by section 11. See Regulations section 1.468B-2(k) for more information.

Designated Settlement Fund

A fund, account, or trust is a designated settlement fund if it meets the following requirements:

• It is established by a court order and completely extinguishes the taxpayer's tort liability.
• No amounts may be transferred to it other than in the form of a qualified payment (defined below).
• It must be administered by persons, a majority of whom are independent of the taxpayer.
• It is established for the principal purpose of resolving and satisfying present and future claims against the taxpayer arising out of personal injury, death, or property.
• The taxpayer may not hold any beneficial interest in the income or corpus of it.
• The taxpayer elects to have it treated as a designated settlement fund.

A qualified payment is any money or property that is transferred to a designated settlement fund under a court order other than:

• Any amount that may be transferred from the fund to the taxpayer (or any related person).
• The transfer of any stock or indebtedness of the taxpayer (or any related person).

Note. A designated settlement fund is taxed in the same manner as a qualified settlement fund. In addition, if a fund does not meet the requirements of a designated settlement fund but does meet the requirements of a qualified settlement fund, the fund is treated as a qualified settlement fund.

Period Covered

A qualified settlement fund's tax year is the calendar year.

Address

Include the suite, room, or other unit number after the street address. If the Post Office does not deliver mail to the street address and the fund or the administrator has a P.O. box, show the box number instead of the street address.

Employer Identification Number (EIN) of Fund

Enter the fund's EIN. If the fund does not have an EIN, it must apply for one on Form SS-4, Application for Employer Identification Number. If the fund has not received its EIN by the time the return is due, write Applied for in the space provided for the EIN. See Pub. 583 for details.

Final Return, Name Change, Address Change, and Amended Return

Indicate a final return, name change, address change, or amended return by checking the appropriate box. Use Form 8822, Change of Address, to notify the IRS of the new address.

Part I. Income and Deductions

Income

Note. Amounts transferred to the fund by or on behalf of a transferor are generally excluded from income.

Line 1. Taxable interest. Enter total taxable interest received or accrued during the tax year, including original issue discount. Do not include any tax-exempt interest here. Report tax-exempt interest as an item of information under Additional Information, on page 2, line 2.

Do not offset interest expense against interest income.

Line 3. Capital gain net income. Every sale or exchange of a capital asset must be reported in detail on Schedule D (Form 1120), Capital Gains and Losses, even if there is no gain or loss.

Line 5. Other income. Enter other taxable income not reported on lines 1 through 4. List the type and amount of income on an attached schedule. If the fund has only one item of other income, describe it in parentheses on the dotted line next to the entry space for line 5.

Deductions

Note. Do not deduct:

Line 11. Items of loss, deduction, or credit from a partnership interest. For tax years ending before 2003, a fund that holds a partnership interest it acquired before February 15, 1992, is allowed a deduction for its distributive share of that partnership's items of loss, deduction, or credits, described in section 702(a) that would be deductible in determining taxable income (in the case of a tax credit, the income tax liability) of a corporation. The deduction is allowed only to the extent of the fund's distributive share of that partnership's items of income and gains described in section 702(a) for that tax year. If the fund has an interest in more than one partnership, attach a schedule showing each partnership's items of loss, deduction, and credit, and that partnership's items of income or gain. Credits against tax are treated as deductions by dividing the amount of the credit by the fund's tax rate. See the instructions for line 16 below for the fund's tax rate for the year.

Note. Limitations on changes in partnership agreement and capital contribution and changes in a qualified settlement fund's distributive share of items of income, gain, loss, deduction, or credit are disregarded if:

Line 12. Other deductions. Enter the total of other deductions not entered on lines 7 through 11. List the type and amount of deduction on an attached schedule. If the fund has only one item of other deduction, describe it in parentheses on the dotted line next to the entry space for line 12.

Line 13. Net operating loss deduction (NOL). Enter the total NOL carryovers from prior tax years, but do not enter more than the fund's taxable income. See Pub. 536, Net Operating Losses, and Regulations section 1.468B-2(b)(4) for more details.

Part II. Tax Computation

Line 15. Modified gross income. Modified gross income of a qualified settlement fund is its gross income, as defined in section 61, computed with certain modifications. See Regulations section 1.468B-2(b) for more information.

Line 16. Total tax. To determine the fund's tax, multiply the amount on line 15 by the tax rate for the tax year that the return is being filed. Enter the result on line 16.

Line 17. Credits and payments. No credits or payments are allowed other than those on lines 17a through 17e.

Line 18. Estimated tax penalty. A fund that does not make estimated tax payments when due may be subject to an underpayment penalty for the period of underpayment. Generally, a fund is subject to the penalty if its tax liability is $500 or more, and it did not timely pay the smaller of:

• Its current year tax liability or
• Its prior year's tax.

See section 6655 for details and exceptions, including special rules for large funds.

Use Form 2220, Underpayment of Estimated Tax by Corporations, to see if the fund owes a penalty and to figure the amount of the penalty. Generally, the fund does not have to file this form because the IRS can figure the amount of any penalty and bill the fund for it.

If Form 2220 is attached, check the box on line 18 and enter the amount of any penalty on that line.

See Form 2220 for other information that may apply.

We ask for the information on this form to carry out the Internal Revenue laws of the United States. You are required to give us the information. We need it to ensure that you are complying with these laws and to allow us to figure and collect the right amount of tax.

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The time needed to complete and file this form will vary depending on individual circumstances. The estimated average time is:

If you have comments concerning the accuracy of these time estimates or suggestions for making this form simpler, we would be happy to hear from you. You can write to the Tax Forms Committee, Western Area Distribution Center, Rancho Cordova, CA 95743-0001.

Do not send the tax form to this address. Instead, see Where To File on page 1.

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