Mass-tort trust qualifies as a settlement fund and transfers are deductible

Plain-English summary

Affiliated companies entered bankruptcy proceedings to resolve thousands of present and future personal-injury claims arising from exposure to a redacted product component. Their reorganization plan created a court-supervised state-law trust that would assume, process, and pay the claims using cash and potentially parent-company stock. The IRS ruled that the trust would be a qualified settlement fund because it was court approved, subject to continuing bankruptcy-court jurisdiction, created to resolve tort claims, and organized as a state-law trust. It also ruled that qualifying cash and stock transfers were ordinary and necessary business expenses deductible in the years transferred, when the liabilities were fixed and economic performance occurred. The deduction did not cover transfers for non-allowable claims or amounts received from insurance settlements that were excluded from gross income.

Ruling snapshot

• Question: Would the bankruptcy trust qualify under section 468B, and when could the affiliated companies deduct their transfers to it?
• Outcome: approved, subject to the stated economic-performance and insurance limits
• Key authorities: IRC §§ 162, 461(h), 468B(g); Treas. Reg. §§ 1.461-1(a)(2), 1.468B-1, and 1.468B-3

Full text (IRS public release)

Internal Revenue Service                                       Department of the Treasury
                                                               Washington, DC 20224

Number: 201718029                                              [Third Party Communication:
Release Date: 5/5/2017                                         Date of Communication: Month DD, YYYY]
Index Number: 468B.06-00, 162.00-00,
              461.00-00                                        Person To Contact:
                                                               ---------------------------------, ID No. ---------
--------------------------                                     ----------
------------------------------------------------------------
----------                                                     Telephone Number:
------------------------------                                 ----------------------
--------------------------------------------------             Refer Reply To:
----------------------------------------------------           CC:ITA:B06
                                                               PLR-130434-16

                                                               Date: February 6, 2017




LEGEND

Parent                     =        ------------------------------

Subsidiary 1               =        -----------------------------

Subsidiary 2               =        ------------------------------------------------

Subsidiary 3               =        ------------------------------------------------------------

Subsidiary 4               =        ------------------------------------------

Date 1                     =        ------------------

Date 2                     =        ----------------------

Date 3                     =        -------------------

Products                   =        -----------------------------

X                          =        -------------

Year                       =        -------

State                      =        --------------

Y                          =        ----------------
PLR-130434-16                               2



Dear -------------------:

This letter responds to your letter postmarked October 3, 2016 requesting certain
rulings concerning the application of various sections of the Internal Revenue Code to
Parent, Subsidiary 1, Subsidiary 2, Subsidiary 3, Subsidiary 4 (collectively,
“Taxpayers”), and a trust (“Trust”). You have requested the following rulings that:

    1. The Trust will constitute a qualified settlement fund under Treas. Reg. §1.468B-1.

    2. Certain transfers made by Taxpayers to the Trust as contemplated by a joint plan
       of reorganization will be deductible by Taxpayers in the year of payment under
       §§ 162 and 461(h).

FACTS

Parent designs, develops, manufactures, and markets proprietary engineered industrial
products. Parent is the ultimate parent of a group of subsidiary companies through
which all of its business operations are conducted and that join in the filing of a
consolidated federal income tax return. Parent uses an accrual method of accounting
and has a taxable year that ends on December 31.

Parent has a single, wholly-owned direct subsidiary, Subsidiary 1. Subsidiary 1
operates numerous businesses through internal divisions or groups as well as through
its own subsidiary entities. Subsidiary 2 and Subsidiary 3 are both direct, wholly-owned
subsidiaries of Subsidiary 1, and Subsidiary 4 is a direct, wholly-owned subsidiary of
Subsidiary 3.

Subsidiary 1 previously operated businesses that manufactured and sold equipment
with components made by other companies, principally Products, that contained X.
Subsidiary 1 received thousands of personal injury claims from individuals alleging
damages from their exposure to X. Accordingly, Subsidiary 1 has thousands of such
direct claims pending against it and expects to continue to receive such claims in the
future.

Subsidiary 2 produces Products; some of the Products previously manufactured by
Subsidiary 2 contained X. Subsidiary 2 has thousands of personal injury claims from
individuals alleging damages from their exposure to X, and anticipates thousands of
such claims will be asserted against it in the future.

Subsidiary 4 previously distributed Products; some of the Products previously
distributed by Subsidiary 4 also contained X. Subsidiary 4 received claims from
PLR-130434-16                                 3


thousands of individuals alleging damages caused in part by their exposure to X. In
Year, Subsidiary 4 ceased business operations, and has no assets or insurance.

Subsidiary 3 manages the defense and resolution of X-related claims against Parent
and its affiliates.

Numerous individuals who asserted X-related personal injury claims against Subsidiary
2 and Subsidiary 4 (as described above) also named Parent, Subsidiary 1, and
Subsidiary 3 in their complaints, alleging that these entities were also liable for injuries
caused by Subsidiary 2 and Subsidiary 4 based on various theories of derivative
liability, including successor, alter ego, and veil piercing liability. These derivative
claims are also expected to continue to be asserted in the future.

On Date 1, Subsidiary 2, Subsidiary 3, and Subsidiary 4 filed voluntary petitions for
relief under chapter 11 of the Bankruptcy Code in the U.S. Bankruptcy Court.

On Date 2, Parent, Subsidiary 1, Subsidiary 2, and Subsidiary 3 reached a
comprehensive settlement agreement with representatives for present and future X
personal injury claimants (“Comprehensive Settlement”). On Date 3, to implement the
Comprehensive Settlement, the parties filed a joint plan of reorganization under chapter
11 of the Bankruptcy Code (“Plan”) that will permanently extinguish Taxpayers’ and their
affiliates’ liability for certain present and future X-related personal injury claims
(“Claims”). The Plan provides for the creation of a State statutory trust (“Trust”) for the
purpose of assuming liability for, receiving, processing, resolving, and paying the
Claims. On the effective date of the Plan (“Effective Date”), the Claims will be assumed
by the Trust.

An agreement that outlines the nature of the Trust (“Trust Agreement”) is incorporated
into the Plan. The sole beneficiaries of the Trust will be holders of Claims. The Plan
provides that on the day immediately preceding the Effective Date, Subsidiary 2 or
Subsidiary 3 will transfer a certain amount of cash to the Trust, Subsidiary 1 will transfer
a certain amount of cash to Trust, and on or before the first anniversary of the Effective
Date of the Plan, Subsidiary 1 will transfer a certain amount of cash to Trust.
Additionally, the Plan provides that Parent, Subsidiary 1, and the Trust will enter into an
agreement (“Funding Agreement”) pursuant to which the Trust will have the rights to
purchase from Subsidiary 1, for $1, shares of Parent common stock with a value of $Y
sometime between the first and second anniversary of the Effective Date. In certain
circumstances, the Funding Agreement allows for the payment of $Y in cash to the
Trust in lieu of selling the Parent common stock.

Pursuant to the Trust Agreement, all monies remaining in the Trust after payment of all
liabilities of the Trust shall be given to one or more organization(s) exempt from federal
income tax under section 501(c)(3).
PLR-130434-16                                  4


REPRESENTATIONS

Parent makes the following representations regarding the Trust:

    (a) The Trust will be established to resolve or satisfy tort claims for damages
        allegedly sustained as a result of individuals’ exposure to X.

    (b) The Trust will be a trust under the laws of State.

    (c) The Plan contains provisions for the creation of the Trust, which will be effective
        only when approved by the U.S. Bankruptcy Court and affirmed by the U.S.
        District Court, and will be subject to the continuing jurisdiction of the Bankruptcy
        Court.

    (d) Neither Taxpayers, nor any related person, will own any beneficial interest,
        directly or indirectly, in the corpus or income of the Trust.

    (e) The Trust will not be funded with amounts received by Taxpayers from the
        settlement of insurance claims that are excludable from Taxpayers’ gross
        income. Furthermore, the Trust will not be funded with amounts that represent
        payments for prejudgment and/or postjudgment interest.

    (f) Taxpayers will not have refund or reversion rights in the Trust's assets or income.

    (g) The Funding Agreement is properly treated as Taxpayers’ obligation to provide
        cash or stock in the future as described in § 1.468B-3(c)(3).

REQUESTED RULINGS

    1. Trust’s Status as a Qualified Settlement Fund

Parent’s first requested ruling is that the Trust, upon its formation, will be a qualified
settlement fund under § 1.468B-1 for federal income tax purposes.1


1
 Ordinarily, the Service does not issue letter rulings regarding the tax consequences of
a taxpayer who is not directly involved in the request if the requested letter ruling would
not address the tax liability of the requester. See section 6.06 of Rev. Proc. 2017-1,
2017-1 I.R.B. 2017-1, 20. Although the Trust is not a party to this ruling request, the
characterization of the Trust as a qualified settlement fund affects the timing of
economic performance with respect to assets transferred by Taxpayers to the Trust,
and therefore affects the timing of Taxpayers’ deductions for amounts transferred to the
Trust (see Parent’s second requested ruling, below).
PLR-130434-16                                 5


Section 468B(g)(1) provides, in part, that nothing in any provision of law shall be
construed as providing that an escrow account, settlement fund, or similar fund is not
subject to current income tax. Pursuant to the authority of section 468B(g), the
Secretary has published §§ 1.468B-1 through 1.468B-5 regarding qualified settlement
funds.

Section 1.468B-1(a) provides that a qualified settlement fund is a fund, account, or trust
that satisfies the requirements of § 1.468B-1(c). First, § 1.468B-1(c)(1) requires that the
fund, account, or trust is established pursuant to an order of, or it 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 continued jurisdiction of that governmental
authority. Second, § 1.468B-1(c)(2) requires that the fund, account, or trust 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 at least one claim asserting liability (i) under the Comprehensive
Environmental Response, Compensation and Liability Act of 1980; (ii) arising out of a
tort, breach of contract, or violation of law; or (iii) designated by the Commissioner in a
revenue ruling or revenue procedure. Third, § 1.468B-1(c)(3) provides that the fund,
account, or trust must be a trust under applicable state law, or its assets must be
otherwise segregated from other assets of the transferor (and related persons).

Based on the facts presented and the representations provided herein, the three
requirements of § 1.468B-1(c) will be satisfied and, at that time, the Trust will be a
qualified settlement fund for federal income tax purposes. First, the Trust will be
approved by the Bankruptcy Court and affirmed by the district court, and the Trust will
be subject to the continuing jurisdiction of the Bankruptcy Court. See § 1.468B-1(c)(1).
Second, the Trust will be established to resolve or satisfy tort claims brought against
Taxpayers for damages allegedly sustained as a result of individuals’ exposure to X.
See § 1.468B-1(c)(2). Third, the Trust will be a trust under state law. See § 1.468B-
1(c)(3).

    2. Taxpayers’ Deductions for Transfers to Trust

Parent’s second requested ruling is that Taxpayers may deduct the amounts transferred
to the Trust under §§ 162 and 461(h), in the years those amounts are transferred.

Section 162(a) of the Code provides the general rule that there shall be allowed as a
deduction all the ordinary and necessary expenses paid or incurred during the taxable
year in carrying on any trade or business. See also § 1.162-1(a).

Section 461(a) provides that a deduction shall be taken for the taxable year that is the
proper taxable year under the method of accounting used in computing taxable income.
PLR-130434-16                                 6



Section 1.461-1(a)(2) provides that, under an accrual method of accounting, a liability is
incurred, and generally is taken into account for federal income tax purposes, in the
taxable year in which all the events have occurred that establish the fact of the liability,
the amount of the liability can be determined with reasonable accuracy, and economic
performance has occurred with respect to the liability.

Section 461(h)(1) provides that in determining whether an amount has been incurred
with respect to any item during any taxable year, the all events test shall not be treated
as met any earlier than when economic performance with respect to the item occurs.

Section 461(h)(4) provides that the all events test is met with respect to any item if all
events have occurred which determine the fact of the liability and the amount of such
liability can be determined with reasonable accuracy.

Section 1.468B-3(a)(1) provides that a transferor must treat a transfer of property to a
qualified settlement fund as a sale or exchange of that property for purposes of § 1001.
In computing the gain or loss, the amount realized by the transferor is the fair market
value of the property on the date the transfer is made to the qualified settlement fund.
Because the issuance of a transferor's debt, obligation to provide services or property in
the future, or obligation to make a payment described in § 1.461–4(g), is generally not a
transfer of property by the transferor, it generally does not result in gain or loss to the
transferor under this paragraph (a)(1).

Section 1.468B-3(c)(1) provides that, except as otherwise provided in that section, for
purposes of § 461(h), economic performance occurs with respect to a liability described
in § 1.468B-1(c)(2) (determined with regard to § 1.468B-1(f) and (g)) to the extent the
transferor makes a transfer to a qualified settlement fund to resolve or satisfy the
liability.

Section § 1.468B-3(c)(2)(i)(A) and (B) provide that economic performance does not
occur to the extent the transferor (or related person) has a right to a refund or reversion
of a transfer if that right is exercisable currently and without the agreement of an
unrelated person that is independent or has an adverse interest (e.g. the court or
agency that approved the fund or the fund claimants), or money or property is
transferred under conditions that allow its refund or reversion by reason of the
occurrence of an event that is certain to occur, such as the passage of time, or if
restrictions on its refund or reversion are illusory.

Section 1.468B-1(h)(2) provides that economic performance does not occur with
respect to transfers to a qualified settlement fund for non-allowable claims.
PLR-130434-16                                 7


Section 1.468B-3(d) provides that no deduction is allowed to a transferor for a transfer
to a qualified settlement fund to the extent the transferred amounts represent amounts
received from the settlement of an insurance claim and are excludable from gross
income.

Section 1.468B-3(c)(3) provides that economic performance does not occur when a
transferor transfers to a qualified settlement fund its debt (or the debt of a related
person). Instead, economic performance occurs as the transferor (or related person)
makes principal payments on the debt. Similarly, economic performance does not occur
when a transferor transfers to a qualified settlement fund its obligation (or the obligation
of a related person) to provide services or property in the future, or to make a payment
described in § 1.461–4(g). Instead, economic performance with respect to such an
obligation occurs as services, property or payments are provided or made to the
qualified settlement fund or a claimant.

Based on the facts represented, the amounts transferred to the Trust will be used to
satisfy the Claims, which are liabilities described in § 1.468B-1(c)(2). These liabilities
arose as a result of Taxpayers’ principal business activities. Thus, such amounts will be
deductible under § 162(a) as ordinary and necessary business expenses.

To the extent that the all events tests under § 1.461-1(a)(2), including economic
performance, are met, the amounts transferred to the Trust will be deductible in the
taxable year of the transfer. With respect to the transfers of cash described in the Plan,
Taxpayers’ liability is fixed and determinable with reasonable accuracy, and economic
performance will occur at the time the cash is transferred to the Trust. Furthermore, to
the extent Parent and/or Subsidiary 1 transfer cash or stock to the Trust pursuant to the
Funding Agreement, the liability of Parent and/or Subsidiary 1 liability will be fixed and
determinable with reasonable accuracy, and economic performance will occur at the
time the cash or stock is transferred pursuant to § 1.468B-3(c)(3).

Therefore, we conclude that Taxpayers may deduct under § 162 the amount of cash
and the value of stock transferred to the Trust in the taxable year or years of the
transfers, but only to the extent that (i) the transfers are made to resolve or satisfy a
liability described in § 1.468B-1(c)(2) and (ii) the transferred amounts do not represent
amounts received from the settlement of an insurance claim which is excludable from
Taxpayers’ gross income.

PROCEDURAL MATTERS

Except as expressly provided herein, no opinion is expressed or implied concerning the
tax consequences of any aspect of any transaction or item discussed or referenced in
this letter.
PLR-130434-16                                  8


This ruling is directed only to the taxpayer requesting it. Section 6110(k)(3) provides
that it may not be used or cited as precedent.

In accordance with the Power of Attorney on file with this office, a copy of this letter is
being sent to Parent’s authorized representative.

A copy of this letter must be attached to any income tax return to which it is relevant.
Alternatively, taxpayers filing their returns electronically may satisfy this requirement by
attaching a statement to their return that provides the date and control number of the
letter ruling.

The rulings contained in this letter are based upon information and representations
submitted by Parent and accompanied by a penalty of perjury statement executed by an
appropriate party. While this office has not verified any of the material submitted in
support of the request for rulings, it is subject to verification on examination.

                                       Sincerely,



                                       Roy Hirschhorn
                                       Chief, Branch 6
                                       Office of Associate Chief Counsel
                                       (Income Tax & Accounting)