Bankruptcy tort-claim trust qualifies as a settlement fund and permits a current deduction

Plain-English summary

A corporate group faced more than a redacted number of disputed product-related tort claims and placed a redacted cash amount into a bankruptcy-court-approved trust to resolve them. The court retained continuing jurisdiction, restricted the fund to the purposes in the trust agreement, and limited any reversion until claims were satisfied or the court terminated the trust. The IRS ruled that the trust met all three requirements for a qualified settlement fund under Treasury Regulation Section 1.468B-1. It also ruled that the contribution satisfied the all-events test and economic-performance rules for the contested liabilities. The taxpayer could deduct the contribution as an ordinary and necessary business expense under Section 162 in the year of transfer, and the restricted possibility of a future reversion did not prevent economic performance.

Ruling snapshot

• Question: Does the court-supervised tort-claim trust qualify as a settlement fund, and may the taxpayer deduct its contribution in the year transferred?
• Outcome: Approved on both questions
• Key authorities: IRC §§ 162(a), 461(a), (f), and (h), and 468B(g); Treas. Reg. §§ 1.162-1(a), 1.461-1(a)(2), 1.461-2(a)(1), 1.468B-1, and 1.468B-3(c) and (f)

Full text (IRS public release)

Internal Revenue Service                            Department of the Treasury
                                                    Washington, DC 20224

Number: 202139004                                   Third Party Communication: None
Release Date: 10/1/2021                             Date of Communication: Not Applicable
Index Number: 162.00-00, 461.00-00,
              461.07-00, 468B.01-00                 Person To Contact:
                                                    -------------------, ID No. ----------
---------------------                               Telephone Number:
-----------------------------                       --------------------
---------------------------                         Refer Reply To:
--------------------------                          CC:ITA:B06
---------------------------                         PLR-100285-21
                                                    Date:
                                                    July 02, 2021




                                        LEGEND

Taxpayer                        =   -----------------------------------------------------------
Company 1                       =   ------------------------------------------------------------------
Company 2                       =   ------------------------------------------------
Company 3                       =   ----------------------------------------------------
Company 4                       =   ------------------------------------------
Bankruptcy Court                =   -------------------------------------------------------------------
                                    ----------------------------------------------------------
Trust                           =   -------------------------------------------------------------------
                                    -----------
Trustee                         =   -------------------------------------------------------------------
                                    -------
Industry                        =   ---------------------------------------------------
State A                         =   ----------
State B                         =   -------------
State C                         =   -------------------
Date 1                          =   ------------------
Date 2                          =   -------------------------
Date 3                          =   ----------------------
Date 4                          =   -------------------------------
Date 5                          =   ---------------------------
Date 6                          =   ---------------------
Date 7                          =   -------------------------
Year 1                          =   -------
Number X                        =   -----------
Amount Y                        =   --------------------

PLR-100285-21                                2



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

This letter responds to your letter dated December 17, 2020, requesting certain rulings
concerning the application of various sections of the Internal Revenue Code and the
Income Tax Regulations to Taxpayer and Trust. You have requested the following
rulings that:

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

    2. The all events test and economic performance requirements are satisfied under
       §§ 461(a), (f), and (h) and § 1.468B-3(c) with respect to the amount of the
       Contribution (as defined below), and Taxpayer is entitled to claim a deduction
       under § 162 in the amount of the Contribution in the taxable year during which
       the transfer to the Trust is made.

                                         FACTS


Taxpayer is a State A corporation and the ultimate parent of a group of entities that are
included in the filing of a consolidated federal income tax return. Taxpayer’s
consolidated return is filed on a calendar year basis using the accrual method of
accounting.

Company 1 and Company 3 are organized as State B limited liability companies, and
Company 2 is organized as a State C limited liability company. Company 1, Company
2, and Company 3 are wholly and indirectly owned by Taxpayer, and each is treated as
a disregarded entity for federal income tax purposes. Accordingly, each of Company 1,
Company 2 and Company 3 is treated as owned by Taxpayer as their regarded owner
for federal income tax purposes.

Company 2 and Company 3 were formed when Company 4, which was wholly owned
by Company 1, completed a restructuring on Date 1 pursuant to which Company 2 and
Company 3 were formed and Company 4 ceased to exist, as described in more detail
below.

Company 4 previously manufactured and sold a variety of products primarily used in
Industry (the “Products”). Company 4 was the subject of more than Number X tort
claims alleging damages arising in connection with certain of the Products.

When Company 4 completed the restructuring, certain assets and liabilities of Company
4, including liabilities for Products-related tort claims (other than those liabilities for
which the exclusive remedy is provided under a workers’ compensation statute or
similar laws) (“Claims”) were transferred to Company 2, and the remaining assets and
liabilities of Company 4 became assets and liabilities of Company 3. Company 2

PLR-100285-21                                  3

disputes the validity and amount of the Claims. Company 2 expects that Claims will
continue to be asserted against Company 2 in the future. Based on negotiations
between Company 2, Company 3, and the court-appointed representatives for
Products-related tort claimants, Company 2 and Company 3 believe that the aggregate
amount of funding needed to fund the Trust to resolve or satisfy the Claims will likely
equal or exceed Amount Y.

On Date 2, Company 2 filed a voluntary petition for relief under Chapter 11 of the
Bankruptcy Code in the Bankruptcy Court.

On Date 3, Company 2 and Company 3 agreed to establish the Trust, to be funded by
Company 3 with Amount Y in cash (the “Contribution”) to resolve and satisfy the Claims
either (a) in connection with a Chapter 11 plan that established a trust under the
Bankruptcy Code (a “Plan”) or (b) if no Plan became effective, by settlement or final
order outside of a Plan. The terms of the Trust are set forth in a trust agreement, the
terms of which are described in further detail below, that was submitted to the
Bankruptcy Court for its approval on Date 4 (the “Trust Agreement”).

On Date 5, the Bankruptcy Court entered an order (the “Order”) that, among other
things, (i) approved the Trust Agreement, (ii) provided that the Trust shall be established
in accordance with and governed by the terms of the Trust Agreement, (iii) mandated
that the Trust funds be earmarked for and only used for the purposes provided in the
Trust Agreement, and (iv) acknowledged and determined that the Bankruptcy Court
shall be the supervisory court with respect to the Trust and shall retain jurisdiction over
the Trust for the life of the Trust. On Date 6, Company 2, Company 3, and the Trustee
entered into the Trust Agreement. On Date 7, Company 3 transferred the Contribution
to the Trust. No portion of the Contribution represents amounts received from the
settlement of an insurance claim within the meaning of § 1.468B-3(d). Further, the
Trust Agreement contemplates the possibility that additional contributions may be made
in the future in accordance with the purposes approved under the Trust Agreement.

Specifically, the Trust Agreement provides that the purposes of the Trust are to (i)
resolve or satisfy the Claims; (ii) collect, invest, and distribute the Trust funds in
accordance with the terms of the Trust Agreement; (iii) pay expenses and costs related
to the administration of the Trust and any and all other liabilities of the Trust in
accordance with the terms of the Trust Agreement; (iv) at all times qualify as a qualified
settlement fund; and (v) otherwise administer the Trust pursuant to the express
provisions of the Trust Agreement and any other agreements entered into by the
Trustee or the Trust in accordance with the terms of the Trust Agreement. The Trustee
is responsible for, inter alia, holding, administering, and distributing the Trust’s assets in
accordance with the terms of the Trust Agreement and will act as its fiduciary until the
termination of the Trust.

The Trustee is also required to invest and reinvest the Trust’s assets. To meet this
obligation, pursuant to the Trust Agreement the Trustee’s authority over the investment
of the Trust’s assets is delegated to the “Portfolio Manager,” which will be Company 3

PLR-100285-21                                 4

(or its designee). Notwithstanding this delegation to the Portfolio Manager, the Portfolio
Manager’s discretion is limited to investment decisions, and ultimate control over the
Trust and its assets rests with the Trustee. Only the Trustee has the right to dispose of
the assets in the Trust, and the Portfolio Manager’s discretion with respect to
investment decisions is subject to guidelines set forth in the Trust Agreement that were
approved by the Bankruptcy Court.

Company 3 has limited reversion rights with respect to the Contribution and any other
assets it may transfer to the Trust. These amounts, including earnings that may accrue
on the Contribution amount, will be returned to Company 3 only if and when: (i) the
Bankruptcy Court determines that all Claims have been paid or otherwise satisfied; or
(ii) an order dissolving or otherwise terminating the Trust is issued by the Bankruptcy
Court. The Trust Agreement prevents modification or amendment of the restrictions on
Company 3’s limited reversion rights.

Company 3 expects that all of the Contribution will be used to resolve or satisfy the
Claims and therefore does not expect any assets in the Trust to revert to Company 3.

                                 REQUESTED RULINGS

    1. Trust’s Status as a Qualified Settlement Fund under § 1.468B-1

Taxpayer’s first requested ruling is that the Trust constitutes a qualified settlement fund
under § 1.468B-1.1

Section 468B(g)(1) provides that “[n]othing 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.” Section 468B(g)(1) authorizes the issuance of regulations
providing for the taxation of any such account or fund whether as a grantor trust or
otherwise. Sections 1.468B-1 through 1.468B-5 regarding qualified settlement funds
were issued pursuant to § 468B(g).

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


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 § 6.06 of Rev. Proc. 2020-1, 2020-1
I.R.B. 2020-1, 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 Company 3 to the Trust,
and, therefore, affects the timing of deductions taken by Taxpayer for amounts
transferred to the trust (see Taxpayer’s second requested ruling, below).

PLR-100285-21                                  5

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. 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, we conclude that the Trust is a qualified settlement fund.
First, the Trust was established pursuant to an order by the Bankruptcy Court and is
subject to the continuing jurisdiction of the Bankruptcy Court. See § 1.468B-1(c)(1).
Second, the Trust was established to resolve or satisfy tort claims for damages
allegedly sustained as a result of Taxpayer’s manufacture and sale of the Products.
See § 1.468B-1(c)(2). Third, the Trust is organized under applicable state law. See §
1.468B-1(c)(3). Thus, the three requirements of § 1.468B-1(c) are satisfied and the
Trust constitutes a qualified settlement fund under § 1.468B-1.

    2. Taxpayer’s Deduction for Transfers to Trust

Taxpayer’s second requested ruling is that the Contribution to the Trust satisfies the all
events test and economic performance requirements of §§ 461(a), (f), (h) and § 1.468B-
3(c), and that Taxpayer may claim a deduction under § 162 in the amount of the
Contribution in the taxable year of transfer to the Trust.

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.

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(f) provides that if (1) the taxpayer contests an asserted liability, (2) the
taxpayer transfers money or other property to provide for the satisfaction of the asserted
liability, (3) the contest with respect to the asserted liability exists after the time of the
transfer, and (4) but for the fact that the asserted liability is contested, a deduction
would be allowed for the taxable year of the transfer (or for an earlier taxable year)

PLR-100285-21                                 6

determined after application of § 461(h), then the deduction shall be allowed for the
taxable year of the transfer. See also § 1.461-2(a)(1).

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(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.

Sections 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-3(f)(1) provides that a transferor must include in gross income any
distribution it receives from a qualified settlement fund.

Section 1.468B-3(f)(3) provides that a distribution described in § 1.468B-3(f)(1) or (f)(2)
is excluded from the gross income of a transferor to the extent provided by § 111(a)
(regarding the recovery of tax benefit items).

Based on the facts presented, we conclude that the Contribution to the Trust satisfies
the all events test and the economic performance requirements of §§ 461(a), (f), and
(h). We also conclude that Taxpayer may deduct the amount of the Contribution under
§ 162 as an ordinary and necessary business expense in Year 1.

Economic performance occurred under § 461(h)(1) at the time of the Contribution with
respect to the Claims because the Contribution satisfies the requirements of § 1.468B-
3(c)(1).

The fact that Company 3 has a reversion right with respect to the Trust funds does not
prevent economic performance from occurring under § 1.468B-3(c)(2)(i)(A) or (B).
Under the Trust Agreement, Company 3’s reversion right is not currently exercisable.
Moreover, the circumstances permitting the reversion of Trust funds to Company 3 are

PLR-100285-21                                  7

restricted and dependent upon events that are not certain to occur and are not illusory,
and in all cases are subject to the approval of the Bankruptcy Court. See § 1.468B-
3(c)(2)(i).

Taxpayer’s liability with respect to the Claims is a contested liability within the meaning
of § 461(f). But for the fact that the Claims are contested, a deduction would be allowed
for the taxable year of the transfer. All of the events have occurred to establish the fact
of Taxpayer’s liability with respect to the Claims, and the amount of Taxpayer’s liability
can be determined with reasonable accuracy.

                                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.

This ruling is directed only to the taxpayer who requested 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 your authorized representatives.

A copy of this letter must be attached to any federal 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 the taxpayer 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 A. HIRSCHHORN
                                       Branch Chief, Branch 6
                                       Office of Associate Chief Counsel
                                       (Income Tax & Accounting)


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