Statutory product-liability escrows qualify as settlement funds and deposits are deductible

Plain-English summary

A manufacturer that was not a defendant in product litigation was required by multiple jurisdictions to deposit amounts into escrow accounts based on its sales of the redacted product. The accounts could be used only to pay claims arising from the manufacturer's production and sale of that product, with unused amounts potentially reverting after a redacted number of years. The IRS ruled that the accounts met the three requirements for qualified settlement funds: they were established by law under continuing governmental jurisdiction, addressed claims arising from past conduct and alleged legal violations, and held assets segregated from the transferor. The manufacturer's required deposits were ordinary and necessary business expenses, and the statutory formula fixed the liability with reasonable accuracy. Transfers to the qualified settlement funds also completed economic performance, so the accrual-method manufacturer could deduct them in the year transferred. The possible future reversion did not change that result because recovery depended on the uncertain outcome of claims, but any later refunds, interest, appreciation, or other distributions back to the manufacturer must be included in income.

Ruling snapshot

• Question: Are the statutory escrow accounts qualified settlement funds, and may the manufacturer deduct required deposits in the year transferred?
• Outcome: Approved on both questions
• Key authorities: IRC §§ 162(a), 461, 468B(g); Treas. Reg. §§ 1.461-1(a)(2), 1.468B-1, 1.468B-3

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 202443004 [Third Party Communication:
Release Date: 10/25/2024 Date of Communication: Month DD, YYYY]
Index Number: 468B.01-00, 162.00-00,
461.00-00 Person To Contact:
---------------------, ID No. -----------------
------------------------------------------------------------ Telephone Number:
----------------------------------------------------- -------------------
-------------------------- Refer Reply To:
-------------------- CC:ITA:B06
----------------------------------- PLR-101392-24
Date:
July 24, 2024

Taxpayer = ------------------------------------------------------------------------------
-----------------------------------
Contributor = ----------------------------------------
Activities = ------------------------------------------------------------------------------
---------------------
Product Z = --------------------------------------------------
Plaintiffs = ---------------
Claims = ------------------------------------------------------------------------------
---------------------------------------------------------------------------
MSA = -----------------------------
Date 1 = -------
Date 2 = -------
Date 3 = -----------------------
X = -------------------
Escrow Agent Banks = ------------------------------------------------------------------------------
---------------------
Number = --------------

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

This is in response to your ruling request on behalf of Taxpayer, joined by Contributor,
dated December 28, 2023, and supplemented by correspondence dated May 14, 2024.

You requested the following rulings concerning the tax treatment of certain escrow
accounts required by and established pursuant to law:

1. The escrow accounts administered by Taxpayer are qualified settlement funds
   within the meaning of § 1.468B-1 of the Income Tax Regulations; and

PLR-101392-24 2

2. The contributions made by Contributor to the escrow accounts administered by
   Taxpayer are deductible for the taxable year in which they are made under
   §§ 162(a) and 461 of the Internal Revenue Code and § 1.468B-3.

FACTS

Taxpayer is funded by Contributor. Contributor is engaged in the Activities of Product Z.
Contributor is an S corporation using an overall accrual method of accounting and has a
taxable year ending December 31.

Various Plaintiffs brought litigation against major manufacturers and sellers of Product
Z. The Plaintiffs sought various Claims. Contributor was not a party defendant in the
suit.

On November 28, 1998, the Plaintiffs entered into a settlement agreement with the party
defendant manufacturers to resolve the litigation. Under the settlement agreement, the
party defendant manufacturers are required to make annual payments into escrow
accounts for the benefit of the Plaintiffs. In exchange for the payments under the
settlement agreement, the Plaintiffs release the party defendant manufacturers from all
past, present and future claims arising from the Activities of Product Z. The amount of
these payments is determined based on the party defendant manufacturers’ sale of
Product Z within the relevant jurisdiction. Under the settlement agreement, the escrow
accounts established pursuant to the settlement agreement are intended to qualify and
be treated as qualified settlement funds under § 1.468B-1.

The party defendant manufacturers contended, and the Plaintiffs agreed, that the
manufacturers of Product Z not named in litigation should be required to make annual
contributions similar to those required by the party defendant manufacturers under the
settlement agreement. The settlement agreement directs the relevant jurisdiction to
enact legislation requiring non-party manufacturers to either generally abide by the
terms of the settlement agreement (i.e., become a defendant manufacturer and perform
financial obligations under the settlement agreement), or establish escrow accounts and
make contributions for the benefit of the Plaintiffs in jurisdictions in which the non-party
manufacturers’ Product Z are sold. Contributor opted for the latter. Therefore, as a
non-party manufacturer of Product Z selling Product Z within relevant jurisdictions,
Contributor is required to establish escrow accounts under each Plaintiff’s enacted
legislation.

Each Plaintiff enacted the legislation mandated by the settlement agreement (enacted
legislation). The enacted legislation is identical or substantially similar to a model
statute attached to the settlement agreement. The model statute explains that financial
burdens imposed by Product Z should be borne by Product Z’s manufacturers rather
than by the Plaintiffs to the extent that such manufacturers either determine to enter into
a settlement with the Plaintiffs or are found culpable by the courts. The amount of the

PLR-101392-24 3

annual contribution due by the non-party manufacturers is determined based on the
non-party manufacturer’s sale of Product Z within the relevant jurisdiction.

Under the settlement agreement, the relevant jurisdictions are required to diligently
enforce the provisions of their legislation to protect their claim to receive annual
payments from the party defendant manufacturers. If the Plaintiffs fail to diligently
enforce their legislations against a non-party manufacturer, the Plaintiffs can be subject
to a downward adjustment of the Plaintiffs’ entitled annual payment from the party
defendant manufacturers, which is meant to offset a potential market loss as to the party
defendant manufacturers caused by the Plaintiffs’ failure to hold the non-party
manufacturers to their escrow payment obligations.

The legislation enacted by the Plaintiffs requires each of the non-party manufacturers to
establish and make annual contributions to an escrow account for the benefit of each of
the Plaintiffs. The escrow accounts were established in Date 1 and Contributor began
making annual deposits to the escrow accounts in Date 2. As of Date 3, Contributor
has deposited a total of $X. As long as Contributor remains a Product Z’s manufacturer
selling Product Z within a relevant jurisdiction, it will continue to be required by enacted
legislation to make annual deposits into such escrow accounts, based on its Product Z’
sales, either at the Escrow Agent Banks, or similar financial institutions. Under the
enacted legislation, the escrowed funds may be used only to satisfy claims arising from
the manufacture and sale of Product Z by Contributor. The escrowed funds are
released from escrow in the order in which they were placed into escrow and only to the
extent and at the time necessary to make payments required under judgement or
settlement. Under the enacted legislation, any remaining funds will revert to Contributor
after Number years from the day they were contributed.

Under the enacted legislation, the relevant jurisdiction may use civil litigation to enforce
the escrow contribution requirement. A court can require the non-party manufacturers
to make the required contribution, can impose civil penalties up to 300% of the
delinquent contributions, and can prohibit non-party manufacturers from selling Product
Z to consumers within the relevant jurisdiction for a certain period.

Contributor expects that the Plaintiffs in which it does business will make claims against
it, that all of the contributed funds will be used to satisfy the claims if the claims are
successful, and nothing will remain to revert to Contributor.

RULINGS REQUESTED

1. The escrow accounts administered by Taxpayer are a qualified settlement fund
   within the meaning of § 1.468B-1.

2. The contributions made by Contributor to the escrow accounts administered by
   Taxpayer are deductible for the taxable year in which they are made under
   §§ 162(a), 461 and 1.468B-3.

PLR-101392-24 4

LAW & ANALYSIS

1. The escrow accounts administered by Taxpayer are a qualified settlement fund
   within the meaning of § 1.468B-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 three 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 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).

Section 1.468B-1(j)(1) provides that if a fund, account or trust is established to resolve
or satisfy claims described in § 1.468B-1(c)(2), the assets of the fund, account, or trust
are treated as owned by the transferor of those assets until the fund, account, or trust
also meets the requirements of § 1.468B-1(c)(1) and (c)(3). On the date the fund,
account, or trust satisfies all the requirements of § 1.468B-1(c), the transferor is treated
as transferring the assets to a qualified settlement fund.

Section 1.468B-2(k)(2) provides that a qualified settlement fund is in existence for the
period that (i) begins on the first date on which the fund is treated as a qualified
settlement fund under § 1.468B-1; and (ii) ends on the earlier of the date the fund (A) no
longer satisfies the requirements of § 1.468B-1; or (B) no longer has any assets and will
not receive any more transfers.

Based on the facts represented, Taxpayer satisfied all three requirements of
§ 1.468B-1(c) in the year the escrow accounts were established, and therefore are

PLR-101392-24 5

treated as a qualified settlement fund as of the date established. First, with respect to
§ 1.468B-1(c)(1), the Plaintiffs are governmental authorities as the term is used in that
context. The escrow accounts were established pursuant to the Plaintiffs’ enacted
legislation and are subject to the continuing jurisdiction of each of the relevant Plaintiffs.
The appropriate official of the Plaintiffs has the authority to monitor and pursue in court
charges against Taxpayer to enforce annual compliance with the Plaintiffs’ enacted
legislation.

Second, with respect to § 1.468B-1(c)(2), under all these facts and circumstances, we
are persuaded that Taxpayer established the escrow accounts to resolve or satisfy
contested or uncontested claims that have resulted or may result from a related series
of events that has occurred and that has given rise to at least one claim asserting
liability arising out of a violation of law.

The event (or related series of events) that has already occurred are the Activities of
Product Z. The claim has already arisen that a manufacturer of Product Z is financially
liable to reimburse the Plaintiffs for the costs associated with the harms related to the
sale of Product Z. The regulation requires only that at least one “claim” asserting
liability has resulted or may result. Each of the Plaintiffs has already made at least one
claim asserting liability against each non-party manufacturer of Product Z by means of
having an enacted legislation pursuant to the model statute and by means of making a
demand for deposits against Contributor.

It is also clear that Taxpayer established and funded the escrow accounts to resolve or
satisfy the claims (whether eventually contested or uncontested) and demands made by
the Plaintiffs. The objective of the enacted legislation is to force non-party
manufacturers who refuse to opt into the settlement agreement to assume a share of
the financial burdens created by the harms allegedly caused by the use of Product Z.
Each relevant jurisdiction has enacted legislation that applies to any non-party
manufacturer of Product Z selling Product Z within the relevant jurisdiction. The amount
of a manufacturer’s annual deposits paid into the escrow accounts is based on a
manufacturer’s sales of Product Z during the year in question. Contributor is such a
manufacturer and the amounts of its legally-obligated deposits are calculated on that
basis.

Note that the facts in this case are distinguishable from Example 7 in § 1.468B-1(l)
regarding a landfill operator. There, a corporation owned and operated a landfill in a
state that required the corporation to transfer money to a trust annually based on the
total tonnage of material placed in the landfill during the year. Under the law, the
corporation is required to perform (either itself or through contractors) specified closure
activities when the landfill is full, and the trust assets would be used to reimburse the
corporation for these closure costs. The trust in that example is not a qualified
settlement fund because it is established to secure the liability of the corporation to
perform such closure activities. The instant case does not involve a performance
liability. The funds transferred to the escrow accounts under the enacted legislation are

PLR-101392-24 6

not used to secure the future performance of Contributor. To the contrary, the funds will
be used to satisfy the Plaintiffs’ claims based on the past conduct of Contributor;
conduct that is related to known harm stemming from the use of Product Z and that has
given rise to known liabilities (e.g., increase in financial burdens on the Plaintiffs).

Third, with respect to § 1.468B-1(c)(3), the assets in the escrow accounts are otherwise
segregated from other assets of Taxpayer (and related persons). Beginning in Date 1,
the escrow accounts were established with Escrow Agent Banks. Under the
regulations, a separate bank account is sufficient to satisfy this requirement. See
§ 1.468B-1(h)(1).

2. The contributions made by Contributor to the escrow accounts administered by
   Taxpayer are deductible for the taxable year in which they are made under
   §§ 162(a), 461 and 1.468B-3.

Section 162(a) 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 § 1.162-1(a).

Section 461(a) provides, in part, that a deduction shall be taken for the taxable year
which is the proper taxable year under the method of accounting used in computing
taxable income.

Section 1.461-1(a)(2) provides, in part, that under an accrual method of accounting, a
liability is incurred, and generally 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)
determined after application of § 461(h), then the deduction shall be allowed for the
taxable year of the transfer.

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

PLR-101392-24 7

Section 1.468B-3(c)(1) provides that for purposes of § 461(h), economic performance
occurs with respect to a liability described in § 1.468B-1(c)(2) 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) provides that economic performance does not occur to the
extent (A) the transferor (or a 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 (B) 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 represented, the contributions made by Contributor to the escrow
accounts administered by Taxpayer are deductible in the taxable year of the transfer.
The amounts transferred into escrow accounts will be used to pay money damages to
the Plaintiffs for liabilities that arose as a result of Contributor's principal business
activity, that is, the Activities of Product Z. Thus, such amounts are deductible under
§ 162(a) as ordinary and necessary business expenses. Further, Contributor may take
the deduction for the amounts transferred into the escrow account in the year
transferred because the all events test is met and economic performance occurs in that
year under § 1.461-1(a)(2). The first prong of the all events test, i.e., all the events have
occurred that establish the fact of the liability, is met because this is a contested liability
within the meaning of § 461(f). The second prong, i.e., the amount of the liability can be
determined with reasonable accuracy, is met because the amount of the liability can be
readily ascertained based on the formula prescribed by the enacted legislation. Finally,
under § 1.468B-3(c), transfers to a qualified settlement fund to resolve or satisfy claims
for which it is established constitute economic performance.

In addition, the fact that the enacted legislation provides for a reversion of monies if any
remain after Number years from the date of the transfers does not prevent economic
performance from occurring. The enacted legislation provides that the monies
transferred into the escrow accounts revert to Contributor after Number years from the
date of the transfers if the Plaintiffs have not filed and prevailed on claims either by
obtaining a judgment against, or a settlement with, Contributor. The funds exist to
satisfy the Plaintiffs' claims brought against Contributor within Number years after the

PLR-101392-24 8

date monies are transferred into the funds. Thus, Contributor may not access the funds
for any purpose other than satisfying the Plaintiffs' claims during the Number years.
Contributor expects that claims will be made against all the assets of the funds and, if
successful, the funds will be used to satisfy the Plaintiffs' claims and that nothing will
remain to revert to Contributor. There is no guarantee that any amounts will revert to
Contributor after Number years. The reversion in this case requires not only the
passage of time, but also the successful defense against claims brought by the Plaintiffs
before anything reverts to Contributor. Although the passage of time (i.e., Number
years) is certain to occur, it is clearly uncertain whether the Plaintiffs will file or prevail
on claims against Contributor. Thus, the payments are not transferred under conditions
that allow their refund or reversion by reason of the occurrence of an event that is
certain to occur. Finally, Contributor does not have a currently exercisable right to a
refund or reversion.

However, to the extent Contributor receives any distributions from the escrow accounts,
e.g., overpayments, refunds, interest, or other appreciation on the funds, Contributor
must include such amounts in its gross income.

The ruling contained in this letter is based upon information and representations
submitted by or on behalf of Taxpayer and accompanied by a penalty of perjury
statement executed by an individual with authority to bind Taxpayer and Contributor and
upon the understanding that there will be no material change in facts. While this office
has not verified any of the material submitted in support of the request for this ruling, it
is subject to verification on examination. The Associate office will revoke or modify a
letter ruling and apply the revocation retroactively if there has been a misstatement or
omission of controlling facts; the facts at the time of the transaction are materially
different from the controlling facts on which the ruling was based; or, in the case of a
transaction involving a continuing action or series of actions, the controlling facts
change during the course of the transaction. See section 11.05 of Rev. Proc. 2024-1,
2024-1 I.R.B. 1, 65.

No opinion is expressed concerning the federal tax consequences under any Code
provision other than the provisions specifically cited above. Except as expressly
provided, 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
concerns only the federal income tax treatment of Taxpayer's and Contributor’s income
and may not be cited or relied upon by any other taxpayer, including Taxpayer’s
beneficiaries. We express no opinion whether Taxpayer or Contributor is appropriately
taking into account under § 61 and § 1.468B-2 any income generated from the
investment of the escrow accounts.

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.

A copy of this letter must be attached to any income tax return to which it is relevant.

PLR-101392-24 9

In accordance with the power of attorney on file with this office, a copy of this letter is
being sent to each of Taxpayer's authorized representatives.

                                            Sincerely,



                                            ANNA W. GLEYSTEEN
                                            Senior Technician Reviewer, Branch 6
                                            Office of Associate Chief Counsel
                                            (Income Tax & Accounting)

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