Are SEC insider-trading disgorgement funds -- like the Boesky, Siegal, and Kidder Peabody funds -- subject to New York corporate franchise tax under Article 9-A or personal income tax under Article 22, and are the individual claimants or original defendants separately taxed on the funds' earnings?

Plain-English summary

Lee S. Richards was the court-appointed receiver of three separate settlement funds -- the Boesky Disgorgement Fund, the Siegal Disgorgement Fund, and the Kidder, Peabody Disgorgement Fund -- each created by a federal court order to settle an SEC enforcement action alleging insider trading. Under each Court Order, the defendant deposited money with the receiver, and that money, plus any earnings, was to be paid out to injured claimants under an SEC-approved distribution plan. The receiver had no say over who got paid or how much; investments were restricted by the Court Order to U.S. government securities and FDIC-insured CDs or money-market accounts at large banks; and no money could ever go back to the defendant. On March 15, 1993, the receiver elected, for each fund, "qualified settlement fund" (QSF) status under the newly finalized Treasury Regulations implementing IRC § 468B(g). The funds happened to be held in New York, but only because that is where the receiver and the litigation were located, not because of any deliberate choice to create a New York tax presence.

The receiver asked the Department three questions. First, are the Disgorgement Funds "corporations" subject to New York's Article 9-A corporate franchise tax? The Department said no: Tax Law § 208.1 and Reg. § 1-2.3 treat a trustee-run business trust as a "corporation" only if the trustee is actually conducting a business, and merely investing restricted funds and collecting/reinvesting income -- with only incidental replacement of securities -- is not conducting a business (citing Smadbeck, Nauss, Burrell, and City Bank Farmers Trust Co.). The Department noted it had reached the same conclusion for a similarly structured settlement fund in a prior opinion involving a Buxbaum-Banco Popular settlement fund.

Second, are the Disgorgement Funds "trusts" subject to Article 22 personal income tax? Again no. Tax Law § 607(a) says Article 22 terms follow federal tax-law meanings unless New York clearly requires otherwise. Federally, once a fund elects QSF status under IRC § 468B(g), Treas. Reg. § 1.468B-1(b) classifies it specifically as a qualified settlement fund rather than as a trust -- even if it could otherwise have qualified as a trust under Treas. Reg. § 301.7701-4. Because New York follows that federal non-trust classification, the Disgorgement Funds are not "trusts" for Article 22 purposes either (a conclusion the Department had reached before, in its own prior Buxbaum settlement-fund opinion, on the same theory). Separately, Tax Law § 601(g) exempts from Article 22 any association, trust, or unincorporated organization that is taxed as a corporation for federal purposes -- and a QSF's tax on its "modified gross income" under IRC § 468B is treated by the Code as a tax on corporations, which independently confirms the funds sit outside Article 22.

Third, are the claimants or the original defendants separately taxed on the funds' earnings? The Department did not answer this -- it said the question is purely factual and outside the scope of an Advisory Opinion (Tax Law § 171-Twenty-fourth; 20 NYCRR § 2376.1(a)). Under Treas. Reg. § 1.468B-4, whether a distribution is included in a particular claimant's gross income depends on the nature of that claimant's own underlying claim, treated as if the defendant had paid the claimant directly. Because Tax Law § 612 has no special modification for QSF distributions, New York simply follows whatever the federal, claimant-specific answer turns out to be. So the result here is a rare "no New York tax at the entity level at all" -- neither corporate franchise tax nor personal income tax reaches the Disgorgement Funds themselves -- but that says nothing about whether any given claimant will owe tax once they actually receive their share.

What this means for you

Receivers and administrators of court-ordered settlement or disgorgement funds

If you administer a fund created by a federal court order to settle an SEC or similar enforcement action, and your investment authority and distribution decisions are dictated entirely by the court order and a regulator-approved plan (rather than your own discretion), that fact pattern supports treating the fund as not "conducting a business" for New York franchise-tax purposes. Electing qualified settlement fund status under IRC § 468B(g) is also relevant on the income-tax side: because a QSF is not classified as a trust for federal purposes, and New York follows federal classification under Tax Law § 607(a), the fund is likely outside Article 22 as well. Keep clear records of the court order's restrictions on your investment and distribution authority, since that lack of discretion is central to both conclusions.

Accountants advising claimants who will eventually receive a distribution

Do not assume that because the fund itself pays no New York corporate or personal income tax, a distribution to your client is automatically tax-free. This opinion expressly declines to decide that question, because it depends on the nature of each claimant's own underlying claim (as though the original defendant had paid the claimant directly). You will need to analyze what the claimant's claim against the defendant actually was -- for example, whether it was a return of investment loss, lost profits, or something else -- to determine the federal and New York tax treatment of the distribution your client receives.

Common questions

Q: Why weren't the Disgorgement Funds treated as corporations under Article 9-A?
A: Because the receiver's activities were limited to holding court-restricted investments (U.S. government securities and FDIC-insured CDs/money-market accounts) and distributing money under an SEC-approved plan he had no discretion over. New York case law (Smadbeck, Nauss, Burrell, City Bank Farmers Trust Co.) holds that merely investing funds and collecting/reinvesting income, without more, is not "conducting a business," which is what Tax Law § 208.1 and Reg. § 1-2.3 require for a trustee-run entity to count as a "corporation."

Q: Why weren't the Disgorgement Funds treated as trusts under Article 22?
A: Because Tax Law § 607(a) ties Article 22 terminology to federal tax-law meanings, and each fund had elected qualified settlement fund status under IRC § 468B(g). Under Treas. Reg. § 1.468B-1(b), that election makes the fund a QSF rather than a trust for federal purposes, even though it might otherwise have qualified as a trust. New York followed that federal non-trust classification. Tax Law § 601(g), which exempts entities taxed as corporations federally, provided an independent second reason for the same result.

Q: Does this mean the money the claimants eventually receive is tax-free in New York?
A: No. The Department expressly did not decide whether claimants or the original defendants owe New York tax on the funds' earnings, calling that a factual question outside the scope of an Advisory Opinion. Under Treas. Reg. § 1.468B-4, that answer depends entirely on the nature of each claimant's own underlying claim against the defendant, and New York (via Tax Law § 612, which has no special QSF modification) simply follows whatever the federal, claimant-specific treatment turns out to be.

Q: Does it matter that the funds happened to be held in a New York bank?
A: No. The opinion notes that the funds' situs and the limited investment activity were dictated entirely by the SEC and the Court Order, and that being held in New York was "fortuitous" rather than a deliberate connection to the state. The tax analysis turned on the nature of the receiver's activities and the funds' federal QSF classification, not on where the accounts happened to sit.

Q: Was this the first time the Department reached this kind of conclusion?
A: No. The opinion cites the Department's own earlier advisory opinions involving a similarly structured Buxbaum-Banco Popular settlement fund -- one addressing the corporate franchise tax question and one addressing the trust/Article 22 question -- both reaching the same "not taxable at the entity level" conclusions being applied here.

Citations and references

• Tax Law § 208.1 - defines "corporation" to include a business conducted by a trustee where interest or ownership is evidenced by certificate, but only where the trustee is conducting a business
• Tax Law § 209.1 - imposes the Article 9-A franchise tax on corporations doing business, employing capital, or owning/leasing property in New York
• Reg. § 1-2.3 of the Business Corporation Franchise Tax Regulations - mere investment of funds and collection/reinvestment of income, with incidental replacement of securities, does not constitute conducting a business
• Tax Law § 607(a) - Article 22 terms follow federal tax-law meanings unless a different meaning is clearly required
• Tax Law § 601(g) - an association, trust, or unincorporated organization taxed as a corporation for federal purposes is not subject to Article 22
• Tax Law § 611, § 612 - New York taxable income and adjusted gross income computation; no special modification exists for qualified settlement fund distributions
• Tax Law § 171-Twenty-fourth; 20 NYCRR § 2376.1(a) - an Advisory Opinion addresses only a specified set of facts and cannot resolve open factual questions, such as a particular claimant's tax treatment
• IRC § 468B(g) - permits a fund to elect qualified settlement fund status
• Treas. Reg. § 1.468B-1(b) - a fund that could otherwise be classified as a trust is instead classified specifically as a qualified settlement fund for federal tax purposes
• Treas. Reg. § 1.468B-4 - whether a distribution is includible in a claimant's gross income depends on the nature of that claimant's own underlying claim, as if paid directly by the defendant
• Smadbeck v. St. Tax Comm., 33 NY2d 930 (1973) - the conduct of business is more than ownership of property and collection/distribution of income from it
• People ex rel. Nauss v. Graves, 283 NY 383, 386 (1940) - same principle
• Burrell v. Lynch, 274 AD 347, 352 (1948) - incidental replacement of securities and reinvestment, as with an ordinary trust, does not constitute conducting a business
• City Bank Farmers Trust Co. v. Graves, 272 NY 1, 6 (1936) - same principle

Source

• Landing page: https://www.tax.ny.gov/pubs_and_bulls/advisory_opinions/income_ao_1994.htm
• Opinion: https://www.tax.ny.gov/pdf/advisory_opinions/income/a94_2i.pdf

Original ruling text

New York State Department of Taxation and Finance

TSB-A-94 (2) I
Income Tax
February 1, 1994

Taxpayer Services Division
Technical Services Bureau
STATE OF NEW YORK
COMMISSIONER OF TAXATION AND FINANCE
ADVISORY OPINION

PETITION NO. I931108B

On November 8, 1993, a Petition for Advisory Opinion was received from Lee
S. Richards, Receiver under Boesky/Siegal/Kidder-Peabody Disgorgement Funds,
Richards Spears Kibbe & Orbe, 140 Broadway, New York 10005.
The issues raised by Petitioner, Lee S. Richards, Receiver under
Boesky/Siegal/Kidder-Peabody Disgorgement Funds, are (1) whether the disgorgement
funds are corporations under Article 9-A of the Tax Law and the earnings of each
disgorgement fund taxable under Article 9-A of the Tax Law; (2) whether the
disgorgement funds are trusts and subject to tax section 601 of Article 22 of the
Tax Law and the earnings of each disgorgement fund taxable under Article 22 of
the Tax Law and (3) whether the claimants or the defendants are separately
subject to New York income tax on the earnings of the disgorgement funds.
Petitioner is the receiver of deposits in three settlement funds, Boesky
Disgorgement Fund, Siegal Disgorgement Fund and Kidder, Peabody Disgorgement Fund
(hereinafter "Disgorgement Funds") established by court order in final settlement
of three separate actions brought by the Securities & Exchange Commission
(hereinafter "SEC") against defendants alleging violations of the insider trading
laws (each a "Court Order").Pursuant to each Court Order, the defendant deposited
amounts with Petitioner,which amounts, together with any earnings thereon, are
to be disbursedto persons allegedly injured by the particular defendant and
certain related parties pursuant to a court-approved plan proposed by the SEC.
Each Court Order severely limits Petitioner's authority to invest the
Disgorgement Funds by restricting the class of permissible investments to U.S.
government securities entitled to the full faith and credit of the United States,
and FDIC insured certificates of deposit or money market accounts at any domestic
bank having a combined capital and surplus of at least $5,000,000,000. Petitioner
has no discretion to make distributions to claimants, which are to be governed
entirely by the SEC plan of distribution approved by court order. Pursuant to
each Court Order, in no circumstance is any portion of the Disgorgement Fund to
be returned to or otherwise made available to the defendant, his or its heirs or
successors.
On March 15, 1993, Petitioner filed an election with the Internal Revenue
Service (hereinafter "IRS") on behalf of each Disgorgement Fund to be treated as
a "qualified settlement fund" in accordance with the newly finalized Treasury
Regulations under section 468B(g) of the Internal Revenue Code (hereinafter
"IRC"). But for Petitioner's election, approved by the SEC and the Court, the
Disgorgement Funds are nottaxable entities and are not required to file annual
Federal income tax returns.Since their inception, however, Petitioner has filed
Federal Form 1041 annuallywith the IRS and Form IT-205 with the New York State
Department of Taxation and Finance for each Disgorgement Fund solely to disclose
the amount of income earned.
TP-9 (9/88)

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February 1, 1994

The income earned is continually added to the underlying deposits and the
entire amount is reinvested for ultimate distribution to claimants. Because
distributions relate solely to the underlying claim or injury, they do not
reflect any separate accounting or allocation of the income earned by the
Disgorgement Funds. Likewise, the taxation of a distribution in the hands of the
claimant is based solely on the particular nature of the claim presented. Thus,
the tax treatment of each distribution can vary considerably from claimant to
claimant.
The class of claimants is widely-defined and dispersed. The situs of the
funds themselves and the limited investment activity with respect thereto is
determined entirely by the SEC and the Court Order. It is fortuitous that they
are presently held within the State of New York. The claimants have no rights
to "earnings" but, rather, to some aggregate sum payable pursuant to the court
approved plan.
Section 209.1 of the Tax Law imposes, annually, a franchise tax on every
corporation for the privilege of exercising its corporate franchise, or of doing
business, or of employing capital, or of owning or leasing property in New York
State in a corporate or organized capacity, or of maintaining an office in New
York State for all or any part of each of its fiscal or calendar years.
Section 208.1 of the Tax Law provides that:
The term "corporation" includes an association, within the meaning
of paragraph three of subsection (a) of section seventy-seven
hundred one of the internal revenue code, a joint-stock company or
association, a publicly traded partnership treated as a corporation
for purposes of the internal revenue code pursuant to section
seventy-seven hundred four thereof and any business conducted by a
trustee or trustees wherein interest or ownership is evidenced by
certificate or other written instrument ...
The term "corporation" is defined in section 1-2.3 of the Business
Corporation Franchise Tax Regulations, which provides, in part, that:
(a) The term 'corporation' means an entity created as such under the
laws of the United States, any state, territory or possession
thereof, the District of Columbia, or any foreign country, or any
political subdivision of any of the foregoing, which provides a
medium for the conducting of business and the sharing of its gains.
. . .
(b) ... An entity conducted as a corporation is deemed to be a
corporation.
. . .
(2) A business conducted by a trustee or trustees in which interest
or ownership is evidenced by certificate or other written instrument
includes, but is not limited to, an association commonly referred to
as a business trust or Massachusetts trust. In determining whether
a trustee or trustees are conducting a business, the form of the
agreement is of significance but is not controlling. The actual
activities of the trustee or trustees, not their purposes and
powers, will be regarded as decisive factors in determining whether

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TSB-A-94 (2) I
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February 1, 1994

a trust is subject to tax under article 9-A of the Tax Law.
The
mere investment of funds and the collection of income therefrom,
with incidental replacement of securities and reinvestment of funds,
does not constitute the conduct of a business in the case of a
business conducted by a trustee or trustees ....
For New York State franchise tax purposes, an unincorporated entity is not
taxed as a corporation unless its activities are conducted in a manner whereby
the entity presents itself as a corporation, in which case it is deemed to be a
corporation.
The conduct of business is more than the ownership of property and the
collection and distribution of income derived from that property. (Smadbeck v
St Tax Comm, 33 NY2d 930 (1973); People ex rel Nauss v Graves, 283 NY 383, 386
(1940)). It is "more than the mere investment of funds and the collection of
income therefrom, with the incidental replacement of securities and the
reinvestment of funds that constitute the corpus, as in the case of an ordinary
trust." (Burrell v Lynch, 274 AD 347, 352 (1948); see also, City Bank Farmers
Trust Co. v Graves, 272 NY 1, 6 (1936)).
Herein, with respect to Petitioner's first issue, the activities of
Petitioner, do not constitute the conduct of a business as contemplated by
section 208.1 of the Tax Law and section 1-2.3 of the Business Corporation
Franchise Tax Regulations. (See, Samuel R. Buxbaum, Administrator Buxbaum-Banco
Popular Settlement Fund, Adv Op Comm T & F, April 30, 1993, TSB-A-93(10)C.)
Accordingly, each Disgorgement Fund is not deemed to be a corporation for
purposes of Article 9-A and is not subject to the tax imposed by such Article and
the earnings of each Disgorgement Fund are not subject to tax under Article 9-A.
With respect to Petitioner's second issue, the New York State personal
income tax under Article 22 of the Tax Law is imposed on resident and nonresident
trusts.
Section 607(a) of the Tax Law provides, in pertinent part, that:
Any term used in this article shall have the same meaning as when
used in a comparable context in the laws of the United States
relating to federal income taxes, unless a different meaning is
clearly required ....
For Federal income tax purposes, each Disgorgement Fund has elected under
section 1.468B-5(b)(2) of the Treasury Regulations to be treated as a qualified
settlement fund for all taxable years since inception. Pursuant to section
1.468B-l(b) of the Treasury Regulations, a fund, account, or trust that is a
qualified settlement fund that could be classified as a trust within the meaning
of section 301.7701-4 of the Treasury Regulations, is classified as a qualified
settlement fund for purposes of the IRC. Accordingly, since each Disgorgement

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Fund is not treated as a trust for Federal income tax purposes, each Disgorgement
Fund, pursuant to section 607(a) of the Tax Law, is not treated as a trust for
purposes of Article 22 of the Tax Law; (See Samuel R. Buxbaum, Administrator
Buxbaum-Banco Popular Settlement Fund, Adv Op Comm T & F, April 30, 1993, TSB-A­
93(5)I.)
Further, section 601(g) of the Tax Law provides that an association, trust
or other unincorporated organization which is taxable as a corporation for
Federal income tax purposes shall not be subject to tax under Article 22 of the
Tax Law. Herein, each Disgorgement Fund is a qualified settlement fund under
section 468B of the IRC and pursuant to such section, each Disgorgement Fund is
a person for Federal income tax purposes that is taxed on its modified gross
income and the tax imposed is treated as a tax on corporations.
Accordingly, each Disgorgement Fund is not subject to the tax imposed under
Article 22 of the Tax Law and the earnings of each Disgorement Fund are not
taxable under Article 22.
With respect to Petitioner's third issue, section 611 of the Tax Law
provides that New York taxable income of a resident individual is the
individual's New York adjusted gross income less the individual's New York
deduction and New York exemptions. Section 612 of the Tax Law provides that the
New York adjusted gross income of a resident individual means the individual's
Federal adjusted gross income as defined in the Laws of the United States for the
taxable year, modified as required by such section. There is no modification in
section 612 of the Tax Law with respect to income that is a distribution to a
claimant from a qualified settlement fund. The income is treated the same for
New York State personal income tax purposes as it is treated for Federal income
tax purposes. Section 1.468B-4 of the Treasury Regulations states that whether
a distribution to a claimant is includible in the claimant's gross income is
generally determined by reference to the claim in respect of which the
distribution is made and as if the distribution were made directly by the
transferor.
Accordingly, the determination of whether the claimants or the defendants
are separately subject to New York State personal income tax on the earnings of
the Disgorgement Funds is a factual matter not susceptible of determination in
an Advisory Opinion. An Advisory Opinion merely sets forth the applicability of
pertinent statutory and regulatory provisions to a "specified set of facts." Tax
Law, §l71.Twenty-fourth; 20 NYCRR 2376.1(a).

DATED: February 1, 1994

s/PAUL B. COBURN
Deputy Director
Taxpayer Services Division

NOTE: The opinions expressed in Advisory Opinions are
limited to the facts set forth therein.