In Ritter v. Commissioner, TC Memo. 2017-185 (September 19, 2017), the Tax Court held that a taxpayer’s receipt of a payment from a section 468B qualified settlement fund (QSF) was includable in gross income for the 2013 taxable year. The QSF was established pursuant to a settlement agreement between a federal banking regulator and the taxpayer’s former mortgage servicer (Bank) in which the Bank agreed to take certain actions to remedy deficiencies and unsafe or unsound practices in (i) the Bank’s residential mortgage servicing and (ii) the Bank’s initiation and handling of foreclosure proceedings. The Bank foreclosed on the taxpayer’s principal residence in 2010 while the taxpayer was in bankruptcy proceedings and protected by federal bankruptcy law.
Under section 468B, whether a payment from a QSF is includable in a payee’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 to the payee by the transferor to the QSF. The terms of the settlement agreement at issue provided that a borrower was not required to show financial harm or request a review in order to receive a payment from the QSF, and the settlement agreement expressly provided that such payments from the QSF did not “in any manner reflect specific financial injury or harm that may have been suffered by borrowers receiving payments.” Further, such payments did not include any amounts for lost equity. Because the taxpayer was not required to show financial harm or request a review prior to receiving his payment, and the settlement agreement expressly provided that the QSF payment did not reflect any financial injury or harm or include amounts for lost equity, the Tax Court found that there was no evidence to establish that the taxpayer’s QSF payment was or was intended to be a deemed increase or decrease to the amount realized by the taxpayer from the foreclosure of his principal residence. Also, no other provision of the Internal Revenue Code entitled the taxpayer to exclude the payment. Thus, the Tax Court held that the taxpayer was required to include the payment in his gross income for the 2013 taxable year.
Practice Point: Ritter highlights the need for careful drafting of settlement agreements to ensure that they reflect the intentions and understandings of the parties.