Donald Trump moved to dismiss a $10bn lawsuit against the IRS on Monday, dropping his claims amid reports he is considering a settlement with the federal government that would create a $1.7bn fund to compensate allies for supposed persecution by the government.

The Monday filing came just two days ahead of a 20 May deadline in which the judge overseeing the case asked the parties for briefing on whether a legitimate controversy existed – a requirement for any lawsuit – because Trump controls the IRS.

The filing made clear that Trump’s attorneys are trying to resolve the case before the judge overseeing it can intervene and issue an adverse ruling.

“Upon the filing of this notice, no judicial analysis is appropriate,” Trump’s lawyers said in a brief filing on Monday requesting dismissal of the suit.

The settlement will reportedly create a $1.776bn fund called the “Truth and Justice Commission”, according to ABC News. Trump could not receive payments from the commission, though people affiliated with him could seek compensation, according to the outlet. Five commissioners – four of whom would be appointed by the attorney general and removable by Trump – would oversee the body’s work, and it would not have to disclose its reasons for awarding the money.

The suit sought damages after Charles Littlejohn, an IRS contractor, leaked Trump’s tax returns to ProPublica and the New York Times.

Neither the justice department nor attorneys representing Trump returned a request for comment.

Democrats have harshly criticized the rumored settlement, saying it amounts to the creation of a slush fund for the president’s allies. Ninety-three congressional Democrats – including Hakeem Jeffries, a Democratic leader of New York – filed an amicus brief with the court on Monday saying such a claim would be illegal.

“Trying to hide this deal from the courts is corruption in plain sight. Trump is funneling taxpayer dollars to his political allies, and we will hold him accountable and block this billion-dollar giveaway at a time when Americans are already squeezed by inflation,” said Andrew Warren, deputy legal director at the Democracy Defenders Fund.

The settlement comes after US district judge Kathleen Williams, a Barack Obama appointee overseeing the case, appointed a group of lawyers to advise her on whether there was sufficient controversy in the case to proceed. Those attorneys filed their brief last week and noted that there were numerous potential defenses the justice department could offer to push back against Trump’s claims – several of which they were asserting in other cases involving the leaks of IRS records.

There is “reason to believe that the president is, in fact, exercising his control over the defendants in this litigation”, they wrote.

Watchdog groups pledged they would challenge the legality of any settlement. “Any settlement would be outrageously unethical and likely a violation of the Constitution’s Domestic Emoluments Clause,” said Donald Sherman, the president and CEO of Citizens for Responsibility and Ethics in Washington (Crew).

“This case was always a sham, and another ploy by the President to access taxpayer funds to line his pockets. The Justice Department needs to explain themselves here – because there is no legal authority for this settlement,” said Skye Perryman, president and CEO of Democracy Forward, another watchdog group.