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IRS concludes on payments to receive settlement proceeds

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Tax Hot Topics Payments to receive settlement proceedsThe IRS concluded in a field attorney advice (FAA) memorandum (FAA 20154701F) released Nov. 20 that an individual did not incur a capital gain from payments received under a contractual right to receive settlement proceeds.

The facts in the FAA memorandum are partially redacted, but provide that an individual taxpayer entered into a purchase and sale agreement with another party in which the taxpayer purchased an interest in a contractual right to receive a percentage of a settlement. The purchase and sale agreement specified that the amount to be funded under the agreement would be used for a specified purpose.

The taxpayer received a series of payments over a period in full satisfaction of the settlement interest and reported long-term capital gain.

Section 1001 provides that gain from the sale or other disposition of property is determined by the excess of the amount realized over the adjusted basis. Section 1222(3) provides that the term “long-term capital gain” means gain from the sale or exchange of a capital asset (as defined in Section 1221) held for more than one year.

Under Section 1234A, taxpayers are required to recognize capital gain or loss related to the cancellation, lapse, expiration or other termination of a right or obligation (other than a securities futures contract as defined in Section 1234B) with respect to property which is (or would be) a capital asset in the hands of the taxpayer.

In FAA 20154701F, the taxpayer took the position that his payments received under the settlement interest were capital gains pursuant to Section 1234A. However, the IRS concluded that the payments under the settlement interest should be ordinary income.  

The IRS noted in the FAA memorandum that the purchase and sale agreement called only for the purchase of the settlement interest and not the subsequent transfer of the settlement interest back to the seller. Thus, the IRS concluded there was no disposition of property necessary to have gain under Section 1001, and the arrangement was inconsistent with the notion that there was an associated sale or disposition of the settlement interest.  

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