IRS concludes on payments to receive settlement proceeds

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.  

Tax professional standards statement
This content supports Grant Thornton LLP’s marketing of professional services and is not written tax advice directed at the particular facts and circumstances of any person. If you are interested in the topics presented herein, we encourage you to contact us or an independent tax professional to discuss their potential application to your particular situation. Nothing herein shall be construed as imposing a limitation on any person from disclosing the tax treatment or tax structure of any matter addressed herein. To the extent this content may be considered to contain written tax advice, any written advice contained in, forwarded with or attached to this content is not intended by Grant Thornton LLP to be used, and cannot be used, by any person for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code.

The information contained herein is general in nature and is based on authorities that are subject to change. It is not, and should not be construed as, accounting, legal or tax advice provided by Grant Thornton LLP to the reader. This material may not be applicable to, or suitable for, the reader’s specific circumstances or needs and may require consideration of tax and nontax factors not described herein. Contact Grant Thornton LLP or other tax professionals prior to taking any action based upon this information. Changes in tax laws or other factors could affect, on a prospective or retroactive basis, the information contained herein; Grant Thornton LLP assumes no obligation to inform the reader of any such changes. All references to “Section,” “Sec.,” or “§” refer to the Internal Revenue Code of 1986, as amended.