Litigation is an unfortunate reality in the business world, and businesses that are sued often make payments to settle the litigation brought against them. The tax treatment of such payments is a perennial source of controversy between taxpayers and the Internal Revenue Service. A recent decision of the Seventh Circuit Court of Appeals, affirming a memorandum decision of the Tax Court,1 illustrates the range of possible tax outcomes—including immediate deduction, capitalization into the cost of a tangible or intangible asset, and, possibly, no tax benefit at all—and the method of analysis generally applied by the courts that determines the appropriate treatment of the making of settlement payments by reference to a characterization of the underlying claims with respect to which the payments are made.
‘WellPoint v. Commissioner’
WellPoint Inc. is a provider of health insurance on a for-profit basis through various subsidiaries including a number of licensees of the Blue Cross and Blue Shield Association (“Blue Cross companies”). The payments in issue before the Seventh Circuit were made by WellPoint in settlement of litigation that arose from the merger into WellPoint, during the period of 1993 to 1997, of three Blue Cross companies, one in each of Connecticut, Kentucky, and Ohio, that had previously provided health insurance on a not-for-profit basis.
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