Disputes often follow the sale of the stock of a corporation. The buyer, creditors of the corporation, or others in some manner adversely affected by the transaction may assert claims against the seller. If the seller makes a payment to resolve such claims, upon either a settlement or an adverse judgment, issues often arise as to the tax treatment of that payment; if the seller dies before resolution of the dispute, and payment is made not by the seller but by the seller’s estate, the complexity of those tax issues is multiplied.
Background
Under Arrowsmith1 and other cases, the tax treatment of a payment made in settlement of a dispute is generally determined by reference to the tax treatment of the underlying transaction from which the claim arose. For example, if the underlying transaction was a sale of the stock of a corporation and resulted in capital gain (or loss) to the seller, a payment later made by the seller to the buyer, in satisfaction of claims arising from the sale, will generally result in a capital loss deductible, if at all, under Internal Revenue Code (IRC) §165. Ordinary tax accounting rules, including the economic performance requirement of IRC §461(h), will often not permit such a loss to be deducted in any taxable year before that of payment.
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