Stockholder Litigation Settlements


G

Geezer

I have received a couple cash settlements as a result of class action suits
against management of a few companies whose stock I own or owned. Typically
the lawyers who win these suits take their commissions and disappear,
providing no guidance to the stockholders about how to treat the
settlements. Searching the web and talking to amateur tax experts, I found
advice that since these suits usually are the result of management actions
which artificially inflated the price of the shares when I purchased the
stock, the settlement should be treated a decrease in the basis of the
stock, reflecting what should have been the fair market price of the shares
I purchased. I have been entering this as a "return of capital" in Quicken,
and will report this income in TurboTax as more capital gain or less capital
loss when I sell the stock in the future. In one case where I had
previously sold the stock, I reported it in TurboTax on Schedule D as
capital gain with zero basis. Is all of this the correct way to treat these
settlements?

I just received a 1099-MISC for a settlement I received last year. The
language on the 1099 implies that this should be reported as "other income"
on line 21 of my 1040. I had already accounted for this settlement in
Quicken as another reduction in basis. Does the 1099-MISC obligate me to
change the way I am treating this settlement payment? In this case, an
agreed settlement was reached without a legal finding against the
management - since they are thus not legally guilty of manipulating the
stock price (even though the evidence shows they did), is the settlement no
longer a return of capital? Is so, what is it? Gary Q
 
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A

Andrew

Geezer said:
I have received a couple cash settlements as a result of class action
suits against management of a few companies whose stock I own or
owned. Typically the lawyers who win these suits take their
commissions and disappear, providing no guidance to the stockholders
about how to treat the settlements. Searching the web and talking to
amateur tax experts, I found advice that since these suits usually
are the result of management actions which artificially inflated the
price of the shares when I purchased the stock, the settlement should
be treated a decrease in the basis of the stock, reflecting what
should have been the fair market price of the shares I purchased. I
have been entering this as a "return of capital" in Quicken, and will
report this income in TurboTax as more capital gain or less capital
loss when I sell the stock in the future. In one case where I had
previously sold the stock, I reported it in TurboTax on Schedule D as
capital gain with zero basis. Is all of this the correct way to
treat these settlements?

I just received a 1099-MISC for a settlement I received last year.
The language on the 1099 implies that this should be reported as
"other income" on line 21 of my 1040. I had already accounted for
this settlement in Quicken as another reduction in basis. Does the
1099-MISC obligate me to change the way I am treating this settlement
payment? In this case, an agreed settlement was reached without a
legal finding against the management - since they are thus not
legally guilty of manipulating the stock price (even though the
evidence shows they did), is the settlement no longer a return of
capital? Is so, what is it? Gary Q
 
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R

R. C. White

Hi, Gary.

Step 1: Understand what happened - in the real world.

Step 2: Figure out how to record and report what happened.

Trying to do Step 2 before Step 1 results in frustration - and probably
errors.

You can't properly record the cash you received from the settlement until
you know why it was paid. That's true whether you are using Quicken or a
pencil and paper. What was alleged in the litigation? What was in the
settlement agreement? Did a judge approve the settlement?

Was the amount you received "compensatory" (making up for your losses) or
"punitive" (punishing management for misdeeds)? Did it come from the
company treasury or from the pockets of the managers? Who knows? Heck, you
haven't even told us the name of the company, much less what the argument
was about in THIS case.
Searching the web and talking to amateur tax experts, I found
advice that since these suits usually are the result of management actions
This topic is not one for "amateur tax experts". You can't rely on what
such suits are "usually" about; you must find out the legal reason that you
got THIS cash settlement.
I just received a 1099-MISC for a settlement I received last year. The
language on the 1099 implies that this should be reported as "other
income"
on line 21 of my 1040.
See what I mean? Some kinds of damages are fully taxable as "ordinary
income"; others reduce basis, as you've heard; some kinds are not taxable at
all!
I had already accounted for this settlement in
Quicken as another reduction in basis. Does the 1099-MISC obligate me to
change the way I am treating this settlement payment?
No, the company cannot dictate how you must report your income. Only you
can decide that. However, if you don't agree with the 1099-MISC, then it's
up to you to either get the company to change it or report the settlement
you received in the way you think is proper - and be prepared to defend your
position if the IRS questions it.

As Andrew said, you probably would get better guidance in
misc.taxes.moderated. You might find something helpful on the company's
website, probably under "investor relations". Even better advice is to take
the documents to your own CPA or tax attorney.

I've been retired for over a decade and tax rules change daily, so my advice
is waaay out of date. Please let us know what you learn.

RC
 

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