Tax question

[freddyw]

I recently received a settlement from a class action lawsuit against Nortel. The class action lawsuit was a result of Notel cooking their books back in 2001. Folks who purchased stock in Nortel during that timeframe lost alot of $ as a result of their fraud as the stock value plummeted when the truth came out.

The settlement was awarded finally as a combination of both Nortel common stock and a check. Upon receiving the stock, I immediately sold it and reinvested it in index funds.

My question is: Do I have to claim and pay any federal or state taxes on any portion of the settlement as part of my 2008 tax return given the significant amount of $ lost due to Nortels' deceit and fraud? :confused:

[MasterBlaster]

In general awards for non-physical injuries and all punitive damages are taxable. If the settlement was to compensate you for lost market gains (or trading losses) of your stock holdings then you need to subtract the settlement from your original stock basis and claim some long-term capital gains. The lawyer and court fees may or may not be taxed or deducted depending on the settlement.

What exactly was the settlement for ? A fraud penalty ? Or what ?

This matter gets kind of tricky. I suggest you discuss it with a professional.

[Animorph]

I had somewhat the same problem with the WorldCom settlement. Presumably you did claim a lower capital gain due the drop in stock price at the time you sold, so you have already deducted the loss and the settlement is new income.

I searched the internet and found one guy that added the settlement amount as a capital gain, which seems reasonable enough. However, everything else I could find about settlements in general said they were normal income, not capital gains. I was surprised to find almost nothing directly related to the WorldCom settlement. Surely many people had to deal with that.

I went ahead and claimed it as normal income just to be safe. You should probably get a professional opinion if that is not an easy option in your case. It's definitely taxable.

[OAG]

Shoot a letter off to IRS and/or the attorneys that got paid (although I doubt they will even answer you). I am surprised there are not some IRS "private letter rulings" that came out of the older WorldCom settlement floating around that could set a basis for your handling of this. However, I suspect you may have a part of this ruling that is aimed at compensating you for lost value of the stock and part is punitive in nature. If that is true treating the stock part as capital gain and the punitive payment part as ordinary income may be appropriate. Assuming you are a calendar year filer you have a few months to deal with the IRS via a request for a PLR for your case (only cost will be time and a little effort composing the letter to them).

I found this entry (Note the phone number listed towards the center of the announcement): http://www.nortelsecuritieslitigation.com/home_en1.php3