In PLR 200724012, the IRS addressed the federal income tax treatment of a settlement received by a taxpayer from his stockbroker for the alleged mishandling of his account. The alleged mishandling resulted in the taxpayer suffering losses which were treated as capital losses. Since the settlement payment was integrally related to the prior loss, the IRS ruled that it was entitled to be treated as a long term capital gain and subject to the reduced 15% rate of tax on such gains.
This ruling represents the application by the IRS of a long standing doctrine first set forth by the Supreme Court in the case of Arrowsmith v. Commissioner. In Arrowsmith, the circumstances were reversed in that the taxpayer had realized a capital gain upon a liquidation of a corporation and in a subsequent year was required to pay a liability attributable to the corporation. The Supreme Court held that the two transactions were integrally related and should be treated as parts of a single transaction. Thus, since the taxpayer had realized a capital gain on the liquidation, the later payment must be treated as capital loss. In the recent private letter ruling the loss came first, followed by a recoupment from the broker, which was allowed capital gain treatment.