The Internal Revenue Service issued a revenue procedure that provides guidance on the treatment of taxpayers who accept certain types of settlements of potential legal claims relating to auction rate securities.

In general, an auction rate security is a security in which the payment rate is reset periodically (typically every seven to 28 days), pursuant to an auction rate-setting process, or a similar remarketing agent rate-setting process, that is designed to produce the minimum payment rate necessary to enable all interested sellers to sell the security to willing buyers at a price equal to the par amount of the security, plus accrued but unpaid periodic payments.

A "failed" auction or remarketing occurs if the auction or remarketing fails to produce buyers for all interested sellers at a payment rate that is at or below the maximum payment rate specified by the terms of the auction rate security.

On Feb. 12, 2008, auctions of auction rate securities began to fail. As a result of the auction failures, many taxpayers were unable to sell auction rate securities for the par amount of the securities.

Taxpayers may assert legal claims against another person or corporation for its conduct as it relates to auction rate securities, alleging, for example, that the corporation improperly failed to disclose at the time of the taxpayer's purchase, the potential that the auction rate security could become illiquid. In order to settle these claims, the corporation may make a settlement offer to the affected taxpayers, saying that if the taxpayer releases various claims, the taxpayer will have the right during a specified period known as a "window period" to cause the corporation to buy the taxpayer's auction rate securities for the par amount. 

The IRS said it will not challenge the following positions for taxpayers within the scope of the revenue procedure: (1) the position that the taxpayer continues to own the auction rate security upon accepting (or "opting into") the settlement offer; (2) the position that the taxpayer does not realize any income as a result of accepting the settlement offer and does not reduce the basis of the auction rate security from its original purchase price; and  (3) the position that the taxpayer's amount realized from the sale of the auction rate security during the window period to the person or corporation offering the settlement is the full amount of the cash proceeds received from that person.

Revenue Procedure 2008-58 applies to taxpayers who, before June 30, 2009, accept settlement offers that include window periods that do not extend beyond Dec. 31, 2012, and require that the taxpayer deliver an auction rate security that the taxpayer purchased on or before Feb. 13, 2008. However, the revenue procedure does not apply to taxpayers who accept a settlement offer with respect to an auction rate security, make the election described in the revenue procedure, and take the position that they continue to own the auction rate security following such an acceptance and election.


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