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.
