Received a check in the mail today pursuant to the terms of the Settlement. The letter accompanying it says it is a distribution from a "Qualified settlement fund" as defined in Code of Fed Regs Sections 1.468B-1-5. Says we should consult our own tax advisor to determine the tax consequences. Seems like it should be considered a return of capital, reducing my cost basis. Is this correct?
Under normal circumstances, you would reduce your cost basis if you still owned the securities. If you no longer owned any securities, you would report the payment as a long term capital gain.
However, I am not sure what cost basis you still have in the GM in which you received a settlement. That GM went bankrupt and when it came out of bankruptcy, the common stock was worthless. Anyone who still owned GM probably should have written it off as worthless as of 12/31/09.
It also could be from GM Global Notes (bonds) which are in default but not technically worthless. Last time I checked they had a real bid value of about $31 per $100. They are in limbo now; with GM eventually supposed to convert them to the new GM stock and some warrants to purchase more stock. I also received a settlement check (relatively minor) with same instructions. I have yet to determine whether it represents a partial return of capital (unlikely since the bonds still exist in default), compensatory (actual) damages, or punitive damages. Each gets different tax treatment. I'm inclined to view it as damages, but have to research further to see whether it's compensatory (non-taxed) or punitive (taxable).
It seems to me that the company is forcibly converting a bond in which you had a basis of, say, $1,000 to some cash ($100?) plus some equity and warrants (unspecified, but FMV today is $310, since that's what the bonds ex- the payment you received are selling for). I would consider it a return of capital; anything else can lead to incorrect tax calculations: if it's compensatory damages, it's not taxable; but it doesn't decrease your basis, so if the other stuff you get eventually sells for $1,000, you gained $100 non-taxably. However, if it's punitive, you pay tax on the $100 even if you eventually end up with only $410 for your $1,000 basis.
Seth
There are no damages. GM & Deloitte & Touche, its outside accountant, agreed to pay $303M to settle a class action lawsuit relating false and misleading statements that inflated the price of securities purchased during the relevant period. All payments are a return of capital. If you no longer own the securities (common & preferred stock and other GM debt securities), then you have LTCG. If you still own the debt securities, you have a reduction in cost basis.
Maybe the 1099 you'll receive next January will answer your question.
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