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million. Xerox indicated that it would go no higher than $6
million, and petitioner's counsel, who believed that Xerox's
mitigation argument was a strong one, advised petitioner to accept
that amount. The parties eventually agreed to a settlement by
which Xerox would pay $5,950,000 in cash and cancel the $395,183
debt owed by Wehr (and assumed by the S corporations) to Xerox, for
a total of $6,345,183. The lawsuit was then dismissed with
prejudice. The cash payment was made by Xerox on or before
December 31, 1992.
Reporting of the Settlement
The S corporations allocated the settlement with Xerox as
follows: $3,502,541 to Venturedyne; $2,842,183 to Carnes. The S
corporations each reported the settlement as long-term capital gain
on their respective 1992 corporate income tax returns. Petitioners
similarly reported their allocable share of the settlement
($6,194,437) as long-term capital gain on their 1992 joint income
tax return. In calculating the capital gain, neither the S
corporations nor petitioners attributed any basis to the lawsuit.
In the notice of deficiency, respondent determined that the
settlement proceeds should have been reported as ordinary income.
OPINION
The sole issue for decision herein is whether the proceeds
received by the S corporations from the settlement of Wehr's
lawsuit against Xerox (the settlement proceeds) should be
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