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policy was titled in the name of Pacific Bank, and that the
policy was never titled in the name of either or both
petitioners. Respondent concludes that the $500,000 is taxable
as ordinary income in that no property (other than money) ever
changed hands in connection with the settlement and that the
$500,000 was received by petitioners in extinguishment of any
right that they may have had in the Crown life policy.
We agree with respondent that the $500,000 is taxable to
petitioners as ordinary income. In Nahey v. Commissioner, 111
T.C. 256 (1998), affd. 196 F.3d 866 (7th Cir. 1999), the
taxpayers’ S corporations acquired the assets of a corporation
that included the acquired corporation’s pending lawsuit against
Xerox Corp. seeking damages for breach of contract. The
S corporations settled the lawsuit, and the taxpayers reported
their share of the settlement proceeds as capital gain. This
Court held that the proceeds were not received by the
S corporations from a sale or exchange. The Court ruled that the
S corporations’ rights in the lawsuit vanished both in form and
substance upon the receipt of the settlement proceeds and that
Xerox Corp. received in the settlement nothing other than the
discharge of the liabilities that arose as a result of the
lawsuit. Id. at 264-265;2 accord Steel v. Commissioner, T.C.
2The Court of Appeals for the Seventh Circuit appears to
have affirmed our decision in Nahey v. Commissioner, 111 T.C. 256
(continued...)
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