Hudson v. Commissioner
20 T.C. 734, aff'd 216 F.2d 748 (6th Cir. 1954)

  • Harahan won a lawsuit against Cole and was awarded $75k. However Cole didn't pay.
  • Eventually Harahan sold her interest in the Cole judgment to Hudson and Taylor for $11k. Hudson and Taylor then negotiated with Cole and settled the judgment for $21k.
  • When they filed their taxes, Hudson and Taylor reported their profit on the deal (~$5k each) as a long-term capital gain. The IRS denied the claim. Hudson and Taylor appealed.
    • The IRS argued that it was not a long-term capital gain but instead was ordinary income (which was taxed at a higher rate).
    • Hudson and Taylor argued that the judgment was a capital asset, and the settlement was a "sale or judgment of a capital asset" which met the definition of the relevant section of the tax code (then 26 U.S.C. 117, now 26 U.S.C. 1222).
  • The Tax Court found for the IRS.
    • The Tax Court found that the judgment was not 'property' but just a debt. Hudson and Taylor did not recover the money as the result of any sale or exchange but only as a collection of settlement of the judgment.
    • The Court found that since the settlement of a debt is not a "sale or exchange," then the tax code provisions related to capital gains are inapplicable and the profits are to be treated as ordinary income.