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damages and other damages, the allocation is generally binding for tax
purposes to the extent that the agreement is entered into by the parties in an
adversarial context at arm's length and in good faith. Where the taxpayer's
claims are settled and the express allocations among the various claims are
contained in the settlement agreement, we carefully consider such allocations,
if these express allocations were, negotiated at arm's length between the
parties. In Robinson v. Commissioner, supra, the parties had made an
allocation that was reflected in the final judgment as being 95 percent in
payment for mental anguish and 5 percent for lost profits. We held that the
allocation in the final judgment did not control the tax effects because it
was uncontested, nonadversarial, and entirely tax-motivated, and did not
accurately reflect the underlying claims. In the McKay case we stated that
the settlement was made by hostile parties who were in an adversarial position
with respect to the allocations to be made in the settlement. In that case we
pointed out that the taxpayer wanted the settlement award to be as high an
amount as possible to compensate him for his losses and wanted the other party
to be punished for its behavior. However, the other party wanted to minimize
the amount payable to the taxpayer as well as to avoid making any payment on
account of the taxpayer's RICO claim. We pointed out that the party dealing
with the taxpayer in that case had made it clear that he would not settle if
any damages were allocated to RICO claims because of the negative impact that
payment of such damages would have on its reputation in the oil industry. The
settlement agreement stated affirmatively that no amount was being paid to the
taxpayer to satisfy damages under RICO. In that case, the settlement
agreement provided:
"McKay has necessarily acceded to Ashland's demand that nothing be
allocated to the RICO Claim, punitive damages claims, or alleged
intentional misconduct claims and Ashland and McKay have both
relied upon their appellate counsel's consensus estimate of
McKay's probability of appellate success with respect to the two
other claims. * * * "
McKay v. Commissioner, 102 T.C. at 473.
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