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Section 61(a) defines gross income broadly as "all income
from whatever source derived". Gross income specifically
includes compensation for services. Sec. 61(a)(1). Exclusions
from income are matters of legislative grace and are construed
narrowly. Commissioner v. Schleier, 515 U.S. 323, 328 (1995);
Mostowy v. United States, 966 F.2d 668, 671 (Fed. Cir. 1992). A
taxpayer seeking an exclusion from income must be able to point
to an applicable statute and show that he comes within its terms.
Section 104(a)(2) excludes from gross income "the amount of
any damages received (whether by suit or agreement and whether as
lump sums or as periodic payments) on account of personal
injuries or sickness". The phrase "damages received" is further
defined as "an amount received * * * through prosecution of a
legal suit or action based upon tort or tort type rights, or
through a settlement agreement entered into in lieu of such
prosecution." Sec. 1.104-1(c), Income Tax Regs. Thus, to
qualify for the exclusion, the taxpayer must satisfy a two-prong
test. The taxpayer must show that (1) the cause of action giving
rise to the recovery is "based upon tort or tort type rights" and
(2) the damages were received "on account of personal injuries or
sickness." Commissioner v. Schleier, supra at 337. If a
settlement is attributable to claims based on tort or tort type
rights as well as other rights, the taxpayer bears the burden of
establishing which portion of the settlement is attributable to
damages received based upon tort or tort type rights. Similarly,
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Last modified: May 25, 2011