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entered into in lieu of such prosecution. [Sec. 1.104-
1(c), Income Tax Regs.]
Accordingly, to exclude damages from gross income pursuant to
section 104(a)(2), the taxpayer must establish that: (1) The
underlying cause of action is based upon tort or tort type
rights, and (2) the damages were received on account of personal
injuries or sickness. Commissioner v. Schleier, 515 U.S. at ___,
115 S. Ct. at 2167.
Turning to the first requirement of Commissioner v.
Schleier, supra, we examine whether petitioner's claim was "based
upon tort or tort type rights". Citing United States v. Burke,
504 U.S. 229, 237 (1992), respondent argues that petitioner's
claim, which arose under title VII, was not based upon tort or
tort type rights. Petitioners, however, argue that the State
Farm payment was made to settle petitioner's claim of tortious
discrimination under California and Federal law. Additionally,
petitioners argue that, pursuant to the settlement agreement,
petitioner released all of her rights against State Farm,
including tort or tort type rights.
Where amounts are received pursuant to a settlement
agreement, the nature of the claim that was the actual basis for
settlement controls whether such amounts are excludable from
gross income pursuant to section 104(a)(2). United States v.
Burke, supra at 237. The critical question is "in lieu of what
were damages awarded" or paid. Bagley v. Commissioner, 105 T.C.
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