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Under section 104(a)(2), gross income does not include "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". Section 1.104-1(c), Income Tax
Regs., provides:
(c) Damages received on account of personal
injuries or sickness.-- * * * The term "damages
received (whether by suit or agreement)" means 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.
Thus, an amount may be excluded from gross income only when
it was received both: (1) Through prosecution or settlement of
an action based upon tort or tortlike rights; and (2) on account
of personal injuries or sickness. Commissioner v. Schleier,
supra; Wesson v. United States, 48 F.3d 894, 901-902 (5th Cir.
1995); Bagley v. Commissioner, 105 T.C. 396, 416 (1995).
Where damages are received pursuant to a settlement
agreement, the nature of the claim that was the actual basis for
settlement controls whether such damages are excludable under
section 104(a)(2). United States v. Burke, 504 U.S. 229, 237
(1992); Thompson v. Commissioner, 866 F.2d 709, 711 (4th Cir.
1989), affg. 89 T.C. 632 (1987); Robinson v. Commissioner, 102
T.C. 116, 126 (1994), affd. in part and revd. in part 70 F.3d 34
(5th Cir. 1995). "[T]he critical question is, in lieu of what
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Last modified: May 25, 2011