- 8 -
settlement agreement entered into in lieu of such prosecution."
Petitioner's settlement proceeds of $18,120 may be excluded from
gross income only if petitioners show that: (1) The underlying
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. Both elements of this two-part test must
be satisfied before a taxpayer is allowed to exclude amounts
received from gross income.
In the case of amounts received pursuant to a settlement
agreement, the nature of the underlying claim, not the validity
of such claim, determines whether it is excludable under section
104(a)(2). United States v. Burke, 504 U.S. 229, 237 (1992).
Determination of the nature of the claim is factual. Bagley v.
Commissioner, 105 T.C. 396 (1995), affd. 121 F.3d 393 (8th Cir.
1997). A key question to ask is in lieu of what were the damages
paid. Church v. Commissioner, 80 T.C. 1104 (1983). Where the
settlement agreement lacks express language stating the reason
for the payment, the most important element is the intent of the
payor. Knuckles v. Commissioner, 349 F.2d 610, 613 (10th Cir.
1965), affg. T.C. Memo. 1964-33. Although the payee's belief is
relevant to this inquiry, the ultimate character of the payment
hinges on the payor's dominant reason for making the payment.
Fono v. Commissioner, 79 T.C. 680 (1982), affd. without published
Page: Previous 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 Next
Last modified: May 25, 2011