David R. Green and Carolyn B. Green - Page 8

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          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           





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