- 24 -
Accordingly, on the basis of all the facts and circumstances
of this case, we find that $4,682,116 of the settlement proceeds
was paid to petitioner in lieu of actual damages, which is
excluded from gross income under section 104(a)(2), and
$3,817,884 was paid in lieu of punitive damages and interest,
which is included in gross income under section 61.
Issue 3. Deductibility of Attorney's Fees Under Section 162
In the notice of deficiency, respondent allowed petitioners
a deduction under sections 212(1) and 265 for legal fees
allocable to the taxable portion of the settlement proceeds.
Petitioners assert in their reply brief that if this Court finds
that petitioners realized the amount paid to petitioner's
attorneys, they are entitled to deduct that amount under section
162(a) as an ordinary and necessary expense incurred during the
taxable year in carrying on a trade or business.
In analyzing the issue of whether the attorney's fees were
an expense incurred for the production or collection of income
under section 212(1) or as an ordinary and necessary expense
under section 162(a), we consider the origin and character of the
claim with respect to which the litigation expense was incurred.
United States v. Gilmore, 372 U.S. 39 (1963).
13(...continued)
and multiplying that amount by their $3 million payment.
Similarly, the amount allocated to punitive damages is
calculated by dividing the balance of their liability, $10
million minus $2,097,201, by their total liability, $10 million,
and multiplying that amount by their $3 million payment.
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