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We held that under section 265, the portion of the
attorney's fees allocable to the settlement amount for wrongful
discharge was not deductible, but the portion of the attorney's
fees allocable to the taxable portion of the suit, the breach of
contract action, was deductible under section 162.
The facts of McKay v. Commissioner, supra, are clearly
distinguishable from the facts of this case. In McKay, the
taxpayer had two causes of action--one arising from the law of
torts, the other from the law of contracts. The taxpayer in
McKay received separate settlement amounts for each claim. In
this case, petitioner has brought suit for a claim in tort,
personal injury. Furthermore, the damages petitioner received
all flow from the personal injury suit. McKay v. Commissioner,
supra, is therefore, inapposite.
We agree with respondent's determination that the portion of
petitioner's legal expenses allocable to the punitive damages and
the interest received on the award are deductible under section
212(1) as expenses paid for the production of income. This
treatment is consistent with other cases in which the taxpayer
received damages in a defamation action. See, e.g., Roemer v.
Commissioner, supra at 700; Church v. Commissioner, 80 T.C. 1104,
1110-1111 (1983).
Section 265, however, disallows deductions for amounts that
are allocable to tax-exempt income. Consequently, only the
attorney's fees attributable to punitive damages and interest are
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