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1. Lindsey Settlement
The notice of deficiency determined that petitioners must
include the entire $550,000 Lindsey settlement in gross income.
Respondent now concedes that petitioners need only include
$400,000 of the settlement amount, and not the $150,000 paid to
petitioner’s and CRI’s attorneys. Respondent contends that
petitioners received the $400,000 as a constructive dividend from
CRI because Lindsey's intent in settling the suit was to
compensate CRI for economic damages. Petitioners concede that
$50,000 of the $400,000 was taxable income to them as a
constructive dividend from CRI. We thus address whether
petitioners may exclude from gross income the remaining $350,000
they received pursuant to the Lindsey settlement agreement.
a. Allocation in the Settlement Agreement
The Lindsey settlement agreement allocates $50,000 of the
settlement to CRI and the remaining $500,000 to petitioner
“individually for mental anguish, pain and suffering, damage to
his reputation and loss of good will”. Petitioners argue that
the allocation in the Lindsey settlement agreement is controlling
for tax purposes because an express allocation is the most
important factor in determining the effect of a settlement and
because the parties were adversarial when the agreement was
executed. Respondent contends that the written allocation should
be disregarded because it was not adversarial or made at arm's
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