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injuries or sickness”.5 “The term ‘damages received (whether by
suit or agreement)’ means an amount received (other than
workmen’s compensation) through prosecution of a legal suit or
action based upon tort or tort type rights, or through a
settlement agreement entered into in lieu of such prosecution.”
Sec. 1.104-1(c), Income Tax Regs.
In order to exclude payments under section 104(a)(2)
petitioner must show: (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. See Commissioner v. Schleier, supra at 337; Mayberry
v. United States, supra at 858; Bagley v. Commissioner, 105 T.C.
396, 416 (1995), affd. 121 F.3d 393 (8th Cir. 1997).
The tax consequences of payments made pursuant to a
settlement agreement depend on the nature of the claims that were
the actual basis for settlement, not on the validity of those
claims. See Bagley v. Commissioner, supra at 406; Threlkeld v.
Commissioner, 87 T.C. 1294, 1297 (1986), affd. 848 F.2d 81 (6th
Cir. 1988); Bent v. Commissioner, 87 T.C. 236, 244 (1986), affd.
835 F.2d 67 (3d Cir. 1987); Seay v. Commissioner, 58 T.C. 32, 36-
5The Small Business Job Protection Act of 1996, Pub. L. 104-
188, sec. 1605(a), 110 Stat. 1755, 1838, amended sec. 104(a)(2)
to narrow the exclusion for personal injury damages received
after Aug. 20, 1996, in tax years ending after that date. Under
the amendment, personal injury or sickness must be physical. The
amendment, however, does not apply to the years before us in this
case and, therefore, has no bearing on our decision.
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