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Discussion
Section 61 provides that all income, from whatever source
derived, is includable in gross income unless specifically
excluded by another provision. Commissioner v. Glenshaw Glass
Co., 348 U.S. 426, 430 (1955). Compensation for services is
specifically included in the definition of gross income. Sec.
61(a)(1); see also Commissioner v. Smith, 324 U.S. 177, 181
(1945) (“any economic or financial benefit conferred on the
employee as compensation” is includable in taxable income,
whatever the form or mode by which it is effected). With respect
to damages, “‘whether a claim is resolved through litigation or
settlement, the nature of the underlying action determines the
tax consequences of the resolution of the claim.’” Milenbach v.
Commissioner, 106 T.C. 184, 198 (1996) (quoting Tribune Publg.
Co. v. United States, 836 F.2d 1176, 1177 (9th Cir. 1988)). In
characterizing the settlement payment for tax purposes, we ask:
“‘In lieu of what were the damages awarded?’” Id. (quoting
Raytheon Prod. Corp. v. Commissioner, 144 F.2d 110, 113 (1st Cir.
1944), affg. 1 T.C. 952 (1943)).
The settlement here in question resolved petitioner’s
lawsuit against Kits for its failure to pay petitioner overtime
compensation or wages. The proceeds of the settlement were paid
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