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the attorney who represented petitioners in the suit against the
insurance company. The letter contained a list of checks paid to
petitioners in the total amount of $269,467.20 and the attorney’s
conclusion that “The appraiser’s award was $128,084. Therefore
$25,616.80 of the $130,000 could logically be for damages due to
the removal of the berm with the remainder ($104,383.20) being
bad faith”.
In a January 23, 1996, letter, to the examining agent,
petitioners’ attorney in the insurance case attempted to recant
his earlier letter, stating that, notwithstanding his March 28,
1995, letter, the settlement payment was for neither bad faith
damages nor punitive damages. In addition, the enrolled agent
wrote to the examining agent reiterating that the attorney’s “bad
faith” characterization was a mistake. Despite the attempts to
correct the attorney’s statement, the examining agent concluded
that $104,000 of the $130,000 payment from the insurance company
was for punitive damages and was therefore income taxable to
petitioners for 1991.
Further, although petitioners’ claim for refund of 1991 tax
relied on the casualty loss provisions of section 165, during the
examination petitioners argued that some injury or sickness was
caused by the insurance company’s actions. Under this argument,
petitioners contended that the $130,000 was excludable as payment
for physical injury under section 104.
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