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representative, an enrolled agent, contended that the entire
insurance recovery was used to repair their residence, so that no
part was attributable to punitive damages. Petitioners, in their
amended return, had taken the position that the amount received
was a casualty loss under section 165. It also appears that, at
the examination, petitioners argued that the $130,000 was not
taxable because it was due to personal injury within the meaning
of section 104. Ultimately, the examiner concluded that $104,000
of the $130,000 payment was received in settlement of
petitioners’ claim for punitive damages.
After the examination was complete, petitioners hired a law
firm to seek consideration of the examiner’s findings by Appeals
and to attempt settlement of the controversy. They attempted to
show that the cost of repairing their residence exceeded the
total payments received from the insurance company. Petitioners,
by using this approach, hoped to convince the Appeals officer
that no part of the settlement payment could have been for
punitive damages. Petitioners chose this approach after
evaluating the available evidence and balancing the viability of
their position at the Appeals conference with the much larger
cost of obtaining information from third parties. Petitioners’
approach to settlement did not result in an agreement with the
Appeals officer. The Appeals officer concluded that the $130,000
was received in settlement of petitioners’ claim for punitive
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