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applicability of this statute but later settled with the State
for $150,000. The firm of Merten & Associates did not pay any
part of its $3,864,012 to the State of Oregon for this
statutorily imposed liability.
Petitioner filed his 1995 Federal income tax return as
married filing separately. He included a disclosure statement
with his 1995 return explaining that the compensatory damages,
the punitive damages, and the interest on the part of the award
used to pay his attorney’s fees were excludable from his gross
income under section 104(a)(2). Accordingly, petitioner reported
as income only the interest on the part of the award disbursed
directly to him.
Respondent made the following determination concerning the
litigation award:
Total amount of damages awarded: $8,728,559
Less interest reported by the
petitioner: (1,421,420)
Less amount excluded, under I.R.C.,
sec. 104(a)(2) for emotional
distress: (625,000)
Increase to income reported by
petitioner: 6,682,139
Respondent allowed, as a miscellaneous itemized deduction,
$3,317,316 for attorney’s fees paid to Merten & Associates.
OPINION
We consider three interrelated issues: (1) Whether any
portion of damages received in settlement of petitioner’s legal
claim is excludable under section 104(a)(2); (2) whether the
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