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nonemployee compensation in the amount of $60,000 representing
the amount paid by DFAS pursuant to the mediation agreement.
Petitioners did not include this payment as income on their 1997
Federal income tax return. In the notice of deficiency,
respondent determined that the $60,000 payment constituted gross
income and further determined petitioners failed to report $344
in interest income on their 1997 Federal income tax return. As
noted earlier, petitioners conceded the unreported interest
income adjustment, and respondent conceded that $5,000 of the
$60,000 payment was excludable from gross income.
Section 104(a)(2) excludes from gross income "the amount of
any damages (other than punitive damages) received (whether by
suit or agreement and whether as lump sums or as periodic
payments) on account of personal physical injuries or physical
sickness". Section 1.104-1(c), Income Tax Regs., defines
"damages received" as "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." Amounts are
excludable from gross income only when (1) the underlying cause
of action giving rise to the recovery is based on tort or tort
type rights, and (2) the damages were received on account of
personal injuries or sickness. Commissioner v. Schleier, 515
U.S. 323, 337 (1995).
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