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account of personal physical injuries or physical sickness”.
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, 336-337 (1995); sec. 1.104-1(c), Income
Tax Regs. Damages are not excludable from gross income under
section 104(a)(2) if the damages are received pursuant to the
settlement of economic rights arising out of a contract. See
Robinson v. Commissioner, 102 T.C. 116, 126 (1994), affd. in
part, revd. in part on another ground 70 F.3d 34 (5th Cir. 1995);
see also Fono v. Commissioner, 79 T.C. 680, 692 (1982), affd.
without published opinion 749 F.2d 37 (9th Cir. 1984).
If damages are received pursuant to a settlement agreement,
the nature of the claim that was the actual basis for settlement,
rather than the validity of the claim, determines whether the
damages were received on account of tortlike personal injuries.
See Robinson v. Commissioner, supra at 126. The determination of
the nature of the claim is made by reference to the settlement
agreement in light of the surrounding circumstances. Id. A key
question to ask is: “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)). If the settlement
agreement does not expressly allocate the settlement between
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