-6-
or action based upon tort or tort type rights, or through a
settlement agreement entered into in lieu of such prosecution.”
Sec. 1.104-1(c), Income Tax Regs. In the absence of bona fide
language in a settlement agreement as to the reason for a
settlement payment, we discern that reason by determining the
intent of the payor in making the payment. Robinson v.
Commissioner, 102 T.C. 116, 127 (1994), affd. in part and revd.
in part on another issue not relevant herein 70 F.3d 34 (5th Cir.
1995). We do so on the basis of all the facts and circumstances
of the case, including an analysis of the complaint filed and the
details surrounding the litigation. Id.
Petitioners must meet a two-prong test in order for the net
settlement payment to be excluded under section 104(a)(2). More
specifically, they must prove that: (1) The underlying cause of
action giving rise to petitioner’s recovery of the payment is
based upon tort or tort type rights and (2) the payment was
received on account of personal physical injuries or physical
sickness. Commissioner v. Schleier, supra at 328;3 see also sec.
3 As relevant herein, the Small Business Job Protection Act
of 1996 (SBJPA), Pub. L. 104-188, sec. 1605, 110 Stat. 1838,
amended sec. 104(a)(2) to narrow the exclusion for amounts
received after Aug. 20, 1996. Whereas the text of the
predecessor section allowed an exclusion for damages received “on
account of personal injuries or sickness”, the SBJPA mandated
that the damages could be excluded from gross income only if they
were received “on account of personal physical injuries or
physical sickness”. (Emphasis added.) The Supreme Court in
Commissioner v. Schleier, 515 U.S. 323 (1995), addressed the
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