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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 are received on account of
personal injuries or sickness. Commissioner v. Schleier, 515
U.S. 323, 337 (1995). The flush language in section 104(a)
further provides that “emotional distress shall not be treated as
a physical injury or physical sickness.” Sec. 104.
Where amounts are received pursuant to a settlement
agreement, the nature of the claim that was the actual basis for
settlement controls whether such amounts are excludable from
income under section 104(a)(2). United States v. Burke, 504 U.S.
229, 237 (1992). Determination of the nature of the claim is a
factual inquiry and is generally made by reference to the
settlement agreement. Robinson v. Commissioner, 102 T.C. 116,
126 (1994), affd. in part and revd. in part 70 F.3d 34 (5th Cir.
1995). “[W]here an amount is paid in settlement of a case, the
critical question is, in lieu of what was the settlement amount
paid.” Bagley v. Commissioner, 105 T.C. 396, 406 (1995), affd.
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