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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, supra at 336-337.2
We start our analysis with a focus on whether the settlement
proceeds were received on account of personal physical injuries
or physical sickness. According to petitioner, they were;
according to respondent, they were not. For the following
reasons, we agree with respondent.
The term “damages received”, as used in section 104(a)(2),
means an amount received “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.”
Sec. 1.104-1(c), Income Tax Regs. When damages are received
pursuant to a settlement agreement, as here, the nature of the
claim that was the actual basis for settlement, as opposed to the
validity of that claim, controls whether the amounts are
excludable under section 104(a)(2). United States v. Burke, 504
U.S. 229, 237 (1992); Bagley v. Commissioner, 105 T.C. 396, 406
2 Subsequent to Commissioner v. Schleier, 515 U.S. 323
(1995), Congress amended sec. 104(a) to provide that amounts are
excludable only if received “on account of personal physical
injuries or physical sickness”. Sec. 104(a)(2) (emphasis added);
Small Business Job Protection Act of 1996, Pub. L. 104-188, sec.
1605, 110 Stat. 1838, effective for amounts received after Aug.
20, 1996. Although the amendment narrows the scope of sec.
104(a)(2), it does not otherwise affect the analysis set forth in
Commissioner v. Schleier, supra. See Goode v. Commissioner, T.C.
Memo. 2006-48; Prasil v. Commissioner, T.C. Memo. 2003-100.
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