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In Commissioner v. Schleier, supra, the U.S. Supreme Court
established a two-prong test for determining whether a taxpayer
is eligible to exclude income under section 104(a)(2). The
taxpayer must demonstrate (1) that the underlying cause of action
giving rise to recovery is based upon tort or tort-type rights,
and (2) that the damages were received on account of personal
injuries or sickness. Id. at 336-337.
Where amounts are received pursuant to a settlement
agreement, the nature of the claim underlying the damage award,
rather than the validity of the claim, determines whether damages
are excluded under section 104(a)(2). United States v. Burke,
504 U.S. 229, 237 (1992). The nature of the claim is generally
ascertained by considering the facts and circumstances
surrounding the settlement agreement. Knoll v. Commissioner,
T.C. Memo. 2003-277.
II. Contentions of the Parties
Petitioners contend that the settlement documents reflecting
arm’s-length negotiations and the separately negotiated payments
speak for themselves as to their purpose. In other words, a
portion of the settlement was earmarked for personal injuries as
had been negotiated from the outset, and this payment was
intended for that purpose by the payors. Petitioners also
maintain that intentional infliction of emotional distress is a
tort or tort-like claim, citing United States v. Burke, supra at
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Last modified: November 10, 2007