The IRS and the courts consider the complaint to be the most persuasive piece of evidence concerning the character of a recovery. Authority for this claim is found in Rev. Rul. 85-98. The courts and the IRS will examine the complaint for (i) the nature of the claims it sets forth, (ii) the individual merit of the claims, and (iii) the prayer for relief.
For example, where a complaint failed to state a claim based on personal physical injury or sickness, the Tax Court held that the settlement could not be excludable under Section 104(a)(2). Gunderson v. Commissioner, T.C. Memo 1979-99. Similarly, where a complaint sought only compensation for lost profits, the settlement agreement characterizing the recovery as a long term capital gain was not respected. Longino Estate v. Commissioner, 32 T.C. 904 (1959).
