T.C. Memo. 1996-536
UNITED STATES TAX COURT
BEVERLY T. RUTT-HAHN, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 12947-94. Filed December 5, 1996.
Beverly T. Rutt-Hahn, pro se.
Katherine Holmes Ankeny, for respondent.
MEMORANDUM OPINION
PAJAK, Special Trial Judge: This case was heard pursuant to
section 7443A(b)(3) of the Code and Rules 180, 181, and 182.
Unless otherwise indicated, all section references are to the
Internal Revenue Code in effect for the year in issue. All Rule
references are to the Tax Court Rules of Practice and Procedure.
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Respondent determined a deficiency in petitioner's 1991
Federal income tax in the amount of $1,483. The issues we must
decide are: (1) Whether petitioner may exclude from gross income
under section 104 amounts received from her former employer
pursuant to a settlement agreement; and (2) whether petitioner's
legal expenses are properly deductible as a miscellaneous
itemized deduction.
Some of the facts have been stipulated and are so found.
Petitioner resided in Paradise Valley, Arizona, when her petition
was filed.
For clarity and convenience, our findings of fact and
opinion have been combined.
Petitioner Beverly Rutt-Hahn (petitioner) had been employed
by the United States Postal Service (Postal Service) for a number
of years. As of 1983, petitioner was an EAS-15 Supervisor of
Mails and Delivery at the mail sectional center in Phoenix,
Arizona. In July 1984, petitioner applied for disability
retirement from the Postal Service, and her application was
approved. Thereafter, she began to receive civil service
retirement benefits in the form of a disability retirement
annuity.
In October 1987, petitioner filed a lawsuit against the
Postal Service in the United States District Court for the
District of Arizona. In her "Complaint For Damages And Equitable
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Relief", petitioner alleged that the Postal Service, et al.,
discriminated against her from "1976 to the present" based on her
sex, age (then 48), handicap (heart disease; stress-induced
illness), and in retaliation for having filed prior Equal
Employment Opportunity complaints. Petitioner specifically
alleged, among other things, that:
3.2 Defendants pursued a policy and practice of
failing to provide female employees, and older females
particularly, with equal opportunities for "details"
(temporary promotions) and training in the letter
carrier, supervisory and station management workforce
of the U.S. Postal Service.
* * * * * * *
3.6 Defendants' policy and practice of providing
certain employees with "details" (temporary promotions)
to higher EAS levels, which experience defendants then
consider essential or desirable for promotion into
higher level positions has a disparate impact on
females and particularly those aged 40 and older.
3.7 Defendants treated plaintiff differently from
similarly situated male employees and employees under
age 40 in that:
(a) Plaintiff was held at level EAS-15,
where she performed successfully, during all relevant
times herein, but was not selected for promotions into
positions for which she applied at levels EAS-16
through 20 from 1976 through 1984.
(b) Plaintiff was denied higher level
training details, denied equal access to carrier
supervisory assignments and denied officer-in-charge
assignments by defendants' agents.
(c) Plaintiff's lack of higher level
training details, officer-in-charge assignments and/or
lack of experience in carrier supervision were used as
reasons and/or pretexts for denial of promotion.
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(d) Plaintiff was unfavorably evaluated by
her supervisors and unfavorable evaluations were
maintained in her personnel files.
(e) Plaintiff was issued discriminatory
directives by her supervisors including letters of
deficiency, warning, instruction and concern.
3.8 Plaintiff was coerced into withdrawing a
complaint of sex discrimination filed in 1979 by
statements from the Director of Employee and Labor
Relations that her complaint would harm her career
opportunities.
* * * * * * *
3.11 Defendants' discriminating letters and
evaluations in 1981 created a chilling effect of such
proportion that it was fruitless to apply for
promotions for which she was qualified.
3.12 Defendants treated plaintiff differently
from similarly situated employees by failing to
accommodate plaintiff's handicapping conditions of
heart disease and stress induced illness from November
1983 to the present * * *.
3.13 As a result of filing complaints of
violations of her equal employment opportunity,
plaintiff was denied training details and assignments,
denied promotions, given unfavorable evaluations,
discouraged from applying for promotions and coerced
into withdrawing a complaint alleging sex
discrimination.
Petitioner based her discrimination allegations on the following:
1.1 [Title VII of] The Civil Rights Act of 1964
as amended, 42 USC Sec. 2000 e-16(c);
The Age Discrimination in Employment Act, as
amended, 29 USC Sec. 621, et seq.;
The Civil Rights Attorneys Fee Act of 1976,
as amended, 42 USC Sec. 1988;
39 USC Sec. 409, and application thereof by
the courts, permitting judicial review of final
decisions of the U.S. Postal Service;
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Petitioner's complaint requested, in relevant part, the following
relief:
(4) Equitable relief to make [plaintiff] whole, including:
(a) Back pay and retroactive promotion as
justified by the evidence * * *.
(b) If plaintiff cannot be reinstated because of
the discriminatory work environment, payment for
training and education needed to place plaintiff in
work consistent with her handicap, at a level to earn
comparable wages outside the Postal Service to those
she could have earned but for the discrimination.
(c) Front pay and benefits until plaintiff
obtains comparable employment described in (b) above,
or until early retirement age if she cannot return to
work because of the residual effects of the
discrimination.
(d) Recomputation of retirement benefits to
reflect the retroactive promotions and pay.
(e) Publication of notices to all postal
employees as to plaintiff's quality work performance
and prevailing on issues of discrimination.
(f) Reasonable attorney fees and costs of suit
for the administrative and judicial proceedings in
these cases.
(g) Such other and further relief as the court
may award.
Petitioner's "First Amended Complaint For Damages And
Equitable Relief", filed in January 1988, was identical with
respect to the above quoted language and presented no relevant
changes.
Petitioner and the Postal Service settled petitioner's
lawsuit and entered into a written settlement agreement (the
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agreement) on August 22, 1991. The agreement provided that the
parties,
having agreed to compromise and settle any and all
claims, as set forth below, including, without
limitation, claims for injunctive relief, back pay,
damages, retroactive promotions, attorneys' fees, and
costs, that the said plaintiff may have against the
defendant, and/or the United States Postal Service,
and/or any former or current officers, employees and/or
agents of the United States Postal Service, it is
agreed by the parties as follows:
1. The United States Postal Service agrees to
pay to plaintiff Beverly T. Rutt-Hahn the sum of
$75,000. It is understood and agreed that plaintiff
will be responsible for the payment of any taxes with
respect to this sum.
2. The United States Postal Service agrees to
adjust the records of plaintiff Beverly T. Rutt-Hahn to
reflect a promotion to the maximum of an EAS-20 as of
January 10, 1981 through the effective date of her
retirement. This information will be transmitted by
the Postal Service to the Office of Personnel
Management (OPM) which will then be responsible for
recalculating and paying to plaintiff whatever
additional monies may be due and owing to her, and any
adjustments to her retirement, as a result of the EAS-
20 promotion information supplied by the Postal Service
adjusting plaintiff's records. * * * In addition, the
Postal Service agrees to pay to OPM the requisite
retirement contributions to the Civil Service
Retirement and Disability Fund on its behalf and on
behalf of plaintiff, necessary for OPM to process the
necessary adjustments described above. The parties
agree that the adjustment of plaintiff's records is not
intended to entitle plaintiff to any benefit other than
those monies and retirement adjustments described above
to be determined by OPM. The actions of the United
States Postal Service as set forth in paragraphs one
(1) and two (2) above are accepted by plaintiff and her
counsel as fully discharging, without limitation, all
claims of plaintiff and her counsel including but not
limited to backpay, damages, attorneys' fees and costs.
3. Upon completion by the Postal Service of the
step set forth in paragraph one (1), above, and the
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Postal Service's transmission of information to OPM as
set forth in paragraph two (2), above, and assurance
from OPM of its approval and further action, plaintiff
agrees to stipulate to a dismissal, with prejudice, of
the above-styled litigation, namely Beverly T. Rutt-
Hahn v. Anthony M. Frank, Postmaster General of the
United States Postal Service, No. CIV. 87-1619 PHX WPC.
In addition, after execution of this Settlement
Agreement and OPM's approval, plaintiff also agrees to
withdraw, with prejudice, her claim for attorneys'
fees, costs and other relief in the pending Equal
Employment Opportunity Commission, Office of Federal
Operations' appeal * * *.
4. Each party shall bear its own respective
costs and counsel fees.
5. By this Settlement Agreement plaintiff
waives, releases and abandons any and all claims
against the defendant, the United States Postal
Service, its officers, agents and/or employees, whether
past or present, alleged either in the above-entitled
litigations in paragraph three (3) or in any EEO
complaint or litigation presently filed or pending in
any forum whatsoever, as well as any and all other
claims arising out of the events of said litigations
and other EEO complaints, and agrees to accept those
United States Postal Service actions outlined in
paragraphs one (1) and two (2) in full and complete
settlement and satisfaction thereof. Plaintiff also
waives, releases and abandons any and all rights or
claims she may have or may allege to have to re-
employment with the Postal Service either now or in the
future. Plaintiff agrees that this Settlement
Agreement constitutes res judicata of all of her claims
above described and that she will not raise, litigate
or relitigate any such claims in any other proceeding,
whether judicial or administrative.
In accordance with the agreement, the Postal Service issued
petitioner a check for $75,000 on September 30, 1991. By a
second check dated December 11, 1991, the Postal Service paid
petitioner $23,106.64 as back payment of her increased retirement
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benefits. There is no dispute that petitioner received these
payments in 1991.
On her 1991 Federal income tax return, petitioner subtracted
$41,063, which represents the legal expenses she incurred in
prosecuting her action against the Postal Service, from the
$75,000 payment. She then reported the difference of $33,937 as
"Other income" on line 22 of her return. She reported $42,719 of
pension and annuity income, which included the $23,106.64 of
increased retirement benefits received for her retroactive
promotion. Petitioner also reported wages she received from her
employment with Specialty Graphics in 1991.
Respondent determined that petitioner was not entitled to
exclude the $41,063 in legal expenses from income. Respondent
further determined that petitioner's legal expenses were
deductible as a miscellaneous itemized deduction.
Petitioner now argues that, under section 104(a)(2), neither
the $75,000 payment nor the increased retirement benefits are
taxable income. Petitioner bears the burden to prove she is
entitled to exclude the payments she received in 1991 from
income. Rule 142(a).
Except as otherwise provided, gross income includes income
from all sources. Sec. 61(a); Commissioner v. Glenshaw Glass
Co., 348 U.S. 426 (1955). While section 61(a) is to be broadly
construed, statutory exclusions from income must be narrowly
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construed. Commissioner v. Schleier, 515 U.S. ___, 115 S.Ct.
2159, 2163 (1995).
Under section 104(a)(2), gross income does not include "the
amount of any damages received (whether by suit or agreement and
whether as lump sums or as periodic payments) on account of
personal injuries or sickness". Section 1.104-1(c), Income Tax
Regs., provides "The term 'damages received (whether by suit or
agreement)' 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."
Thus, an amount may be excluded from gross income only when
it was received both: (1) Through prosecution or settlement of
an action based upon tort or tort type rights; and (2) on account
of personal injuries or sickness. Commissioner v. Schleier, 515
U.S. at ___, 115 S. Ct. at 2166-2167.
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 under
section 104(a)(2). United States v. Burke, 504 U.S. 229, 237
(1992); Robinson v. Commissioner, 102 T.C. 116, 126 (1994), affd.
in part, revd. in part 70 F.3d 34 (5th Cir. 1995). The "critical
question is, in lieu of what was the settlement amount paid?"
Bagley v. Commissioner, 105 T.C. 396, 406 (1995). Determination
of the nature of the claim is factual. The most important
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element is the intent of the payor. Robinson v. Commissioner,
supra at 127.
As enumerated in the settlement agreement, the Postal
Service agreed to pay petitioner $75,000 to settle petitioner's
claims. In her initial complaint and her amended complaint,
petitioner based her claims on Title VII of the Civil Rights Act
of 1964 (CRA of 1964), Pub. L. 88-352, 78 Stat. 253 (current
version at 42 U.S.C. sec. 2000e (1994)), and on the Age
Discrimination in Employment Act of 1967 (ADEA), Pub. L. 90-202,
81 Stat. 602 (current version at 29 U.S.C. secs. 621-634 (1994)).
The Supreme Court has held that recoveries received for the
settlement of claims based on Title VII of the CRA of 1964 are
not excludable from gross income under section 104(a)(2). United
States v. Burke, supra. The Supreme Court has also held that
recoveries received for claims based on the ADEA are not
excludable from gross income under section 104(a)(2).
Commissioner v. Schleier, supra. In both cases, the Supreme
Court concluded that because the statutes in question did not
create remedies for personal injuries, the causes of action
invoking those statutes were not based upon tort or tort-type
rights. United States v. Burke, supra at 241-242; Commissioner
v. Schleier, 515 U.S. at ___, 115 S. Ct. at 2167. With regard to
both Title VII and the ADEA, the Supreme Court stated:
Like the pre-1991 version of Title VII, the ADEA
provides no compensation "for any of the other
traditional harms associated with personal injury."
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Monetary remedies under the ADEA are limited to back
wages, which are clearly of an "economic character,"
and liquidated damages, which we have already noted
serve no compensatory function. Thus, though this is a
closer case than Burke, we conclude that a recovery
under the ADEA is not one that is "based upon tort or
tort type rights."
Commissioner v. Schleier, 515 U.S. at ___, 115 S. Ct. at 2167.
Consequently, petitioner is not entitled to exclude from income
the $75,000 she received from the Postal Service.
Petitioner also received $23,106.64 from the Office of
Personnel Management reflecting changes to her disability
retirement benefits. Petitioner appears to make two basic
arguments for exclusion of the disability retirement benefits.
First, she considers it to be part of the total settlement she
received from the Postal Service, and therefore excludable under
section 104(a)(2). For the reasons stated above, the increased
retirement benefits are not damages received on account of
personal injuries or sickness within the meaning of section
104(a)(2).
Petitioner also cites section 104(a)(4) and argues that
gross income does not include a "disability annuity", and
therefore the payment in question is not income.
In the settlement agreement, the Postal Service agreed to
adjust petitioner's records to reflect a promotion, and then
transmit the information to the Office of Personnel Management,
which would then recalculate and pay to petitioner any additional
retirement benefits due based on her retroactive promotion. As
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noted in the settlement agreement, the retirement benefits come
from the Civil Service Retirement and Disability Fund. Though
not explicit in the record, we assume petitioner was a
participant in the Civil Service Retirement System (CSRS), 5
U.S.C. section 8331 et seq., a mandatory pension plan for Federal
employees hired prior to January 1, 1984. Distributions from the
CSRS are subject to taxation under section 72 pursuant to section
402(a). CSRS is a plan that meets the requirements of section
401(a). The law is well established that section 72 governs the
taxation of distributions received pursuant to the CSRS. Malbon
v. United States, 43 F.3d 466 (9th Cir. 1994).
The $23,106.64 of retirement benefits petitioner received
came from her Federal pension plan. Section 61 specifically
provides that gross income includes "pensions". Sec. 61(a)(11).
Section 104(a)(4) excludes from gross income:
amounts received as a pension, annuity, or similar
allowance for personal injuries or sickness resulting
from active service in the armed forces * * * Geodetic
Survey or the Public Health Service, or as a disability
annuity payable under the provisions of section 808 of
the Foreign Service Act of 1980 * * *.
It is obvious that section 104(a)(4) does not apply to the facts
in this case. Haar v. Commissioner, 78 T.C. 864 (1982), affd.
per curiam 709 F.2d 1206 (8th Cir. 1983); Bagnell v.
Commissioner, T.C. Memo. 1993-378.
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Based on the foregoing, we find that petitioner is not
entitled to exclude from gross income the increased retirement
benefits she received in 1991.
The issue of the deductibility of the $41,063 legal expenses
is resolved by considering the context in which the expenses were
incurred. A taxpayer is permitted to deduct legal fees under
section 162 or section 212, provided that the fees have the
necessary connection to profit-seeking activity. Pursuant to
section 62(a), legal fees may be deducted from gross income as a
business expense under section 162 if the fees are directly
related to the taxpayer's trade or business. If the taxpayer's
trade or business is that of being an employee, however, then the
legal expenses will be subject to the limitation of section
62(a)(1) and will be treated as a miscellaneous itemized
deduction pursuant to section 67.
Petitioner's lawsuit against the Postal Service arose from
and was related to her prior employment with the Postal Service.
Thus, her legal expenses originated from and were related to her
trade or business of being an employee. Consequently,
petitioner's legal expenses are a miscellaneous itemized
deduction. We sustain respondent's determination on this issue.
To reflect the foregoing,
Decision will be entered
for respondent.