T.C. Memo. 1997-126
UNITED STATES TAX COURT
REINA MARTINEZ, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 27007-95. Filed March 11, 1997.
Jack F. Bonanno, for petitioner.
Allan D. Hill, for respondent.
MEMORANDUM OPINION
FOLEY, Judge: By notice dated October 5, 1995, respondent
determined a deficiency in petitioner's 1991 Federal income tax
of $159,551. After concessions, the issue for decision is
whether petitioner, pursuant to section 104(a)(2), is entitled to
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exclude amounts received in settlement of a class action suit.
We hold she is not.
Unless otherwise indicated, all section references are to
the Internal Revenue Code as in effect for the year in issue, and
all Rule references are to the Tax Court Rules of Practice and
Procedure.
Background
The facts have been fully stipulated under Rule 122 and are
so found. At the time the petition was filed, petitioner resided
in San Francisco, California.
In the fall of 1974, petitioner sought the entry-level sales
position of trainee agent with State Farm Insurance Co. (State
Farm). State Farm's agents discouraged petitioner from pursuing
such a position.
On June 1, 1979, a class action suit was filed in the U.S.
District Court for the Northern District of California,
Kraszewski v. State Farm Gen. Ins. Co.. The plaintiffs in the
class action alleged that State Farm, in violation of title VII
of the Civil Rights Act of 1964 (Title VII), had discriminated
against women in the hiring of its insurance agents. On November
6, 1981, the District Court bifurcated the litigation into a
liability and a remedy phase.
On April 29, 1985, the District Court ruled in the liability
phase that State Farm was liable under Title VII for classwide
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discrimination on the basis of sex. Specifically, it ruled that
women who attempted to become trainee agents were "lied to,
misinformed, and discouraged in their efforts to obtain the entry
level sales position." The court found State Farm liable with
respect to "all female applicants and deterred applicants who, at
any time since July 5, 1974, have been, are, or will be denied
recruitment, selection and/or hire as trainee agents by defendant
companies within the State of California." Petitioner ultimately
joined the class action suit against State Farm.
The parties to the class action subsequently reached an
agreement in a consent decree as to the remedy phase of the
litigation. The consent decree provided for informal individual
hearings before a special master to determine whether each
claimant was entitled to damages and the amount of such damages.
In October of 1990, petitioner's hearing was held before a
special master who, on January 16, 1991, ruled that State Farm
had discriminated against petitioner. On January 28, 1991, State
Farm issued a $653,230 check payable to petitioner and her
attorney. Petitioner's attorney retained legal fees of $163,308,
and the $489,922 balance was paid to petitioner.
On her 1991 Federal income tax return, petitioner excluded
the $653,230 payment from her gross income. Respondent
determined that the entire amount should have been included in
petitioner's gross income. The petition in this case was filed
on December 28, 1995.
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Discussion
Except as otherwise provided, gross income includes income
from all sources. Sec. 61; 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
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 that "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.
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in part, revd. in part and remanded 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 a factual inquiry.
Robinson v. Commissioner, supra at 127.
The amounts petitioner received under the settlement
agreement were intended to settle petitioner's claim under Title
VII. As a result, the U.S. Supreme Court's decision in United
States v. Burke, supra, controls. In Burke, the Court considered
whether amounts received in settlement of a claim under Title VII
were excludable under section 104(a)(2). The Court analyzed
Title VII and concluded that it did not provide for remedies to
recompense claimants for tort type personal injuries. Instead,
the Court noted that the statute offered only injunctions, back
and front pay, and other equitable relief. Id. at 238-239. As a
result, the Court concluded that Title VII did not redress a tort
type personal injury and consequently that settlement proceeds
based on such a claim are not excludable under section 104(a)(2).
Petitioner contends that Burke is distinguishable.
Petitioner notes that the taxpayers in Burke were employed by the
defendant at the time of the discrimination and that the award
was essentially for a breach of contract. Petitioner contends
that it was the contractlike violation that led the Court to the
conclusion that the Title VII damages were not excludable. As a
result, petitioner contends that, consistent with Burke, an award
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of back pay under Title VII may be excludable where the taxpayer
was not employed by the defendant at the time of the
discrimination.
Petitioner's contention fails to grasp the central thrust of
Burke. In Burke, the Supreme Court concluded that Title VII does
not provide remedies that redress tort type personal injuries.
That rationale does not depend upon the particular circumstances
of a taxpayer's claim under Title VII. All claims under Title
VII, including petitioner's, are subject to the same limited
range of damages. Consequently, we reject petitioner's
contention.
Petitioner also contends that remedies available to her
under other laws redressed tort type personal injuries and that
the consent decree was partially intended to settle these claims.
Petitioner emphasizes that the consent decree indicated that
State Farm was concerned about its liability under other laws.
Petitioner has not established, however, that the payment under
the consent decree was intended to settle petitioner's claims
relating to other laws. In addition, the consent decree failed
to allocate any portion of petitioner's recovery to the
settlement of other claims. Consequently, petitioner has failed
to prove that any part of the recovery is excludable. See Getty
v. Commissioner, 91 T.C. 160, 175-176 (1988), affd. on this
issue, revd. on other issues 913 F.2d 1486 (9th Cir. 1990).
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Accordingly, we conclude that petitioner is not entitled to
exclude any part of the $653,230 recovery under section
104(a)(2).
Petitioner also contends that she is entitled to exclude the
portion (i.e., $163,308) of the settlement used to pay legal
fees. Respondent contends that the legal fees are deductible
under section 212(1) as an expense for the production of income
and treated as a miscellaneous itemized deduction under section
67. We agree with respondent that the legal fees are deductible
to the extent they exceed 2 percent of petitioner's adjusted
gross income. See Alexander v. Commissioner, 72 F.3d 938, 946
(1st Cir. 1995), affg. T.C. Memo. 1995-51; see also sec. 1.67-
1T(a)(1)(ii), Temporary Income Tax Regs., 53 Fed. Reg. 9875 (Mar.
28, 1988).
We have considered all other arguments made by the parties
and found them to be either irrelevant or without merit.
To reflect the foregoing,
Decision will be entered
under Rule 155.