T.C. Memo. 1997-426
UNITED STATES TAX COURT
D. SAM SCHEELE, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 11469-95. Filed September 22, 1997.
R determined a deficiency in tax and a penalty
because P omitted from gross income an amount received
pursuant to a series of agreements relating to a
partnership that had prevailed in a lawsuit and in
which P was a partner. P claimed that he received the
payment in consideration for giving up his claim for
damages on account of personal injuries.
1. Held: P has failed to prove that the payment
was in settlement of a claim for damages on account of
personal injuries.
2. Held, further, P is liable for the penalty
under sec. 6662(a).
Wesley W. Kirtley, for petitioner.
Catherine J. Caballero, for respondent.
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MEMORANDUM OPINION
HALPERN, Judge: Respondent determined a deficiency in
petitioner's Federal income tax for his 1989 taxable year of
$67,883 and a penalty under section 6662(a) of $13,577. The
issues we must decide are (1) whether petitioner may exclude an
amount from gross income as damages received on account of
personal injuries and (2) whether petitioner is liable for the
penalty.
Unless otherwise noted, all section references are to the
Internal Revenue Code in effect for the year in issue, and all
Rule references are to the Tax Court Rules of Practice and
Procedure.
Some of the facts have been stipulated and are so found.
The stipulation of facts filed by the parties, with accompanying
exhibits, is incorporated herein by this reference. We need find
few facts in addition to those stipulated; accordingly, we shall
not separately set forth those findings and shall include our
additional findings of fact in the discussion that follows.
Petitioner bears the burden of proof. Rule 142(a).
Background
Introduction
Petitioner resided in Grants Pass, Oregon, at the time the
petition was filed.
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In November and December 1989, petitioner received from one
Lee Weisel (Weisel) payments totaling $279,219 (the Weisel
payment). Petitioner did not include the Weisel payment as an
item of gross income in his 1989 Federal income tax return.
Petitioner’s omission of the Weisel payment from gross income is
the principal basis for respondent’s determination of a
deficiency. To understand petitioner’s reason for not reporting
the Weisel payment as an item of gross income, it is necessary to
understand something of petitioner’s business dealings during the
years prior to the payment.
Biomass One L.P.
Biomass One L.P. (Biomass) is a Delaware limited partnership
formed in 1984 to own and operate a woodwaste-fired, thermal
electric power and steam generating facility, which was to be
constructed in White City, Oregon (the cogeneration facility).
Biomass Operating Co., Inc. (Biomass Operating), is an
Oregon corporation. Petitioner and Weisel are two of three
shareholders of Biomass Operating. At various times between
December 31, 1984, and January 12, 1989, petitioner, Weisel, and
Biomass Operating were, alone or together, managing general
partners of Biomass.
Sometime in March 1984, Biomass entered into a contract for
the design and construction of the cogeneration facility (the
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construction contract) with four of its limited partners (the
participating limited partners) and with a contractor
(S-P Construction) and an architect/engineer (collectively, the
S-P parties). The participating limited partners had various
ownership interests in S-P Construction and the architect/
engineer.
Biomass Lawsuit
In 1987, Biomass and Biomass Operating sued the S-P parties
for compensatory and punitive damages relating to their
performance of the construction contract (the Biomass lawsuit).
The original complaint (the first complaint) alleges breach of
contract and negligence and includes claims for damages due to
loss of reputation and goodwill. In March 1988, Biomass and
Biomass Operating filed a third amended complaint in the Biomass
lawsuit (the third amended complaint). The third amended
complaint adds Aetna Ins. Co. (Aetna) as a defendant and includes
more detailed allegations relating to the S-P parties'
performance under the construction contract, but makes no claims
for damages due to loss of reputation or goodwill.
In 1989, the Biomass lawsuit was resolved by agreement (the
settlement agreement). The settlement agreement requires
S-P Construction to pay Biomass funds from its insurers totaling
approximately $9,200,000. The settlement agreement includes a
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general release of all claims and counterclaims relating to the
construction contract. Petitioner signed the settlement
agreement, as did the other current and former managing general
partners in Biomass.
A trust account (the trust account) was established by the
law firm of Irell and Manella, attorneys for Biomass, to hold and
disburse the funds received pursuant to the settlement agreement
(the settlement proceeds).
Option Agreement
Previously, on December 31, 1987, petitioner, Weisel, and
certain limited partners of Biomass, including Laurence A.,
Preston R., Daniel R. and Thomas J. Tisch, and Project Capital
1985, a New York general partnership (collectively, the Tisch
group), had entered into an option agreement (the option
agreement).
At the time the option agreement was executed, petitioner
and Weisel had equal interests in Biomass (a 3.3-percent interest
that would become a 14.561-percent interest after the 60th month
of commercial operation of the cogeneration facility). Under the
option agreement, the Tisch group had the option to purchase part
of Weisel’s and petitioner’s interests in Biomass. The amount to
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be paid to petitioner and Weisel upon exercise of the option was
$1 million each.
Part of the consideration received by petitioner and Weisel
for entering into the option agreement was the promise by the
Tisch group to fund the Biomass lawsuit upon agreement being
reached among the Tisch group, petitioner, and Weisel as to the
strategy and approach to be followed in that litigation. Among
the conditions precedent to the Tisch group’s exercise of its
option under the option agreement was that Weisel be given the
opportunity to enter into an agreement with Biomass providing
Weisel the right to receive 7.5 percent of the gross recovery
from the Biomass lawsuit.
The option agreement also provided that, once the Tisch
group exercised its option, petitioner would resign as managing
general partner of Biomass and Weisel would resign as both a
managing general partner and a general partner of Biomass.
The Tisch group exercised its rights under the option
agreement with respect to both petitioner and Weisel. After that
exercise, in accordance with the option agreement, petitioner
retained a 2.2-percent interest in Biomass that would become a
12.262-percent interest in Biomass after the 60th month of
commercial operation of the cogeneration facility, and Weisel
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retained a 2.2-percent interest that would remain a 2.2-percent
interest.
Weisel Resignation Agreement
On October 14, 1988, as required by the option agreement,
Weisel and Biomass entered into an agreement (the Weisel
resignation agreement). Among other things, the Weisel
resignation agreement grants Weisel 7.5 percent of the gross
recovery from the Biomass lawsuit.
Weisel-Petitioner Sharing Agreement
Also on October 14, 1988, Weisel and petitioner entered into
an agreement (the Weisel-petitioner sharing agreement) whereby
they agreed to share their interests in Biomass equally,
including, among other things, Weisel's 7.5-percent interest in
the gross recovery from the Biomass lawsuit. Petitioner and
Weisel had agreed prior to entering into the option agreement
that they would not enter into the option agreement unless they
shared everything they received from Biomass.
Settlement Proceeds
After the settlement of the Biomass lawsuit, by a letter
dated November 14, 1989, Marc D. Rappaport, the then managing
general partner of Biomass authorized Irell and Manella to pay
Weisel 7.5 percent of the settlement proceeds then held in the
trust account. Pursuant to that authorization, payments from the
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trust account in the total amount of $558,438 were made to Weisel
in November and December 1989.
Payment to Petitioner
In November and December 1989, pursuant to the Weisel-
petitioner sharing agreement, petitioner received from Weisel
payments totaling $279,219 (viz, the Weisel payment).
Discussion
I. Deficiency
A. Introduction
We must determine whether the Weisel payment is excludable
from gross income pursuant to section 104(a)(2). In pertinent
part, section 104(a)(2) provides: “gross income does not include
* * * the amount of any damages received (whether by suit or
agreement * * * ) on account of personal injuries or sickness”.
Petitioner argues that the Weisel payment is a recovery for
damage to his professional reputation as a result of the problems
arising out of the construction and performance of the
cogeneration facility and, thus, is excludable under section
104(a)(2) as damages received on account of personal injuries.
Petitioner claims that the Weisel payment was made in liquidation
of claims asserted in the first complaint against the S-P parties
in the Biomass lawsuit. Respondent argues that the settlement
agreement did not settle any claims of personal injury and that
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the Weisel payment was received in consideration for petitioner's
transfer to Weisel of part of petitioner’s substantially larger
interest in Biomass. Petitioner bears the burden of proof,
Rule 142(a), and has failed to prove that the Weisel payment
constitutes an amount of damages received on account of personal
injuries.
B. Biomass Lawsuit
Section 1.104-1(c), Income Tax Regs., interprets section
104(a)(2) as follows:
Section 104(a)(2) excludes from gross income the amount
of any damages received (whether by suit or agreement)
on account of personal injuries or sickness. The term
“damages received (whether by suit or agreement)” means
an amount received (other than workmen's compensation)
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.
The settlement proceeds do not constitute damages received
on account of personal injuries (to petitioner) within the
meaning of section 104(a)(2). The third amended complaint, which
was the basis for the settlement agreement, makes no claims for
damages due to personal injuries to petitioner. The settlement
agreement makes no allocation to claims for such damages, and
petitioner has failed to show that the S-P parties intended to
settle any claims for personal injuries to petitioner. See
Stocks v. Commissioner, 98 T.C. 1, 10 (1992) ("the most important
factor in determining any exclusion under section 104(a)(2) is
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‘the intent of the payor’ as to the purpose in making the
payment") (citing Knuckles v. Commissioner, 349 F.2d 610, 612
(10th Cir. 1965), affg. T.C. Memo. 1964-33); Metzger v.
Commissioner, 88 T.C. 834, 847-848 (1987), affd. without
published opinion 845 F.2d 1013 (3d Cir. 1988). Nor do we infer
from the general release included in the settlement agreement
that any portion of the settlement proceeds constitutes payment
for personal injury claims not specified in that agreement. See
Galligan v. Commissioner, T.C. Memo. 1993-605.
C. Bargained For Consideration
Petitioner argues alternatively that, even if the settlement
proceeds per se do not constitute damages on account of personal
injuries, he received a share of those proceeds by way of the
option agreement, the Weisel resignation agreement, and the
Weisel-petitioner sharing agreement (collectively, the pertinent
agreements) in consideration for his “willingly let[ting] the
claims for damages to reputation and good will be eliminated in
the third amended complaint so the settlement could be directed
toward receipt of insurance proceeds.”
Petitioner has failed to convince us, however, that he
received the Weisel payment in consideration for giving up
(settling) any claims for damages on account of personal
injuries. None of the pertinent agreements mentions the
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elimination of any personal injury claims in the Biomass lawsuit
(or otherwise) as being in consideration for the benefits to be
received by petitioner (or Weisel). The option agreement
provides for agreement to be reached as to strategy and approach
to the Biomass lawsuit, but that provision is insufficient to
convince us that any of the 7.5-percent payment to Weisel was in
consideration for petitioner's giving up any claims. Weisel gave
up a greater portion of his partnership interest than did
petitioner and may have received the 7.5-percent payment in
consideration therefor. Even if we grant that, because of the
Weisel-petitioner sharing agreement, petitioner had a one-half
interest in the 7.5-percent payment, petitioner has failed to
convince us that the 7.5-percent payment was received in
consideration for anything other than the partnership interests
and other items of consideration set forth in the option
agreement. We take the pertinent agreements at face value and
accord little weight to petitioner's uncorroborated and self-
serving testimony. See Tokarski v. Commissioner, 87 T.C. 74, 77
(1986). In addition, we draw a negative inference from
petitioner's failure to present the testimony of any other party
to the transactions. Wichita Terminal Elevator Co. v.
Commissioner, 6 T.C. 1158, 1165 (1946), affd. 162 F.2d 513 (10th
Cir. 1947). In sum, petitioner has failed to convince us that
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the 7.5-percent payment to Weisel (or the Weisel payment to
petitioner) was in consideration for any settlement by petitioner
of a claim for damages on account of personal injuries.
II. Section 6662 Penalty
Section 6662(a) imposes a penalty in the amount of
20 percent of any portion of an underpayment of tax required to
be shown on a return that is attributable to one or more factors
listed in section 6662(b). Those factors include negligence or
disregard of rules or regulations and any substantial
understatement of income tax. The term “negligence” includes
“any failure to make a reasonable attempt to comply with the
provisions” of the Code, and the term “disregard” includes “any
careless, reckless, or intentional disregard.” Sec. 6662(c).
Section 6662(d)(1)(A) provides that there is a substantial
understatement of income tax if the amount of the understatement
exceeds the greater of 10 percent of the tax required to be shown
on the return for the taxable year or $5,000. Petitioner has the
burden of proving that respondent’s determination under section
6662(a) is incorrect. Rule 142(a).
Petitioner has failed to submit any evidence or argument
with respect to respondent's determination that petitioner is
liable for the penalty pursuant to section 6662(a), except for
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his argument that the Weisel payment is excludable under section
104(a)(2). Petitioner has failed to carry his burden of proof
and, thus, petitioner is liable for the penalty imposed by
section 6662(a).
Decision will be entered
for respondent.