T.C. Memo. 1998-8
UNITED STATES TAX COURT
WALTER R. and MARILYN K. EASTER, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 9166-96. Filed January 7, 1998.
Walter R. and Marilyn K. Easter, pro se.
Allan D. Hill, for respondent.
MEMORANDUM OPINION
RAUM, Judge: The Commissioner determined a $33,193
deficiency in petitioners' 1992 Federal income taxes. There are
two issues for consideration: (1) Whether a settlement payment
of $135,000 and an incentive payment of $16,200 paid by State
Farm Insurance Company to petitioner Marilyn K. Easter to
encourage her to settle her sex discrimination claim in a class
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action suit brought under Title VII of the Civil Rights Act of
1964, 42 U.S.C. sec. 2000e et seq., are excludable from
petitioners' gross income pursuant to section 104(a)(2)1, and (2)
whether petitioners are entitled to deduct $37,841 in legal fees,
relating to the State Farm settlement, as a trade or business
expense or as a miscellaneous itemized deduction.
At the time of the filing of their petition, petitioners,
Walter R. and Marilyn K. Easter, resided in Pleasanton,
California. Walter Easter is involved as a petitioner herein
solely because he filed a 1992 joint income tax return with his
wife Marilyn K. Easter. References to petitioner in the singular
will be to Marilyn K. Easter.
Petitioner, whose maiden name was Marilyn Brent, was
employed by State Farm Insurance Company from December 1, 1983,
through February 27, 1986. She was a claimant in a class action
suit filed in the District Court for the Northern District of
California entitled Kraszewski v. State Farm Gen. Ins. Co., 38
Fair Empl. Prac. (BNA) Cas. 197 (N.D. Cal. 1985)(hereinafter "the
class action suit"). On May 11, 1988, petitioner filled out a
document entitled "INITIAL CLAIM FORM" that was used by the law
firm of Farnsworth, Saperstein & Seligman (hereinafter referred
to as the Saperstein firm) to evaluate her claim. During April
1
Unless otherwise indicated, 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.
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1989, the Saperstein firm provided petitioner with a document
entitled "Overview of Final Claimant Selection Process." On
September 1, 1989, Mrs. Easter filed a final claim form with
State Farm.
In January 1988, the Saperstein firm, representing the
plaintiffs, and State Farm entered into a Consent Decree
Regarding Monetary Relief, Instatement Relief, and Notice
(hereinafter referred to as the Consent Decree) in order to
facilitate resolution of the remaining claims. The Consent
Decree limited damages available to class members to: "(1) back
pay; (2) front pay; (3) prejudgment interest; (4) postjudgment
interest; and (5) reasonable attorneys [sic] fees and costs."
The Consent Decree also provides the manner in which the
available damages will be calculated.
On January 17, 1992, District Court Judge Eugene Lynch sent
a document entitled "Communication of State Farm's Settlement
Offer" to all claimants, including Mrs. Easter, that had attached
various documents describing State Farm's settlement offer.
Included in the documents attached was the Master Settlement
Agreement dated January 17, 1992, entered into by the Saperstein
firm and State Farm's attorneys.
On February 12, 1992, petitioner signed a Settlement
Agreement and General Release. In exchange for $135,000 plus
additional payments of up to $18,000 (conditioned upon the
percentage of claimants who settled), petitioner agreed to
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release State Farm from "any claim * * * of any and every kind
based on any federal, state, or local law
* * * as well as any and all claims * * * arising out of or
relating to any alleged discriminatory, improper, or unlawful act
or omission of State Farm." The $135,000 settlement represented
51 percent of the full value of petitioner's $264,935 claim. The
full value of the claim was calculated based on "back pay as a
State Farm agent accrued from the year of the challenged
appointment to February 1, 1992, plus six months of front pay
from that date forward."
During the taxable year 1992, State Farm paid $135,000 in
settlement of Mrs. Easter's claim in the class action suit and an
incentive payment in the amount of $16,200, both in accordance
with the Master Settlement Agreement and the Settlement Agreement
and General Release. Of the $151,200 total amount, $37,841.25
was retained by class counsel as legal fees, and the remainder
was received by Mrs. Easter. On April 24, 1992, the Saperstein
firm sent Mrs. Easter its check for $112,778.29 that represented
her share of the settlement proceeds from her State Farm claim,
less $580.46 taxes withheld.
Section 104(a)(2) allows a taxpayer to exclude from gross
income "the amount of any damages received (whether by suit or
agreement and whether as lump sum or periodic payments) on
account of personal injuries or sickness". In United States v.
Burke, 504 U.S. 229 (1992), the taxpayers brought a sex
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discrimination claim under Title VII of the Civil Rights Act of
1964 against their employer. The parties eventually reached a
settlement in which the employees would receive varying amounts
based on length of service and rate of pay. The employer
withheld Federal income taxes on the amounts received by the
taxpayers. Id. at 230-231. The taxpayers sought refunds of the
withheld taxes on the ground that the settlement amounts were
excludable under section 104(a)(2) as "damages received * * * on
account of personal injuries or sickness." Id. at 232.
The Supreme Court held that the nature of the claim
underlying the taxpayers' settlement awards controlled the
excludability of the settlements under section 104(a)(2). Id. at
237. The Court noted that Title VII under the 1964 Civil Rights
Act limited "available remedies to backpay, injunctions, and
other equitable relief." Id. at 238. The Court further stated
that
The remedy, correspondingly, consists of restoring victims,
through backpay awards and injunctive relief, to the wage
and employment positions they would have occupied absent the
unlawful discrimination. * * * Nothing in this remedial
scheme purports to recompense a Title VII plaintiff for any
of the other traditional harms associated with personal
injury, such as pain and suffering, emotional distress, harm
to reputation, or other consequential damages * * *
Id. at 239. Since the taxpayers could receive under Title VII
only wages, which they otherwise would have paid taxes upon in
the normal course, the Court held that Title VII did not redress
"a tort-like personal injury within the meaning of section
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104(a)(2) and the applicable regulations." Id. at 241.
Accordingly, the settlement amounts received by the taxpayers
were not excludable from gross income under section 104(a)(2).
Id. at 242.
Like the taxpayers in Burke, petitioner brought a sex
discrimination claim under Title VII of the Civil Rights Act of
1964 against her employer. As in Burke, petitioner eventually
settled her claim. The Settlement Agreement and General Release
provides:
The approximate full value of CLAIMANT's claim under the
Consent Decree damage formula as of February 1, 1992, is
$264,935.00, which represents back pay as a State Farm agent
accrued from the year of the challenged appointment to
February 1, 1992, plus six months of front pay from that
date forward.
The settlement amount of $135,000 offered to petitioner
represented 51 percent of the estimated Consent Decree value of
her claim. According to Burke, since the damages available to
petitioner as a Title VII claimant consisted of only wages, which
would otherwise be taxable, the settlement amount she received
does not constitute "damages received * * * on account of
personal injuries". Id. at 242. Thus, it is not excludable
under section 104(a)(2).2
2
In November 1991, the Civil Rights Act of 1991 became
law. Landgraf v. USI Films Prods., 511 U.S. 244, 249 (1994). In
addition to the traditional remedies of backpay and injunction,
the new act allows the plaintiff to recover compensatory and
punitive damages. It also gives the right to a jury trial. Id.
at 252-253. The Supreme Court held that those amendments did not
(continued...)
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Petitioners have not differentiated between the settlement
award and the incentive payment. They contend that the entire
amount is excludable. In Berst v. Commissioner, T.C. Memo. 1997-
137, we held that an incentive payment made to another claimant
in the same class action suit (Kraszewski v. State Farm Gen. Ins.
Co.) was received contingent upon the signing of the Release,
making the incentive amount bargained-for consideration. There
is nothing that distinguishes the present case. Thus, the
incentive payment is also includable in gross income.
In the notice of deficiency, the Commissioner allowed
petitioners to deduct their legal fees as a miscellaneous
itemized deduction. Petitioners have not contested this
treatment except to the extent that they have argued that the
entire award should be excluded from gross income pursuant to
section 104(a)(2). Based on our holding above, we conclude that
petitioners must be treated as having conceded this issue.
Due to a concession by respondent,
Decision will be entered
under Rule 155.
(...continued)
apply retroactively. Id. at 286. Thus, petitioner's Title VII
claim, and its potential exclusion under sec. 104(a)(2), must be
considered in light of the Act under which she sued. Clark v.
Commissioner, T.C. Memo. 1997-156. Since Burke also involved the
application of sec. 104(a)(2) to a settlement award under Title
VII of the 1964 Act, its result is squarely on point for this
case.