T.C. Memo. 1998-274
UNITED STATES TAX COURT
DAVID R. GREEN AND CAROLYN B. GREEN, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket Nos. 8933-94, 6564-96, Filed July 27, 1998.
26100-96.
W. Kevin Jackson, for petitioners.
S. Mark Barnes, for respondent.
MEMORANDUM OPINION
PAJAK, Special Trial Judge: These consolidated cases were
heard pursuant to section 7443A(b)(3) of the Code and Rules 180,
181, and 182. All section references are to the Internal Revenue
Code in effect for the years in issue. All Rule references are
to the Tax Court Rules of Practice and Procedure. Respondent
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determined the following deficiencies in income tax, addition to
tax, and accuracy-related penalties:
Addition to Tax Accuracy-Related Penalty
Docket No. Year Deficiency Sec. 6651(a) Sec. 6662
8933-94 1991 $3,466 --- ---
6564-96 1992 3,435 --- ---
1993 2,823 --- ---
26100-96 1994 2,946 $737 $589
1995 4,860 --- 972
After concessions by petitioners, including the section 6651
addition to tax, the issues for decision in these consolidated
cases are: (1) Whether petitioners are entitled, on the basis of
section 104(a)(2), to exclude the entire $36,000 payment, or a
portion thereof, that petitioner David R. Green received pursuant
to a settlement agreement, and (2) whether petitioners are liable
for accuracy-related penalties under section 6662 for taxable
years 1994 and 1995.
Some of the facts have been stipulated and are so found.
The stipulation of facts and the attached exhibits are
incorporated herein by this reference. Petitioners resided in
Salt Lake City, Utah, at the time the petition was filed in
docket No. 8933-94; petitioner David R. Green resided in
Chandler, Arizona, and petitioner Carolyn B. Green resided in
Salt Lake City, Utah, at the time the petition was filed in
docket No. 6564-96; and petitioner David R. Green resided in
Washington, Utah, and petitioner Carolyn B. Green resided in Salt
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Lake City, Utah, at the time the petition was filed in docket No.
26100-96.
On or about June 1, 1980, petitioner David R. Green
(petitioner) entered into a general agency contract (the
Contract) with Washington National Insurance Co. of Evanston,
Illinois (WNIC). Petitioner was authorized to operate as a
general agent for WNIC in and around Salt Lake City, Utah. As a
general agent, petitioner was to procure, both personally and
through sales agents, applications for individual life and health
insurance on terms authorized by WNIC. As a general agent,
petitioner was also responsible for training and supervising
those sales agents of WNIC operating in Utah. To facilitate his
activities as a general agent, petitioner formed the Financial
Business Corporation (FBC). Sales agents were not employed by
petitioner or FBC but rather were affiliated with WNIC.
WNIC unilaterally terminated the Contract in August 1983.
In a letter to petitioner dated August 2, 1983, Richard C.
Heverly (Heverly), vice president and director of general
agencies for WNIC, outlined the reason for the termination of the
Contract. Heverly indicated that the Contract was being
terminated "for cause". Heverly also indicated that petitioner
had failed to adequately perform his duty to "supervise the
professional activity and conduct" of the sales agents.
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WNIC filed a suit against petitioner and FBC in Federal
District Court for the District of Utah (the District Court). In
turn, petitioner and FBC filed a suit against WNIC and Washington
National Financial Services (WNFS), a related corporation, in the
District Court. For convenience and clarity, WNIC and WNFS will
be collectively referred to as WNIC. In the breach of contract
suit filed by petitioner and FBC against WNIC, tort and tort type
claims were alleged. In response to WNIC's Motion in Limine, the
District Court limited the presentation in the trial to breach of
contract, as explained below. The two cases were consolidated
for trial (the District Court Case).
The jury instructions (Jury Instructions) in the District
Court Case stated that petitioner was suing WNIC for wrongful
termination of his general agency contract. The jury (the Jury)
executed a special verdict form. The Jury found that "just
cause" did not exist for the termination of the Contract and
awarded damages to petitioner in the amount of $159,238 (the Jury
Award). The amount of the Jury Award was the amount that an
economist who testified in the District Court Case calculated
that petitioner would have earned as commissions under the
Contract had the Contract not been terminated by WNIC.
The Judgment does not make any reference to an award based
on a tort or tort type claim. Aside from the $159,238, the
Judgment awarded only amounts of commissions plus interest to
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petitioner and FBC under the breach of contract claims. One of
the awards of commissions plus interest was made only to
petitioner. The Judgment, entered on June 2, 1986, in the total
amount of $1,521,628.04 was based on breach of contract claims.
WNIC's insurance carrier appealed the Judgment to the Tenth
Circuit Court of Appeals (the Court of Appeals). Petitioner did
not appeal the Judgment. Prior to the filing of briefs in the
Court of Appeals, the parties entered into a settlement agreement
(the Settlement Agreement), effective September 23, 1987. In
accord with the Settlement Agreement, petitioner/FBC and WNIC
released all claims that the parties to the District Court Case
asserted against each other, including all contractual and "extra
contractual claims". The Settlement Agreement provided, inter
alia: (1) WNIC would make a lump sum payment in the amount of
$581,500 to FBC, and (2) WNIC would make guaranteed monthly
payments to petitioner in the amount of $3,000 for a period of
240 months ($36,000 per year for 20 years) commencing October 1,
1987. The Settlement Agreement specified that $1,510 of each of
the monthly payments would be paid towards satisfaction of the
Jury Award. The balance of $1,490 of the $3,000 was not
specifically allocated.
Petitioners filed joint Federal income tax returns for 1991,
1992, 1993, 1994, and 1995 (the Returns). On the Returns,
petitioners reported annuity income of $36,000 per year. Of this
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amount, petitioners reported that $17,880 ($1,490 x 12) was
taxable for each year. The remaining $18,120 ($1,510 x 12) for
each year attributable to the amount of the payments made during
the year in satisfaction of the Jury Award was not reported as
taxable.
Respondent determined that the entire $36,000 in payments
for each year is taxable.
Petitioners first appeared before this Court with respect to
taxable year 1991, in a case conducted under the "small tax case"
procedures authorized by section 7463 and Rules 170 through 179.
The parties filed cross-motions for summary judgment under Rule
121. The relevant issue there was whether petitioners were
entitled, on the basis of section 104(a)(2), to exclude the
entire $36,000 payment, or a portion thereof, that petitioner
received pursuant to the Settlement Agreement. In Green v.
Commissioner, T.C. Summary Opinion 1995-167, we denied
petitioners' motion for summary judgment and granted respondent's
motion for summary judgment insofar as we concluded that the
$18,120, attributable to the amount of the Jury Award, was
includable in petitioners' income for 1991. We further concluded
that a material fact remained in dispute with respect to the
remaining portion of the $36,000 payment, or $17,880, which
petitioners initially included in income, but later contended was
excludable under section 104(a)(2). We found that the record was
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incomplete as to the claims that were the basis for that portion
of the Settlement Agreement.
Subsequently, the small tax case designation was removed and
the case was processed according to the regular procedures of
this Court. Petitioners are now before the Court with respect to
taxable years 1991 through 1995. We decline to accept
petitioners' request that we revisit the issue in taxable year
1991 which was resolved in Green v. Commissioner, T.C. Summary
Opinion 1995-167.
Rule 39 requires a party to plead matters constituting an
affirmative defense such as collateral estoppel. Respondent
failed to so plead so we address for each of the years 1992
through 1995 the issue of whether the $18,120 attributable to the
Jury Award is excludable from income under section 104(a)(2).
Section 61 broadly defines gross income as all income from
whatever source derived. Any exclusion of items from income must
be narrowly construed. Commissioner v. Schleier, 515 U.S. 323,
328 (1995). Section 104(a)(2) provides that gross income does
not include "the amount of any damages received (whether by suit
or by agreement * * * ) on account of personal injuries or
sickness". Section 1.104-1(c), Income Tax Regs., provides that
the term "damages received" "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
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settlement agreement entered into in lieu of such prosecution."
Petitioner's settlement proceeds of $18,120 may be excluded from
gross income only if petitioners show that: (1) The underlying
cause of action giving rise to the recovery is "based upon tort
or tort type rights", and (2) the damages were received "on
account of personal injuries or sickness." Commissioner v.
Schleier, supra at 337. Both elements of this two-part test must
be satisfied before a taxpayer is allowed to exclude amounts
received from gross income.
In the case of amounts received pursuant to a settlement
agreement, the nature of the underlying claim, not the validity
of such claim, determines whether it is excludable under section
104(a)(2). United States v. Burke, 504 U.S. 229, 237 (1992).
Determination of the nature of the claim is factual. Bagley v.
Commissioner, 105 T.C. 396 (1995), affd. 121 F.3d 393 (8th Cir.
1997). A key question to ask is in lieu of what were the damages
paid. Church v. Commissioner, 80 T.C. 1104 (1983). Where the
settlement agreement lacks express language stating the reason
for the payment, the most important element is the intent of the
payor. Knuckles v. Commissioner, 349 F.2d 610, 613 (10th Cir.
1965), affg. T.C. Memo. 1964-33. Although the payee's belief is
relevant to this inquiry, the ultimate character of the payment
hinges on the payor's dominant reason for making the payment.
Fono v. Commissioner, 79 T.C. 680 (1982), affd. without published
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opinion 749 F.2d 37 (9th Cir. 1984); Hess v. Commissioner, T.C.
Memo. 1998-240.
After a review of the Settlement Agreement, and the facts
and circumstances surrounding it, we find that for 1992 through
1995, with respect to the $18,120 ($1,510 of each of the $3,000
monthly payments) that was specifically allocated to satisfy the
Jury Award, there is no basis to conclude that such recovery was
based upon a tort or tort type claim.
At the District Court trial, petitioner introduced Mr. Paul
A. Randle (Mr. Paul Randle), an economist and professor of
finance at Utah State University. Mr. Paul Randle's testimony
was offered to establish an economic value for potential loss of
income suffered by petitioner. Mr. Paul Randle determined
petitioner's economic loss by taking the total economic value of
petitioner's earning capacity, adjusted for inflation, based on
his historical performance less any actual earnings after
petitioner's termination and prior to trial. Mr. Paul Randle
determined that petitioner suffered a net economic loss of
$159,238. Following the Jury's special verdict, the District
Court awarded petitioner that amount in paragraph 5 of the
Judgment. In the Settlement Agreement, the parties agreed that
$1,510 of each of the $3,000 monthly payments was to be paid
towards satisfaction of paragraph 5 of the Judgment.
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On the basis of this record, we conclude that such amount
was not based upon a tort or tort type claim, but rather it was
on account of legal injuries of an economic character arising out
of a contract claim. Accordingly, the $18,120 is not excludable
under section 104(a)(2) and thus is includable in petitioners'
income for taxable years 1992 through 1995.
We must now decide whether $17,880, the balance of the
annual $36,000 payment, is excludable from income under section
104(a)(2) for each of the taxable years at issue.
Again, petitioner's settlement proceeds of $17,880 may be
excluded from gross income only if petitioners show that: (1)
The underlying cause of action giving rise to the recovery is
"based upon tort or tort type rights" and (2) the damages were
received "on account of personal injuries or sickness."
Commissioner v. Schleier, supra at 337. The other principles set
forth above also apply.
Petitioners contend that the $17,880 portion payable under
the Settlement Agreement is excludable under section 104(a)(2)
because, in addition to seeking punitive damages, petitioner
asserted five tort claims against WNIC. Petitioners further
contend that petitioner suffered personal injuries to his good
name, personal integrity, and business reputation. Petitioners
made the same contentions with respect to the $18,120 payment
upon which we have ruled above. Thus, petitioners argue that
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because they asserted tort claims and a colorable claim for
personal injuries, that is sufficient to sustain the exclusion of
the entire amount from gross income.
Respondent, on the other hand, contends that the payment
petitioner received pursuant to the Settlement Agreement was not
to settle a tort claim or to pay petitioner on account of
personal injuries. Rather, respondent contends that the payment
was to redress contract claims. Thus, respondent's position is
that such payment fails the two-prong test under Commissioner v.
Schleier, supra at 337, and therefore is not excludable from
gross income under section 104(a)(2).
After a review of the Settlement Agreement, and the facts
and circumstances surrounding it, we find that there is no basis
to conclude that WNIC agreed to pay petitioner $17,880 per year
for 20 years in order to settle a tort or tort type claim, or a
claim for personal injuries.
The Settlement Agreement sets forth six provisions. Under
the Settlement Agreement, WNIC was obligated to "make regular,
guaranteed monthly payments to Green in the amount of $3,000.00
per month for a period of Two Hundred Forty (240) months,
commencing October 1, 1987." There is no language in any part of
the Settlement Agreement that specifically designates any portion
of petitioner's annuity to be paid to settle a tort or tort type
claim. Thus, we look to the intent of the payor, WNIC.
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According to the Settlement Agreement, the parties entered
into the agreement because they "desire to settle and resolve all
present and potential controversies by and between them,
including but not limited to termination of the Suits, the
Appeal, * * * ; and [the parties] desire to terminate any and all
contracts or contractual relationships between them, or any of
them; * * * ." Further, the Settlement Agreement provided that:
2. Release. Green/FBC and WNIC/WNFS, for themselves,
* * * mutually RELEASE, ACQUIT, AND FOREVER DISCHARGE, the
other, * * * from all contracts of any kind whatsoever, * *
* , and from all claims, demands, debts, and causes of
action, known or unknown, past, present or future, arising
out of, or relating to: (1) all written and oral agreements,
including all supplements and modifications thereto, between
them; (2) all claims asserted or assertable by WNIC/WNFS in
the Suits, including, without limitation, all contractual
and extra-contractual claims, statutory and common law
claims, claims for actual and punitive damages, claims for
an accounting, claims for attorney's fees, court costs, and
the like; (3) all claims asserted or assertable by Green/FBC
in the Suits, including, without limitation, all contractual
and extra-contractual claims, statutory and common law
claims, claims for actual and punitive damages, claims for
attorneys' fees, court costs, and the like; (4) all claims
asserted or assertable by Philips in the Suits, including
but not limited to all contractual, tort, statutory, common
law or other claims, * * * ; and (5) any act, transaction or
occurrence prior to the date hereof.
* * * * *
5. Dismissal of the Suits. Green/FBC and WNIC/WNFS
agree to cause all claims asserted in the Suits and in the
Appeal against each other to be dismissed with prejudice,
with the parties to bear their own respective attorneys'
fees and costs.
Whereas the Green/FBC language in paragraph 2, clause (3)
above encompasses contractual and extra-contractual claims, it
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does not list "tort". Yet, in the very next sentence, the
Settlement Agreement in paragraph 2, clause (4) above with
respect to Philips (another party to the suits) specifically
releases all "tort" claims. We view this as another indication
that the Green/FBC and WNIC suits were based on contract, not on
tort.
Thus, we do not believe that WNIC entered into the
Settlement Agreement with the intention of settling a tort or
tort type claim with respect to petitioner. Instead, we believe
that WNIC intended to terminate any and all contractual
relationships between petitioner and FBC.
Our position is further strengthened upon a review of the
other evidence before us. Prior to the District Court trial,
WNIC made a Motion in Limine to preclude petitioner from
injecting into trial matters which WNIC believed were irrelevant,
inadmissable, and prejudicial. WNIC sought to prevent petitioner
from introducing evidence of the kind normally associated with
tort claims and to limit the case to contractual matters. The
District Court granted WNIC's motion, and directed petitioner to
limit his presentation to a claim of breach of contract.
Petitioner's attorney acquiesced. Although petitioner initially
alluded to tort type claims in petitioner's complaint, the case
proceeded to trial before the Jury to determine whether a breach
of contract had occurred. It therefore follows that the Jury's
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deliberation was limited to a cause of action under a breach of
contract theory.
Moreover, in the Jury Instructions with respect to
petitioner, the Jury was instructed to deliberate based upon only
a breach of contract cause of action. The Jury was specifically
instructed that "in awarding damages, if any, you are not
permitted to award any amount for the purpose of punishing any
party, or to make an example of any party." There were no tort
or tort type cause of action instructions to the Jury with
respect to petitioner.
As noted, the District Court's Judgment also is devoid of
any reference to an award based on a tort or tort type claim. In
addition to the $159,238, the Judgment awarded only amounts of
commissions plus interest to petitioner and FBC. The Judgment of
$1,521,628.04 was based solely on breach of contract claims.
After the Jury Trial, WNIC was faced with a liability of
$1,521,628.04, in favor of petitioner and FBC. This Judgment
reflected commissions due, interest thereon, and an amount for
wrongful termination of the general agency contract. Obviously,
WNIC thought it could reduce this liability by its appeal of the
Judgment. Petitioner did not appeal. After settlement
negotiations, WNIC was able to settle for $894,800.00, a
reduction of $626,828.04. WNIC's liability as a result of the
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Judgment based on breach of contract claims was substantially
reduced by the Settlement Agreement.
Petitioner personally was to receive $3,000 a month for 20
years under the Settlement Agreement. This amount had a present
value of $313,000. Mr. Stephen R. Randle (Mr. Stephen Randle),
attorney for petitioner in the District Court action (and brother
of Mr. Paul Randle), claimed he made representations about tort
claims during the settlement negotiations. Because WNIC had
opposed such contentions and the District Court had rejected such
contentions, we do not see how such contentions at the settlement
negotiations could change the nature of the underlying claims
which were based on contract. Moreover, Mr. Stephen Randle
testified that in the Settlement Agreement he designated $1,510
out of the $3,000 monthly annuity as representing personal injury
to petitioner under paragraph 5 of the Judgment. Yet the
Settlement Agreement contains no such designation, and that
$1,510 is the amount we have found above is due to legal injuries
of an economic character arising out of a contract claim. The
only conclusion we can draw is that the remaining $1,490 monthly
payment flows from the commissions plus interest awards and thus
is clearly economic in nature.
As we stated above, petitioner's settlement proceeds may be
excluded from gross income if petitioners show that not only was
the underlying cause of action giving rise to the recovery based
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upon tort or tort type rights, the damages were received on
account of personal injuries or sickness. Commissioner v.
Schleier, 515 U.S. 323, 337 (1995). Petitioner must prove the
existence of both of these elements.
In the instant cases, we find that petitioners failed to
establish that WNIC awarded petitioner the annuity on account of
personal injuries or sickness. The phrase "on account of"
requires a causal connection between the personal injury
sustained and the compensation received. O'Gilvie v. United
States, 519 U.S. 79 (1996); Brabson v. United States, 73 F.3d
1040 (10th Cir. 1996).
Although petitioners contend that petitioner suffered
personal injuries to his good name, personal integrity, and
business reputation, the Settlement Agreement does not provide
for any part of the payment to be on account of personal
injuries. Further, petitioners failed to introduce any competent
evidence to prove that WNIC intended to make payments to
petitioner on account of personal injuries.
We find that WNIC's intent when it entered into the
Settlement Agreement was to settle a contract dispute and not to
settle a tort or tort type claim or a claim for personal
injuries. Accordingly, we conclude that section 104(a)(2) does
not apply to exclude the $17,880 portion of the settlement
payment from gross income.
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In sum, in Green v. Commissioner, T.C. Summary Opinion 1995-
167, we held that the $18,120 attributable to the Jury Award was
includable in petitioners' income in 1991. We likewise hold that
the $18,120 is includable in income for 1992 through 1995. Also,
we find that the $17,880 is includable in income for 1991 through
1995. Thus, the entire annual payment of $36,000 ($18,120 +
$17,880) is includable in income for each of the years from 1991
through 1995.
Finally, we must decide whether petitioners are liable for
accuracy-related penalties in the amounts of $589 and $972 for
1994 and 1995, respectively. Section 6662(a) imposes an
accuracy-related penalty in the amount of 20 percent of the
portion of an underpayment of tax attributable to negligence or
disregard of rules or regulations. Sec. 6662(a) and (b)(1).
Negligence is any failure to make a reasonable attempt to comply
with the provisions of the internal revenue laws. Sec. 6662(c);
sec. 1.6662-3(b)(1), Income Tax Regs. Moreover, negligence is
the failure to exercise due care or the failure to do what a
reasonable and prudent person would do under the circumstances.
Neely v. Commissioner, 85 T.C. 934, 947 (1985). Disregard
includes any careless, reckless, or intentional disregard of
rules or regulations. Sec. 6662(c); sec. 1.6662-3(b)(2), Income
Tax Regs.
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Under section 6664(c), no penalty will be imposed with
respect to any portion of any underpayment if it is shown that
there was a reasonable cause for such portion and that the
taxpayer acted in good faith with respect to such portion. This
determination is based on all of the facts and circumstances.
Sec. 1.6664-4(b)(1), Income Tax Regs. The most important factor
is the extent of the taxpayers' effort to assess their proper tax
liability for the years at issue. Sec. 1.6664-4(b)(1), Income
Tax Regs.
On the record before us, we find that respondent's
determination of penalties under section 6662(a) is correct.
Petitioners filed their 1994 and 1995 returns after Green v.
Commissioner, T.C. Summary Opinion 1995-167 was filed on
September 5, 1995. Petitioners filed their 1994 return on
October 12, 1995. Notwithstanding our holding that the $18,120
payment was not excludable under section 104(a)(2), petitioners
nonetheless continued to exclude that amount on their 1994 and
1995 returns. Petitioners offered no reasonable explanation as
to its exclusion. In this regard, we find that petitioners'
actions were not those of a reasonable and prudent person under
the circumstances. Accordingly, we sustain respondent's
determination on this issue for 1994 and 1995.
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We have considered all arguments made by petitioners and to
the extent not discussed, we find them to be irrelevant or
without merit.
To reflect the foregoing,
Decisions will be entered
for respondent.