Sherman v. Commissioner

T.C. Memo. 1999-202

UNITED STATES TAX COURT

RICHARD AND MARGARET SHERMAN, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 11665-97. Filed June 18, 1999.

Richard Sherman, pro se.

Margaret Sherman, pro se.

Jack H. Klinghoffer, for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

JACOBS, Judge: Respondent determined a $70,120 deficiency in

petitioners' 1993 Federal income tax. The sole issue for decision

is whether the $207,000 Richard Sherman (petitioner) received upon

termination of his employment with International Business Machines
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Corporation (IBM) is excludable from petitioners' 1993 gross income

pursuant to section 104(a)(2) as damages received on account of

personal injury or sickness.

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.

FINDINGS OF FACT

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 New Canaan, Connecticut, at the time

they filed their petition.

Petitioner was born on April 23, 1938. He graduated from Yale

Law School in 1964, and subsequently became a member of the New

York and District of Columbia bars. Margaret Sherman, petitioner's

wife, did not work outside the home.

Employment with IBM

Petitioner was employed by IBM between December 1, 1965, and

May 28, 1993. At all relevant times, he was a staff attorney,

assigned to the IBM corporate division.

The IBM corporate division determined that "permanent resource

reductions" (permanent employee layoffs) were necessary. This

determination was announced sometime in February 1993.
 - 3 -

Mr. D.A. Evangelista was the general counsel of IBM in March

1993. He was informed that his organization had to reduce the

number of employees (attorneys as well as administrative staff)

from 135 to 120. Of the "resource reduction target" of 15, it was

determined that 2 would come from Mr. L.D. Pearson's group, to

which petitioner was assigned.

Petitioner was "identified as surplus" based on an "appraisal

sequence banding" used to compare the performance of employees

during the period of February 16, 1990, to February 15, 1993. The

bandings were alphabetically designed: Band A, was composed of the

highest rated employees, through band G, which was composed of the

lowest rated employees. Of the three attorneys reporting to Mr.

Pearson, one was in band A, another in band C, and the third,

petitioner, was in band E.

For the period February 16, 1990, to February 15, 1993,

petitioner had only two performance evaluations, one conducted in

April 1990, and the other in June 1991. Both placed him in band E.

Petitioner objected to both of these evaluations.

In July 1989, petitioner filed an "open door" request

(internal grievance), questioning whether Mr. Pearson improperly

failed to promote him. In February 1990, petitioner filed another

"open door" request, claiming retribution due to his earlier "open

door" request. In May 1992, petitioner filed an unfair labor
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practice charge against IBM with the National Labor Relations Board

(NLRB). The charge states:

Since on or about May 4, 1992, the above-named
employer [IBM], by its officers, agents and
representatives, informed Richard Sherman that he was
evaluated and ranked in the 10% lowest ranking category,
thereby making him susceptible to a potential future
layoff, because he engaged in concerted activities with
other employees of said employer for the purpose of
collective bargaining and other mutual aid and protection
and in order to discourage employees from engaging in
such activities.

On or about May 4, 1992, the above-named employer
[IBM], by its officers, agents and representatives,
retaliated against Richard Sherman by ranking him in the
10% lowest category making him susceptible to a potential
future layoff, because said employee gave testimony under
the Act.

An NLRB representative informed petitioner that the NLRB was

not going to file a charge against IBM. The NLRB representative

also told petitioner that IBM's outside counsel, Covington &

Burling, stated that petitioner was a "valued employee and that

[petitioner's] continued employment is not threatened." By letter

dated August 27, 1992, petitioner withdrew his charges against IBM.

On March 16, 1993, petitioner was notified that he had been

designated as a "surplus employee", and as a result, his employment

with IBM would likely terminate on May 28, 1993. On March 17,

1993, petitioner wrote a memorandum to Mr. Evangelista requesting

that his surplus designation be withdrawn. On March 22, 1993,

petitioner wrote a memorandum to four of IBM's management

executives, including IBM's chief executive officer and chief
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personnel officer, requesting that his surplus designation be

withdrawn. In a footnote to this memorandum, petitioner referred

to a dispute between IBM and Mr. Murray, an attorney in IBM's legal

department who had been fired. The footnote stated:

IBM Legal management chose not to negotiate with Mr.
Murray, and instead fired him. IBM is now in extensive
litigation with Mr. Murray. By current estimate, IBM has
already spent more than $800,000 (internal and external
costs) on litigation involving Mr. Murray.

On March 24, 1993, petitioner wrote a second memorandum to the same

four IBM management executives, requesting an "open door" with

regard to his surplus employee designation. In this request,

petitioner stated:

There is one aspect of the Open Door procedure which is
troublesome and which I ask you to address. Legal
management has the right to review Open Door
investigation reports and conclusions prior to their
submission to the chairman's office for decision. I
understand that Legal management has used that power in
the past to modify some reports and conclusions. In the
case of this Open Door, that would create a conflict of
interest. Therefore, I ask that the Legal Department not
be permitted to review the investigator's findings prior
to submission to executive and oversight management.

Sometime in the latter part of March 1993, petitioner

collapsed while at work, losing consciousness for a brief period of

time. Petitioner's collapse resulted in injuries (including hand

tremors, weight loss, and severe headaches). All medical expenses

incurred by petitioner as a result of his injuries were submitted

to IBM and paid under IBM's medical plan.
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On May 6, 1993, petitioner was advised that his "open door"

request had been denied, and despite his objections, his employment

would be terminated on May 28, 1993. IBM offered petitioner an

opportunity to participate in its Corporate Transition Program

(CTP), whereby petitioner would be entitled to receive the

equivalent of 1-year's salary--$107,000--on the condition he

execute an appropriate release.

At this time, petitioner learned that IBM was hiring new,

younger attorneys (recent graduates or individuals about to

graduate from law school). Petitioner consulted an attorney who

advised him that he had a viable cause of action against IBM for

age discrimination. Accordingly, petitioner refused to participate

in the CTP.

Negotiations between IBM representatives and petitioner

ensued. During the course of these negotiations, petitioner

threatened to obtain an injunction against IBM to stop its layoff

program (at that time, IBM was laying off 30,000-40,000 employees).

On May 13, 1993, petitioner and IBM entered an agreement entitled

"Settlement Agreement and Release" (settlement agreement). The

settlement agreement states in pertinent part:

WHEREAS, Mr. Sherman has made certain
allegations about the propriety and lawfulness
of his having been designated as a "surplus
employee" resulting in claims of physical and
mental injury and stress;
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WHEREAS, IBM and Mr. Sherman understand
and recognize the inherent expense and risk
involved in litigation;

WHEREAS, IBM and Mr. Sherman wish to
resolve finally, completely and forever all
disputes including but not limited to
allegations of physical and mental injury,
unfair labor practices, discrimination,
retaliation, or any other allegations of
unlawful conduct that Mr. Sherman has made or
could have made, whether known or unknown,
concerning anything that has occurred during
his employment with IBM;

* * * * * * *

NOW, THEREFORE, it is hereby agreed as
follows:

1. IBM agrees to pay Mr. Sherman the
sum of $103,500 fifteen days after he signs
this Agreement and has his signature notarized
and $103,500 on December 31, 1993. For
withholding purposes, IBM is required to
withhold certain sums pursuant to the tax code
and regulations; but it will do so without
prejudice to Mr. Sherman taking the position
that some or all of these sums are excludable
from his taxable income.

* * * * * * *

4. Mr. Sherman will cease being an IBM
employee on May 28, 1993.

* * * * * * *

6. Mr. Sherman agrees to release IBM
from all claims, demands, actions, liabilities
or charges (hereinafter "claims") that he may
have against IBM of whatever kind or nature for
or on account of anything that has occurred,
including but not limited to, any claims for
physical and mental injury, and any claims
which are related to his employment with IBM,
such as claims of retaliation, the termination
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of that employment, or eligibility for other
severance payments or his eligibility or
participation in the Retirement Bridge Leave of
Absence or CTP.

* * * * * * *

c. This Agreement releases, but
is not limited to, claims for physical and
mental injury, claims arising under the Age
Discrimination in Employment Act of 1967, as
amended, the National Labor Relations Act of
1935, as amended ("NLRA"), Title VII of the
Civil Rights Act of 1964, as amended, the
Employee Retirement Income Security Act of
1974, as amended or any other federal, state,
or local law pertaining to employment,
including but not limited to, discrimination or
retaliation in employment based on sex, race,
national origin, religion, disability, veteran
status, age and the filing of an unfair labor
practice charge with or supplying an affidavit
to the National Labor Relations Board. This
Agreement also releases any and all claims
based on theories of contract or tort, whether
grounded in common law or otherwise.

d. This Agreement releases all
claims including those that Mr. Sherman knows
about and those that he may not know about
which have accrued at the time he executed this
Agreement.

* * * * * * *

18. Nothing in this Agreement shall be
construed as or constitute an admission with
respect to the validity of any claims or
allegations which Mr. Sherman has made or could
have made concerning his employment with IBM or
with respect to any other matter.

The settlement agreement did not apportion the $207,000 payment

among the various potential claims.
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In 1993, IBM paid petitioner the $207,000, in two payments of

$103,500. IBM included the $207,000 in petitioner's Form W-2, and

applied withholding tax to the entire amount.

1993 Federal Income Tax Return

On their 1993 Federal income tax return, petitioners excluded

the $207,000 payment from their income. Appended to their return

was a document entitled "Exclusion of Settlement of Personal Injury

Claim (Age Discrimination) from Gross Income". In relevant part,

the document stated:

In exchange for a payment of $207,000 I agreed
in paragraph number 6(c) to release all claims
for age discrimination, including those
available under Title VII of the Civil Rights
Act, as amended. I was 55 years old at the
time IBM was hiring new lawyers (either recent
graduates or persons about to graduate from
law school).

* * * * * * *

Therefore I have excluded the $207,000
settlement for age discrimination from gross
income.

Notice of Deficiency

In the notice of deficiency, respondent determined that the

entire $207,000 settlement payment petitioner received from IBM is

includable in petitioners' 1993 gross income.

OPINION

The sole issue for decision is whether the $207,000

petitioner received as a result of the termination of his
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employment with IBM is excludable from petitioners' 1993 gross

income pursuant to section 104(a)(2).

Pursuant to 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." The regulations provide 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." Sec. 1.104-

1(c), Income Tax Regs. Thus, in order to exclude damages from

gross income pursuant to section 104(a)(2), the taxpayer must

prove: (1) The underlying cause of action is based upon tort or

tort type rights, and (2) the damages were received on account of

personal injuries or sickness. See Commissioner v. Schleier, 515

U.S. 323, 336-337 (1995). The claim must be bona fide. See Taggi

v. United States, 35 F.3d 93, 96 (2d Cir. 1994).

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 from gross income

under section 104(a)(2). See United States v. Burke, 504 U.S. 229,

237 (1992). The crucial question is "in lieu of what was the

settlement amount paid"? Bagley v. Commissioner, 105 T.C. 396, 406

(1995), affd. 121 F.3d 393 (8th Cir. 1997). Determining the nature
 - 11 -

of the claim is a factual inquiry. See Robinson v. Commissioner,

102 T.C. 116, 127 (1994), affd. in part, revd. in part on another

ground and remanded 70 F.3d 34 (5th Cir. 1995).

In the statement appended to their 1993 return, petitioners

state that the $207,000 payment from IBM was in exchange for

petitioner's "release [of] all claims for age discrimination,

including those available pursuant to title VII of the Civil Rights

Act." Subsequent to the filing of petitioner's 1993 return, the

Supreme Court in Commissioner v. Schleier, supra, in resolving a

conflict among the circuits, held that back pay and liquidated

damages recovered for age discrimination under the Age

Discrimination in Employment Act of 1967, Pub. L. 90-202, 81 Stat.

602, currently codified at 29 U.S.C. secs. 621-634 (1994), are not

excludable from gross income under section 104(a)(2) because (1)

the statute does not sound in tort, and (2) no part of the recovery

is received on account of personal injuries or sickness. (We note

that several years prior to rendering its opinion in Schleier, the

Supreme Court in United States v. Burke, supra, held that back pay

awarded in settlement of title VII claims is not excludable from

gross income under section 104(a)(2).)

In their petition that was filed after the Supreme Court

rendered its opinion in Schleier, petitioners assert that the

$207,000 payment was solely in settlement of petitioner's claim for

physical and mental injury. They claim that petitioner had a cause
 - 12 -

of action against IBM for age discrimination which could be brought

either in contract or tort and that petitioner intended to

institute such a lawsuit in tort.

The language of paragraph 6 of the settlement agreement is

clear. In exchange for $207,000, Mr. Sherman agreed to release IBM

from all claims and actions, whether based in contract or in tort.

Specifically, petitioner agreed to release IBM from all claims

arising from "any * * * law pertaining to employment, including but

not limited to, discrimination or retaliation in employment based

on sex, race, national origin, religion, disability, veteran

status, age and the filing of an unfair labor practice charge" as

well as any claims based "on theories of contract or tort". (We

note that the mere listing of a specific cause of action in the

settlement agreement does not prove that petitioner actually

possessed such a claim against IBM. In fact, the settlement

agreement states: "Nothing in this agreement shall be construed as

or constitute an admission with respect to the validity of any

claims or allegations which Mr. Sherman has made or could have made

concerning his employment with IBM or with respect to any other

matter.") Moreover, there is no allocation of the $207,000 payment

to or among any claim or claims petitioner may have had against

IBM.

The settlement agreement neither mentions any specific injury

sustained by petitioner nor states that the amount petitioner is to
 - 13 -

receive thereunder is for a personal injury claim petitioner has

against IBM. The references to physical and mental injury in the

settlement agreement were inserted pursuant to petitioner's

request. Indeed, the cover letter from IBM's corporate counsel to

petitioner (with which was enclosed a draft of the settlement

agreement) states:

The draft attempts to accommodate your request that we
make it clear that you have asserted claims for personal
injuries and that the lump sum payments is in settlement
of those as well as all other claims.

According to petitioner, he collapsed and suffered injuries

(hand tremors, weight loss, and severe headaches) due to the stress

he experienced as a consequence of IBM's termination of his

employment. At trial, we observed that petitioner experienced

tremors in his hands. Although at times, wrongful employment

termination possibly may result in personal injury, if the amount

of lost wages or other compensation received in such cases is not

linked to that personal injury, such an award will not qualify for

the exclusion from gross income provided in section 104(a)(2). See

Commissioner v. Schleier, supra at 330. Such is the case herein.

Where a settlement agreement lacks express language stating

what the settlement amount was paid to settle, then the most

important factor is the intent of the payor. See Knuckles v.

Commissioner, 349 F.2d 610, 612-613 (10th Cir. 1965), affg. T.C.

Memo. 1964-33. The best indicator of IBM's intent is the language
 - 14 -

of the settlement agreement. The agreement's broad language

indicates that IBM considered the $207,000 payment as a quid pro

quo for petitioner's release of all potential claims against IBM,

including, but not limited to, tort claims. IBM did not make an

identifiable portion of the payment in settlement of petitioner's

personal injury claim. The payment was for severance pay as well

as for petitioner's release of potential tort and nontort claims

against IBM.

It is apparent to us that IBM viewed petitioner as litigious.

Petitioner formally disputed management's decision to end his

employment. He threatened to obtain an injunction to stop IBM's

downsizing program. He had previously filed an unfair labor

practice charge against IBM with the NRLB. And he had filed

several formal complaints against his supervisors. It was against

this background that IBM negotiated a termination settlement with

petitioner.

The final settlement amount--$207,000, represented an amount

equal to petitioner's 1-year salary ($107,000), plus $100,000.

Petitioner testified that he wanted a settlement equal to three

times his annual salary (or $321,000).

We conclude that IBM did not intend for any portion of the

$207,000 to be specifically carved out as a settlement of a tort or

tort type claim on account of a personal injury or sickness.
 - 15 -

The United States Court of Appeals for the Second Circuit,

where an appeal in this case would lie, held in Taggi v. United

States, 35 F.3d at 96, that failure to show the amount of a payment

allocable to claims of tort or tort type damages for personal

injuries results in the entire amount being presumed not to be

excludable. See Pipitone v. United States, ___ F.3d ___ (7th Cir.,

June 14, 1999); see also Getty v. Commissioner, 91 T.C. 160, 175-

176 (1988), affd. as to this issue and revd. on other issues 913

F.2d 1486 (9th Cir. 1990); Morabito v. Commissioner, T.C. Memo.

1997-315. As in Taggi, the release in this case is all-

encompassing and includes different potential tort and nontort

claims. As stated, no part of the payment was allocated to any one

cause of action. And, petitioner has not proven which portion, if

any, of the $207,000 was received in settlement of tort or tort

type claims of personal injury. Thus, assuming petitioner

sustained a personal injury as a consequence of IBM's termination

of his employment, the record reflects no basis for an allocation,

and, we are not in a position to apportion the payment among the

various possible tort and nontort claims enumerated in the

settlement agreement. See, e.g., Adams v. Commissioner, T.C. Memo.

1997-357; Morabito v. Commissioner, supra.

We have considered all of petitioners' other arguments and, to

the extent not discussed above, find them to be without merit.
 - 16 -

In sum, we hold that the $207,000 settlement payment

petitioner received from IBM is not excludable from petitioners'

1993 gross income under section 104(a)(2).

To reflect the foregoing,

Decision will be entered

for respondent.