T.C. Summary Opinion 2003-15
UNITED STATES TAX COURT
TONIA V. CATES, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 2312-01S. Filed February 28, 2003.
Timothy J. Condon, Sr., for petitioner.
Sean R. Gannon, for respondent.
POWELL, Special Trial Judge: This case was heard pursuant
to the provisions of section 74631 of the Internal Revenue Code
in effect at the time the petition was filed. The decision to be
entered is not reviewable by any other court, and this opinion
should not be cited as authority.
Respondent determined a deficiency of $8,634 in petitioner’s
1998 Federal income tax. The issue is whether petitioner may
1
Unless otherwise indicated, subsequent section references
are to the Internal Revenue Code in effect for the year in issue.
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exclude from gross income under section 104(a)(2) payments
received by her from her former employer pursuant to a settlement
agreement. Petitioner resided in Machesney Park, Illinois, at
the time the petition was filed.
Background
Rockford Memorial Health Services Corp. (Rockford) hired
petitioner in December of 1992 and promoted her to head secretary
in the Human Resources Department after 1 year. In March of
1995, however, petitioner received an unfavorable performance
evaluation and was placed on a 90-day performance improvement
plan. Petitioner believed that she was exposed to racially
offensive jokes and racial slurs at work and that Rockford
refused to act on her complaints of discrimination and attempted
to discourage any complaints of discrimination. Petitioner asked
to be transferred to an assignment under a different supervisor.
That request was refused. Instead, Rockford terminated
petitioner’s employment on April 25, 1995, after 53 days of her
90-day probationary period. During the time of the alleged
harassment petitioner suffered from headaches, stomach problems,
insomnia, and hypertension.
On April 9, 1997, petitioner filed a complaint in the United
States District Court for the Northern District of Illinois,
Western Division, as a member of a class action suit filed
against Rockford. In the complaint, petitioner alleged that
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Rockford violated Title VII of the Civil Rights Act of 1964, as
amended, and the Civil Rights Act of 1991. Petitioner sought
relief in the amount of back pay and prejudgment interest, and
“compensation for past and future non-pecuniary losses resulting
from the unlawful employment practices * * * including
humiliation”.
On January 22, 1998, petitioner and Rockford entered into a
settlement agreement. The agreement stated in pertinent part:
[Rockford] shall pay to * * * [petitioner] the gross sum of
Forty-Five Thousand Dollars ($45,000) in the form of two
checks made payable to * * * [petitioner]. One check, in
settlement of * * * [petitioner’s] claim for back pay
damages, shall be in the gross amount of Ten Thousand
Dollars ($10,000), less all applicable withholdings,
including FICA. The second check, in settlement of * * *
[petitioner’s] claim for compensatory damages for emotional
injuries, shall be in the gross amount of Thirty-Five
Thousand Dollars ($35,000). [Emphasis added.]
In preparing her 1998 Federal income tax return, petitioner
excluded the $35,000 damage award on the grounds that it was
received in compensation of her “emotional distress due to
physical sickness” and was excludable under section 104(a)(2).
The taxability of the $10,000 petitioner received as back pay is
not in dispute.
Discussion
Section 61 provides that “gross income means all income from
whatever source derived”. Gross income is an inclusive term with
broad scope, designed by Congress to “exert * * * ‘the full
measure of its taxing power.’” Commissioner v. Glenshaw Glass
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Co., 348 U.S. 426, 429 (1955) (quoting Helvering v. Clifford, 309
U.S. 331, 334 (1940)). Statutory exceptions from income are
narrowly construed. Commissioner v. Schleier, 515 U.S. 323, 328
(1995).
Section 104(a)(2) excludes from gross income “the amount of
any damages (other than punitive damages) received (whether by
suit or agreement and whether as lump sums or as periodic
payments) on account of personal physical injuries or physical
sickness”. Section 1.104-1(c), Income Tax Regs., defines
“damages received” as “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.” Amounts are
excludable from gross income only when (1) the underlying cause
of action giving rise to the recovery is based on tort or tort
type rights, and (2) the damages were received on account of
personal injuries or sickness. Commissioner v. Schleier, supra
at 337.
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). Determination of the nature of the claim is a factual
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inquiry,2 and is generally made by reference to the settlement
agreement. Robinson v. Commissioner, 102 T.C. 116, 126 (1994),
affd. in part and revd. in part 70 F.3d 34 (5th Cir. 1995). An
important factor in determining the validity of the agreement is
the “intent of the payor” in making the payment. Knuckles v.
Commissioner, 349 F.2d 610, 613 (10th Cir. 1965), affg. T.C.
Memo. 1964-33.
In examining the nature of the claim, we find that
petitioner filed a complaint under Title VII of the Civil Rights
Act of 1964, as amended, and the Civil Rights Act of 1991. In
United States v. Burke, supra at 237, the Supreme Court held that
recoveries received for the settlement of claims based on Title
VII of the Civil Rights Act of 1964, Pub. L. 88-352, 78 Stat.
253, are not excludable from gross income under section
104(a)(2). The Supreme Court concluded that because the remedies
under the Act did not create remedies for personal injuries, the
causes of action involving the Act were not based on tort or tort
type rights. Id. at 241. In 1991, Congress amended the Civil
Rights Act of 1964, effective November 21, 1991, to permit
recovery of compensatory and punitive damages for certain
violations. Civil Rights Act of 1991, Pub. L. 102-166, sec. 102,
105 Stat. 1072.
2
Sec. 7491(a), concerning burden of proof, has no bearing
on the underlying substantive issue.
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The settlement agreement does not reference whether the
damage award was based on the Civil Rights Act of 1964 or 1991.
However, Rockford clearly intended to pay petitioner a settlement
in compensation of her emotional distress. The settlement
agreement clearly stated that the $35,000 was to compensate her
for “emotional injuries”.
Section 104(a) provides that “emotional distress shall not
be treated as a physical injury or sickness.” The Committee
Report provides “that the term emotional distress includes
physical symptoms (e.g., insomnia, headaches, stomach disorders)
which may result from such emotional distress.” H. Rept. 104-586
(1996), 1996-3 C.B. 331, 482 n.24. Thus, petitioner’s headaches,
insomnia, and stomach problems were intended by Congress to be
treated as emotional distress, and therefore the compensation for
those symptoms is not excluded from gross income under section
104(a)(2).
Moreover, assuming that hypertension is a physical injury (a
point that we specifically do not decide) we cannot find that
Rockford intended to compensate petitioner for her hypertension.
Petitioner’s medical records submitted to this Court establish
that petitioner was first diagnosed with borderline hypertension
in May of 1993. Petitioner was later hospitalized in June of
1993 for hypertension, weakness, and hyponatremia. Petitioner
alleged that she suffered racial discrimination in 1995, perhaps
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as early as 1994. It is, therefore, highly unlikely that
Rockford could have intended to compensate petitioner for her
hypertension because those symptoms appeared before petitioner
suffered any alleged racial discrimination at work.
We hold that the $35,000 award for “emotional injuries” is
not excludable from gross income under section 104(a)(2).
Reviewed and adopted as the report of the Small Tax Case
Division.
Decision will be entered
for respondent.