T.C. Summary Opinion 2003-93
UNITED STATES TAX COURT
DeFOREST AND ROSE M. DORROH, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 3701-01S. Filed July 18, 2003.
DeForest and Rose M. Dorroh, pro se.
Gerald L. Brantley, for respondent.
COUVILLION, Special Trial Judge: This case was heard
pursuant to section 7463 in effect when the petition was filed.1
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 $15,822 in
1
Unless otherwise indicated, section references
hereafter are to the Internal Revenue Code in effect for the year
at issue. All Rule references are to the Tax Court Rules of
Practice and Procedure.
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petitioners' Federal income tax for 1997 and a penalty under
section 6662(a) in the amount of $3,164.
The issues for decision are: (1) Whether $55,000 of a
$60,000 payment received by Rose M. Dorroh (petitioner) from her
former employer during 1997 is excludable from gross income under
section 104(a)(2), and (2) whether petitioners are liable for the
penalty under section 6662(a).2
Some of the facts were stipulated. Those facts, with the
annexed exhibits, are so found and are incorporated herein by
reference. At the time the petition was filed, petitioners were
legal residents of San Antonio, Texas.3
Petitioner was an employee of the Defense Finance and
Accounting Service (DFAS), an agency in the U.S. Department of
Defense. At the time her employment with that agency was
mutually terminated during 1997, petitioner had completed
2
At trial, respondent conceded that $5,000, representing
attorney's fees paid by petitioner in recovering the $60,000, is
excludable from gross income pursuant to decisions of the Court
of Appeals for the Fifth Circuit to which this case would be
appealable were it not a small tax case. Srivastava v.
Commissioner, 220 F.3d 353, 365 (5th Cir. 2000), affg. in part,
vacating and remanding in part T.C. Memo. 1998-362; Cotnam v.
Commissioner, 263 F.2d 119 (5th Cir. 1959), affg. in part and
revg. in part 28 T.C. 947 (1957); Golsen v. Commissioner, 54 T.C.
742, 757 (1970), affd. 445 F.2d 985 (10th Cir. 1971).
Additionally, petitioners conceded unreported interest income of
$344.
3
Petitioners are husband and wife and filed a joint
Federal income tax return for 1997. The principal issue, the
$55,000, involves only Mrs. Dorroh.
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approximately 18-1/2 years of service as a Federal employee.
Petitioner was a data transcriber or a voucher examiner for DFAS
at Kelly Air Force Base at San Antonio, Texas. In essence,
petitioner's duties were to examine vouchers or bills submitted
by commissary vendors and approve them for payment. Petitioner's
relations with her immediate supervisors at DFAS were not good.
During a confrontation with one of her superiors on September 24,
1994, petitioner sustained an injury on the job when she fell,
injuring her head, neck, and back. The injury was disabling, and
petitioner came under the care of a doctor. She was unable to
work for intermittent periods and qualified for worker's
compensation benefits under the Federal Worker's Compensation
Act. Petitioner, however, continued her work with DFAS and
received worker's compensation benefits when she was unable to
work. After her employment with DFAS was mutually terminated in
1997, petitioner continued receiving worker's compensation
benefits. At trial, petitioner had a claim pending for total and
permanent disability benefits.
During the course of her employment, petitioner filed
numerous complaints within and without the chain of command in
DFAS complaining of various workplace conditions. Apparently not
satisfied with whatever actions, if any, that were taken by DFAS
to address these complaints, petitioner contacted a counselor
with the Equal Employment Opportunity Commission (EEOC) at least
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three times during 1995 complaining that DFAS had discriminated
against her based on her race, gender, and in reprisal for having
successfully prevailed against DFAS in an earlier proceeding (the
nature of which was not explained at trial). Petitioner
complained that, as a result, DFAS supervisors made adverse
employee reviews of her, increased her workload, and did not
provide her office accommodations equivalent to those of other
coworkers. Petitioner engaged the services of an attorney, and
an informal complaint of discrimination was filed with EEOC. In
this informal complaint, the relief petitioner sought was (1) a
finding of discrimination, (2) a job performance evaluation of
exceptional with a cash performance award, and (3) compensatory
damages of $300,000 for discrimination in violation of the Civil
Rights Act of 1991, Pub. L. 102-166, sec. 1981, 105 Stat. 1071.
Petitioner's informal complaint did not seek any relief for
physical injury or sickness or any corrective relief relating to
the September 24, 1994, incident when petitioner injured her back
at work.
The EEOC counselor was not able to resolve informally
petitioner's complaint and advised that she could file a formal
complaint with EEOC. Petitioner, through her attorney,
thereafter filed two formal complaints with EEOC, the first in
1995 and the second in 1997. In both formal complaints,
petitioner alleged approximately 40 instances or occurrences in
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which she was discriminated against based on race, color,
national origin, sex, and reprisal for prior complaint activity.
Neither of petitioner's formal complaints involved allegations of
personal physical injuries or physical sickness. After an
investigation by EEOC of the first formal complaint, it was
determined that petitioner had established a prima facie case
that DFAS had discriminated against petitioner on the basis of
race and reprisal. Before an investigation by EEOC was concluded
on the second formal complaint, the parties, DFAS and petitioner,
agreed to submit the case to mediation. An EEOC investigator was
the mediator. Petitioner's attorney represented petitioner in
the mediation proceedings. In due course, a settlement agreement
was reached and signed by the parties on April 2, 1997. In the
agreement, petitioner agreed to resign from her employment with
DFAS and not seek "employment with any DFAS activity world wide".
Petitioner further agreed that she would not file any suit
against DFAS for any violation of the Civil Rights Act of 1964 or
under any other Federal or State law in connection with any of
the formal and informal complaints she had filed with the EEOC
against DFAS. In consideration for petitioner's concessions,
DFAS agreed to pay petitioner $60,000, agreed to various
corrections to petitioner's personnel records, cancellation of
any pending disciplinary actions against her, and give only
"neutral references" in any future employer inquiries of
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petitioner. DFAS paid petitioner the $60,000 during 1997.
The mediation agreement listed each of the formal and
informal complaints petitioner had filed with the EEOC, and the
agreement, by its terms, was for the express settlement of these
complaints. The agreement concluded that it represented the "sum
total" of the provisions made by the parties with each party
"having had the opportunity to read and raise questions about its
meaning prior to signing." Petitioner and her attorney signed
the agreement along with a representative of DFAS and the
mediator. The agreement makes no references to settlement of any
claims by petitioner for physical injuries or sickness or
emotional pain and suffering, nor does the agreement make
reference to petitioner's worker's compensation case and the
worker's compensation benefits she was receiving at that time.
The agreement, however, includes an attachment, not referenced or
identified in the agreement, which is a Standard Form 50-B, U.S.
Office of Personnel Management, entitled Notification of
Personnel Action. That form lists petitioner's resignation from
DFAS on April 4, 1997, which was approved by DFAS on April 15,
1997. The "Remarks" portion of the form states: "I am officially
resigning from Federal service for medical and mental and
physical trauma. Please see my Dr. statement that will
officially be a part of my SF 50."
For the year 1997, DFAS issued to petitioner a Form 1099 for
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nonemployee compensation in the amount of $60,000 representing
the amount paid by DFAS pursuant to the mediation agreement.
Petitioners did not include this payment as income on their 1997
Federal income tax return. In the notice of deficiency,
respondent determined that the $60,000 payment constituted gross
income and further determined petitioners failed to report $344
in interest income on their 1997 Federal income tax return. As
noted earlier, petitioners conceded the unreported interest
income adjustment, and respondent conceded that $5,000 of the
$60,000 payment was excludable from gross income.
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, 515
U.S. 323, 337 (1995).
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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
inquiry 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).
"[W]here an amount is paid in settlement of a case, the critical
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). 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. If the payor's intent
cannot be clearly discerned from the settlement agreement, the
intent of the payor must be determined from all the facts and
circumstances of the case, including the complaint filed and
details surrounding the litigation. Robinson v. Commissioner,
supra at 127.
Although the taxpayer must show that the damages were
received "on account of personal injuries or sickness" under the
second requirement of Commissioner v. Schleier, supra, subsequent
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to that decision, Congress amended section 104(a)4 to provide
that amounts are excludable only if received "on account of
personal physical injuries or physical sickness". Sec. 104(a)(2)
(emphasis added). The flush language in section 104(a) further
provides that "emotional distress shall not be treated as a
physical injury or physical sickness".
Under section 104(a)(2), as amended and in effect for 1997,
the mediation agreement pursuant to which the $60,000 was paid to
petitioner clearly was not a settlement of personal physical
injuries or physical sickness. The agreement is very explicit to
the effect that the payment was in consideration of (1) the
resignation of petitioner as an employee of DFAS, and (2)
petitioner's agreement not to file suit against DFAS for
violations of the Civil Rights Act of 1964. Petitioner, however,
sustained a personal injury in 1994 in the course of her
employment; however, that injury is not addressed in the
mediation agreement, and, moreover, petitioner was otherwise
compensated for that injury through worker's compensation
benefits she was receiving at the time of the agreement and even
at the time of trial. Petitioners argue that, because Standard
Form 50 is attached to the mediation agreement, the language in
4
Small Business Job Protection Act of 1996, Pub. L. 104-
188, sec. 1605, 110 Stat. 1838, effective for amounts received
after Aug. 20, 1996.
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SF 50 is part and parcel of the mediation agreement and,
therefore, establishes that the $60,000 represented payment for
personal physical injuries.5 The Court rejects that argument.
The mediation agreement carefully recites the various bases upon
which settlement was reached. Petitioner's on-the-job injury is
not listed in the mediation agreement. Indeed, if petitioner's
contention is correct, and the work-related injury is deemed to
have been part of the mediation agreement, such a conclusion
could seriously impair petitioner's entitlement to worker's
compensation benefits because the agreement was intended to
settle all differences between the parties. Petitioner, however,
at the time of trial, continued pursuing her worker's
compensation case. On this record, the Court is satisfied that
the $60,000 payment to petitioner by DFAS did not include any
amount for physical injuries or physical suffering. Respondent,
therefore, is sustained on this issue.
The final issue is whether petitioners are liable for the
accuracy-related penalty under section 6662(a) for a substantial
understatement in tax or for negligence or disregard of rules and
regulations. Section 6662(a) provides that, if it is applicable
to any portion of an underpayment in taxes, there shall be added
5
As noted earlier, SF 50, in the Remarks portion, stated
that petitioner was resigning her employment because of "medical,
mental, and physical trauma".
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to the tax an amount equal to 20 percent of the portion of the
underpayment to which section 6662 applies. Under section
6664(c), however, no penalty shall be imposed under section
6662(a) with respect to any portion of an underpayment if it is
shown that there was a reasonable cause for the portion, and that
the taxpayer acted in good faith with respect to the portion of
the underpayment.
Under section 6662(b)(2), there is a substantial
understatement of income tax if the amount of the understatement
exceeds the greater of (1) 10 percent of the tax required to be
shown on the return, or (2) $5,000. Sec. 6662(d)(1)(A). For
purposes of section 6662(d)(1), "understatement" is defined as
the excess of tax required to be shown on the return over the
amount of tax that is shown on the return, reduced by any
rebates. Sec. 6662(d)(2)(A).
Section 6662(d)(2)(B) provides that the amount of the
understatement shall be reduced by that portion of the
understatement that is attributable to the tax treatment of any
item by the taxpayer if there is or was substantial authority for
the treatment, or any item with respect to which the relevant
facts affecting the item's tax treatment are adequately disclosed
in the return or in a statement attached to the return, and there
is reasonable basis for such treatment.
The tax that was required to be shown on petitioners' 1997
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return, based on respondent's adjustments, was $20,761.
Petitioners' return showed a tax of $4,939. Petitioners
understated their tax by $15,822, which clearly exceeds the
greater of $5,000 or 10 percent of the tax required to be shown
on the return (i.e., $2,076.10). It follows that petitioners'
understatement of tax was substantial for purposes of section
6662(d)(1)(A).6
The determination of whether a taxpayer acted with
reasonable cause and in good faith depends upon the facts and
circumstances of each particular case. Sec. 1.6664-4(b)(1),
Income Tax Regs. Relevant factors include the taxpayer's efforts
to assess his or her proper tax liability, the knowledge and
experience of the taxpayer, and reliance on the advice of a
professional, such as an accountant. Drummond v. Commissioner,
T.C. Memo. 1997-71. The most important factor is the extent of
the taxpayer's effort to determine the taxpayer's proper tax
liability. Sec. 1.6664-4(b)(1), Income Tax Regs. An honest
misunderstanding of fact or law that is reasonable in light of
the experience, knowledge, and education of the taxpayer may
indicate reasonable cause and good faith. Remy v. Commissioner,
6
The Court recognizes that, because of respondent's
concession that $5,000 of the $60,000 settlement is excludable
from gross income and petitioners' concession of $344 in
unreported interest income, the exact amount of the
understatement will be determined in the Rule 155 computation.
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T.C. Memo. 1997-72.
Petitioners did not act with reasonable cause and in good
faith in failing to include the DFAS settlement as gross income
on their 1997 return. Prior to filing their return, petitioners,
through their attorney, contacted DFAS about the Form 1099 issued
by DFAS requesting that it be corrected. Petitioners were
advised in two letters from the attorney for DFAS that the
payment to them was not for personal injuries and could not be
excluded from gross income under section 104(a)(2). There is no
showing that petitioners contacted any other professional
advisors on this question. They simply chose to ignore the Form
1099 and did not include the payment as income on their 1997 tax
return. Respondent, therefore, is sustained on this issue.
Reviewed and adopted as the report of the Small Tax Case
Division.
Decision will be entered
under Rule 155.