T.C. Summary Opinion 2005-182
UNITED STATES TAX COURT
VERNADEAN A. PATES, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 5802-04S. Filed December 8, 2005.
Vernadean A. Pates, pro se.
John F. Driscoll, 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.
1
Unless otherwise indicated, subsequent section references
are to the Internal Revenue Code in effect for the year at issue.
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Respondent determined a deficiency of $12,575 in
petitioner’s Federal income tax for 2001. The sole issue for
decision is whether $54,000 of a $90,000 payment received by
petitioner from her former employer during 2001 is excludable
from gross income under section 104(a)(2).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, petitioner was a
legal resident of Birmingham, Alabama.
Petitioner became an employee of Regions Bank (Regions) in
1996. Her employment with Regions was mutually terminated in
November 2001 pursuant to a Settlement Agreement and Release
(Agreement) in which she received the monetary settlement that is
the subject of this litigation.
Petitioner was hired as a money transfer clerk, level II, by
Regions in July 1996 earning $8.75 per hour. Petitioner had
previously worked for several banks in the area, and, when she
left one bank to join Regions, the previous employer listed her
2
Petitioner accepted a $90,000 settlement, and $36,000 of
that amount was paid directly to her attorney for attorney’s
fees. In the notice of deficiency, respondent did not determine
that the $36,000 constituted gross income. In Commissioner v.
Banks, 543 U.S. 426 (2005), the Supreme Court held that
attorney’s fees in a settlement recovery that is excludable from
income under sec. 104 constitute gross income. The attorney’s
fees are deductible as an itemized deduction. Respondent did not
move to increase the income determination to reflect the recent
decision; therefore, the only issue is whether the $54,000 paid
directly to petitioner is taxable.
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as ineligible for rehire because she “would not follow
instructions and caused many disruptions in the work area”. As a
money transfer clerk at Regions, petitioner was reviewed
frequently. In her first review, the supervisors listed
petitioner’s work as unsatisfactory, noting that she often
“bickered” with her coworkers, was not always dependable, and did
not seem to grasp the job. It was particularly noted that
petitioner made multiple wire transfer errors that, had they not
been detected by a supervisor, would have caused Regions to lose
several million dollars. A subsequent review, in January 1997,
showed petitioner dealt well with customers but further stated
she still needed to improve. The review also noted that
petitioner made many errors that caused extra work for other
employees.
Sometime in early 1997, petitioner was transferred to
another department as a utility clerk. Petitioner considered
this a demotion even though she received a slight pay increase.3
Petitioner received one negative review shortly after that
transfer, which noted she was still unreliable. After that,
however, petitioner received satisfactory reviews and continued
to get periodic pay increases.
3
Petitioner testified at trial that she never received pay
raises from Regions; however, she admitted during a deposition in
the title VII lawsuit that she had received numerous pay raises.
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In 1998, petitioner filed a race discrimination action
against Regions with the U.S. District Court for the Northern
District of Alabama, pursuant to title VII of the Civil Rights
Act of 1964, as amended. Petitioner alleged that co-workers whom
she felt were less qualified were receiving jobs and promotions
that she had applied for. Petitioner asserted this was due
solely to her race, African-American.
Petitioner continued working for Regions while her suit was
pending. In November 2001, petitioner and Regions agreed to
mediation, which resulted in a settlement wherein Regions agreed
to pay petitioner $90,000 in return for the dismissal of the
title VII action and her resignation from Regions. Petitioner
received $54,000, and her attorney received $36,000 in fees.
Both parties agreed to keep the terms of the settlement
confidential. Petitioner resigned her employment, and the action
was dismissed by joint stipulation on December 4, 2001.
Petitioner filed her 2001 Federal income tax return timely
but did not include the $54,000 as income on her return. The
sole issue before the Court is whether petitioner must include,
as gross income, the $54,000 settlement she received from
Regions. See supra note 2.
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
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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 are received on account of
personal injuries or sickness. Commissioner v. Schleier, 515
U.S. 323, 337 (1995). The flush language in section 104(a)
further provides that “emotional distress shall not be treated as
a physical injury or physical sickness.” Sec. 104.
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
income 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.
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121 F.3d 393 (8th Cir. 1997). An important factor in determining
the purpose of the payment is the “intent of the payor”.
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.
The agreement that petitioner and Regions entered into
states: “In consideration of the promises made herein by Pates,
Employer agrees that it will pay to Pates and her attorney * * *
($90,000) for attorney’s fees and compensatory damages for
emotional distress under Title VII of the Civil Rights Act of
1964, as amended”. The Agreement is dated November 27, 2001, and
was signed by all parties.
Under section 104(a)(2), as amended and in effect for 2001,
the mediation agreement pursuant to which the $54,000 (excluding
attorney’s fees) was paid to petitioner clearly was not a
settlement for personal physical injuries or physical sickness
but was specifically for emotional stress she sustained due to
racial discrimination. Additionally, no portion of the
settlement included payment for any medical expenses petitioner
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sustained or might sustain for her emotional stress.4
Accordingly, the Court holds that no portion of the $54,000
settlement is excludable from gross income. Respondent,
therefore, is sustained.
Reviewed and adopted as the report of the Small Tax Case
Division.
Decision will be entered
for respondent.
4
Petitioner testified at trial that she developed narcolepsy
and extreme fatigue while working at Regions due to the stress of
her mistreatment. Petitioner, however, did not claim physical
sickness either in the language of her suit against Regions or in
her deposition with Regions’ counsel. The only physical ailments
petitioner claimed during her deposition were unrelated “female
problems”. Furthermore, petitioner stated in her deposition that
she was suing Regions solely for racial discrimination.