Goode v. Comm'r

T.C. Memo. 2006-48

UNITED STATES TAX COURT

JESSE AND TAWARA GOODE, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 9914-04. Filed March 21, 2006.

Ps did not include in their 2001 Federal income
tax return payments totaling $135,000, remitted
pursuant to a settlement agreement entered into between
petitioner-husband (P-H) and the District of Columbia.
Under the terms of the settlement agreement, the
proceeds at issue were designated as attorney’s fees
and “claims and out-of-pocket expenses”, and were to be
considered as non-taxable amounts pursuant to sec.
104(a)(2), I.R.C. Ps were not furnished with a timely,
properly issued Form 1099-Misc., Miscellaneous Income.

Held: Ps are not entitled to exclude the $135,000
settlement payment from their gross income under sec.
104(a)(2), I.R.C. The record does not establish that
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P-H received any part of the $135,000 sum on account of
personal physical injury or physical sickness, as
required by sec. 104(a)(2), I.R.C.

Held, further, Ps are liable for accuracy-related
penalties pursuant to sec. 6662, I.R.C.

Held, further, Jurisdiction of this Court is not
available to consider Ps claim for suspension of
interest under sec. 6404(g), I.R.C.

Thomas F. DeCaro, Jr., for petitioners.

Innessa Glazman Molot, for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

NIMS, Judge: Respondent determined a deficiency of $146,316

in petitioners’ 2001 Federal income tax, as well as an accuracy-

related penalty under section 6662(a) and (d) of $29,263 for

substantial understatement of income tax. Unless otherwise

indicated, all section references are to the Internal Revenue

Code in effect for the year in issue. After concessions, the

issues for decision are: (1) Whether any portion or the entirety

of certain unreported settlement proceeds aggregating $135,000,

specifically identified in a settlement agreement between

petitioner Jesse Goode and the District of Columbia as nontaxable

pursuant to section 104(a)(2), is excludable from petitioners’

2001 gross income; (2) whether petitioners are liable for
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an accuracy-related penalty under section 6662(a); and (3)

whether jurisdiction is available to consider petitioners’ claim

for suspension of interest under section 6404(g).

FINDINGS OF FACT

Some of the facts are stipulated and are found accordingly.

The stipulation of facts, the supplemental stipulation of facts,

and the attached exhibits are incorporated herein by this

reference. At the time of the filing of their petition,

petitioners resided in Washington, D.C.

Petitioner Jesse Goode was employed by the District of

Columbia (the District) for approximately 8 years when placed on

paid administrative leave on January 19, 2000. At that time, he

was serving as the general counsel to the District’s Department

of Human Services. (Petitioner Tawara Goode is a party to this

case solely because she filed a joint Federal income tax return

with petitioner Jesse Goode for the taxable year at issue, and

references herein to petitioner in the singular are to Jesse

Goode).

Precipitating the District’s adverse employment action

against petitioner was a series of news reports in the Washington

Post probing numerous, deplorable incidents of neglect and abuse

suffered by residents of the District’s housing facilities for

individuals with developmental disabilities, which was under the

aegis of the Department of Human Services. On January 17, 2001,
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petitioner filed suit against the District with the United States

District Court for the District of Columbia, seeking damages and

declaratory and injunctive relief. The gravamen of petitioner’s

complaint--comprised of two underlying counts alleging,

respectively, the District’s infringement of petitioner’s First

Amendment rights under 42 U.S.C. sec. 1983 (2000) and violation

of the D.C. Whistleblower Reinforcement Act of 1998, D.C. Code

sec. 1-615.54--concerns the District’s averred retaliatory

conduct against petitioner. Such reprisal was directed at

petitioner, according to the complaint, because of his purported

endeavor to inform various government agencies and officials of

the dire conditions then prevalent in the District’s

developmentally disabled housing program. Petitioner’s damages

were enumerated in the complaint as comprising “emotional and

mental anguish, humiliation and embarrassment, ridicule, physical

pain and physical upset, damage to [petitioner’s] professional

reputation, and damage to his reputation in the community.”

Petitioner did not serve the complaint on the District.

Petitioner’s reason for this was to preserve the viability of one

or both of the asserted claims from the pending expiration of the

period of limitations without impeding the progress of the

settlement negotiations, which had reached a critical juncture.

Petitioner entered into a settlement agreement and general

release with the District on May 14, 2001 (the settlement). The
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settlement provided for, among other specified items of

consideration, the termination of petitioner’s employment, a

mutual omnibus release encompassing any and all litigation-

related claims between the parties, and the remuneration by the

District of the following compensatory sums: (i) $15,904.33,

allocated as severance and accrued leave; (ii) $103,250,

designated as petitioner’s “claims and out-of-pocket expenses”;

and (iii) $31,750, earmarked as petitioner’s counsel fees and

costs. Payment of petitioner’s counsel fees and costs was

remitted directly to petitioner’s attorneys, in accordance with

the settlement.

The settlement, in a provision accompanying the enumeration

of the compensatory payments, contains the following

characterization of the respective $103,250 and $31,750 amounts

(cumulating $135,000, the disputed settlement amount) as:

compensatory damages pursuant to section
104(a)(2) and for out-of-pocket expenses
only; * * * [the disputed settlement amount]
does not constitute wages, and shall be
considered as non-taxable to the fullest
extent permitted by law. The parties
understand and agree that no W-2 form shall
issue from the District of Columbia with
respect to * * * [the disputed settlement
amount].

Relying solely on such representation set forth in the

settlement, petitioners did not include (and did not provide

supplemental disclosure of) the disputed settlement amount in

their 2001 gross income. Of the aggregate settlement proceeds,
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petitioners reported only the $15,904.33 severance payment, as

properly reflected in a Form W-2, Wage and Tax Statement, which

was duly issued by the District.

The District’s Office of the Chief Financial Officer (the

OCFO) issued a Form 1099-Misc., for the 2001 taxable year that

was faulty in two respects: it erroneously disclosed the

disputed settlement amount as $357,462, and was never delivered

to petitioners. A corrected Form 1099-Misc., for taxable year

2001 (the restated 1099) inaccurately restated the disputed

settlement amount as $119,154.33, listed an incorrect address for

petitioner under the form’s appropriate caption (corresponding to

the address of one of the law firms that represented petitioner

in the settlement), and was not ultimately sent to petitioner’s

correct address until March 24, 2004. Correspondence from the

OCFO to petitioner, dated March 22, 2004, indicates that the

numerical error in the restated 1099 is the result of including

the $15,904.33 severance payment in the disputed settlement

amount and excluding the $31,750 attorney’s fees compensation.

OPINION

1. Burden of Proof

The parties dispute whether the burden of proof in this case

has been shifted to respondent pursuant to section 7491. Section

7491(a) imposes the burden of proof on respondent if the taxpayer

introduces credible evidence with respect to any factual issue,
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and complies with the requirements of section 7491(a)(2)(A) and

(B) to substantiate all items at issue, maintain required

records, and cooperate with reasonable requests of respondent.

We find it unnecessary to decide whether petitioners have met the

prerequisites of section 7491, because the record in this case is

not evenly weighted and the resolution of the issues in

controversy does not depend upon which party bears the burden of

proof. We render a decision on the preponderance of the evidence

in the record.

2. Applicability of Section 104(a)(2)

Section 61(a) provides that gross income includes all income

from whatever source derived. While it is axiomatic that section

61(a) broadly applies to any accession to wealth, statutory

exclusions from income are narrowly construed. See Commissioner

v. Schleier, 515 U.S. 323, 327 (1995); United States v. Burke,

504 U.S. 229, 233 (1992); Commissioner v. Glenshaw Glass Co., 348

U.S. 426, 431 (1955). As applicable here, section 104(a)(2)

excludes from gross income, among other items, damages received

pursuant to a settlement “on account of personal physical

injuries or physical sickness”.

Qualification for the section 104(a)(2) exclusion is

predicated on a bipartite analysis, examining whether (1) the

underlying claims were based on tort or tort type rights, and (2)

the damages were received on account of personal physical
 -8-

injuries or physical sickness. Commissioner v. Schleier, supra

at 337; sec. 1.104-1(c), Income Tax Regs. This reformulation of

the two-part test set forth in Schleier incorporates the

amendment to section 104(a)(2) pursuant to the Small Business Job

Protection Act of 1996, Pub. L. 104-188, sec. 1605, 110 Stat.

1838, (the SBJPA amendment), narrowing the exclusion formerly

applying to personal injury damages to those that are physical in

nature. Besides the imposition of this additional prerequisite

into the second prong, the applicable analysis is not otherwise

altered by the SBJPA amendment. Shaltz v. Commissioner, T.C.

Memo. 2003-173; Prasil v. Commissioner, T.C. Memo. 2003-100.

The determination as to whether damages received pursuant to

a settlement fall within the purview of the conjunctive two-prong

test is a factual one. Robinson v. Commissioner, 102 T.C. 116,

126 (1994), affd. in part, revd. in part, and remanded on another

issue 70 F.3d 34 (5th Cir. 1995). Extending beyond the “four

corners” of the settlement documentation, the pertinent analysis

entails a consideration of extrinsic factors informative of the

nature of the underlying claims discharged by the settlement.

Id.; see also Bagley v. Commissioner, 105 T.C. 396, 406 (1995)

(“The critical question is, in lieu of what was the settlement

paid[?]”), affd. 121 F.3d 393 (8th Cir. 1997); Threlkeld v.

Commissioner, 87 T.C. 1294, 1306 (1986), affd. 848 F.2d 81 (6th

Cir. 1988). Relevant extrinsic factors include the details
 -9-

surrounding the litigation, the allegations contained in the

complaint, and the course of the settlement negotiations between

the parties. Robinson v. Commissioner, supra at 127-128.

Express allocations in a settlement, identifying payment

amounts deemed eligible for the section 104(a)(2) exclusion, are

generally accorded conclusive effect for tax purposes. Fono v.

Commissioner, 79 T.C. 680, 693-694 (1982), affd. without

published opinion 749 F.2d 37 (9th Cir. 1984). However, the

statutory proviso contained in the penultimate sentence of

section 104(a) dictates one exception to this principle of

judicial deference to manifest allocations. The penultimate

sentence of section 104(a) provides: “For purposes of paragraph

(2), emotional distress shall not be treated as a physical injury

or physical sickness.”

As elucidated in the legislative history of the SBJPA

amendment, “emotional distress” denotes “symptoms (e.g.,

insomnia, headaches, stomach disorders) which may result from

such emotional distress.” H. Conf. Rept. 104-737, at 301 n.56

(1996), 1996-3 C.B. 741, 1041 n.56. To ascertain whether

settlement proceeds fall within the section 104(a)(2) “physical

injuries or physical sickness” rubric--as opposed to ineligible

payments stemming from physical manifestations of emotional

distress--the caselaw surveys the circumstances surrounding the

origin of the injury redressed in the settlement for a sufficient
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nexus, or “direct causal link”, between the amount paid and the

asserted physical injury. See Lindsey v. Commissioner, 422 F.3d

684, 688 (8th Cir. 2005) (“We agree with the Tax Court that these

health symptoms [i.e., fatigue, indigestion, insomnia, and

incontinence] relate to emotional distress, and not to physical

sickness.”), affg. T.C. Memo. 2004-113; Banaitis v. Commissioner,

340 F.3d 1074, 1080 (9th Cir. 2003), affg. in part and revg. in

part on a different issue T.C. Memo. 2002-5; Allum v.

Commissioner, T.C. Memo. 2005-177 (“The mere mention of ‘personal

physical injury’ in a complaint does not, by itself, serve to

exclude the recovery from gross income under section

104(a)(2)”.).

Judicial approbation of express settlement allocations for

Federal income tax purposes is also not warranted where

circumstantial factors reveal that the designation of the

settlement proceeds was not the result of adversarial, arm’s

length, and good faith negotiations, and is incongruous with the

“economic realities” of the taxpayer’s underlying claims. See

Bagley v. Commissioner, supra at 406-410.

Notably, the final sentence of section 104(a) subsumes

within the scope of the section 104(a)(2) exclusion settlement
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proceeds designated as reimbursement for medical care

attributable to the treatment of emotional distress. The record

does not disclose any such proceeds, as discussed infra.

Petitioner contends that the express characterization of the

disputed settlement amount is dispositive for purposes of the

applicability of the section 104(a)(2) exclusion. While not

apparent from the nature of the two causes of action underlying

petitioner’s complaint, petitioner asserts that the disputed

settlement amount was remitted to compensate him for various

debilitating physical ailments (i.e., migraine headaches,

stomachaches, and hand numbness) developed as a result of

repeated, vehement verbal assaults by the District’s Deputy Mayor

Carolyn Graham (the putative Graham assault).

For the reasons delineated below, we do not endow the

settlement’s characterization of the disputed settlement amount

with dispositive effect for purposes of the applicability of the

section 104(a)(2) exclusion. In brief, the record is devoid of

conclusive proof necessary to establish the requisite causal link

between petitioner’s averred maladies and the payment of the

disputed settlement amount. This evidentiary insufficiency

vitiates petitioner’s contention that his illness was symptomatic

of the species of ailments which are physical in nature within

the scope of the section 104(a)(2) exclusion. Additionally,

circumstantial evidence identified below indicates that the
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settlement allocation was not the result of quid pro quo

negotiations, but the product of unfettered, unilateral

draftsmanship by petitioner, who formulated the provision solely

for tax considerations.

Furthermore, the allocation of the disputed settlement

amount does not satisfy the exclusion provided in the final

sentence of section 104(a) concerning reimbursement of expenses

for emotional distress-related medical treatment. While the

allocation of the disputed settlement amount identifies “out-of-

pocket” expenses as a general, catchall compensatory item, in

addition to the payments specified as “pursuant to section

104(a)(2)”, the record contains no evidence reflecting any

medical expenses petitioner may have incurred.

The bona fide nature of petitioner’s averred symptoms was

substantiated by the testimony of Arabella Teal (Teal), a former

official in the District’s Office of the Corporation Counsel and

the District’s principal representative in the settlement. In

stating that she could not recall requesting, receiving, or

reviewing any medical documentation corroborating petitioner’s

illness, Teal remarked that the settlement discussions did

include petitioner’s “emotional and physical reaction to what had

happened, because that’s one of the things that [the District]

had to evaluate in terms of deciding whether to settle the case.”

(Emphasis added.) Teal stated that although she may have
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neglected to confirm independently petitioner’s physical

condition, she did not doubt the veracity of his alleged health

complications, because she regarded petitioner’s representative

as a prominent, trustworthy attorney and observed petitioner in

what may be inferred to have been impaired physical health.

Teal’s testimony excerpted above conflates petitioner’s

emotional suffering with the consequent physical reaction

petitioner experienced as a result of that trauma. This

illustrates the fact that the District conceived of petitioner’s

illness, although evidently grievous, as emanating from a

physical manifestation of emotional distress encompassed within

the limitation set forth in the penultimate sentence of section

104(a). Petitioner’s divergent positions during the course of

the proceedings regarding the cause of his injuries further

indicate that his symptoms exhibit the hallmarks of a stress-

induced condition. At trial, petitioner testified that negative

publicity engendered by the Washington Post’s investigative

reports was a substantial contributing factor to the onset of his

ailments:

Q You testified that you had a physical and
emotional reaction to this whole process. Did this
publicity have any effect on that, and if so, what?

A Yes. This was a significant component of the
whole problem. * * * But there is my name in The
Washington Post. You know, my name is at the city
council hearing when they had the investigation. So
yes, all this publicity had a huge impact on me.
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By contrast, petitioner’s brief attributes his symptoms

exclusively to the putative Graham assault: “Ms. Graham’s

offensive conduct was the only predicate for the injuries * * *

[petitioner] sustained, and, hence, the basis for the * * *

[District’s] decision to settle * * * [petitioner’s] claim for

physical pain and suffering.”

Additionally, the allocation of the disputed amount was not

apparently contested by the District during the course of the

settlement negotiations with petitioner, and thus, the

designation of the proceeds is not consonant with the nature of

petitioner’s underlying claims. Petitioner’s complaint against

the District contains no mention or allusion to the putative

Graham assault. Petitioner’s explanation for such conspicuous

omission was that the complaint, which was never served on the

District, was filed close to the expiration of the period of

limitations for one or both of the causes of action, and was

drafted in a sterile manner without reference to the putative

Graham assault so as not to disrupt the progress of the

settlement negotiations. Apart from petitioner’s self-serving

testimony, however, there is no evidence present in the record to

establish that the putative Graham assault ever occurred.

Moreover, Teal testified at trial that the District’s

standard settlement agreements, utilized to resolve disputes of a

similar nature to that involving petitioner, were relatively
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brief and rudimentary in format, and did not specify the

designation of the compensatory damage payments. According to

Teal’s recollection at trial, she perceived of the

characterization of the disputed settlement amount as outside the

scope of the controversy between the District and petitioner.

Teal had been informed that the settlement allocation did not

present any potential adverse ramifications for the District

because, irrespective of the express settlement allocation, the

District would defer to respondent’s ultimate determination of

the applicability of the section 104(a)(2) exclusion.

Petitioner asserts that the characterization of the disputed

settlement amount was the result of quid pro quo negotiation

because petitioner’s municipal income tax liability, derived from

his computation of adjusted gross income for Federal income tax

purposes, would be correspondingly lower if the section 104(a)(2)

exclusion applied. The record contains no evidence, however,

that Teal was ever cognizant of or considered such diminishment

to the District’s municipal fisc.

Petitioner argues that the $31,750 designated as attorney’s

fees reimbursement is distinguishable from the remainder of the

disputed settlement amount because the attorney’s fees payment

was remitted directly to petitioner’s counsel. (Respondent

concedes, though, that the attorney’s fees compensation is

deductible as a miscellaneous itemized deduction.) The Supreme
 -16-

Court, in Commissioner v. Banks, 543 U.S. 426 (2005), found such

a feature of a settlement payment to be inconsequential under the

anticipatory assignment of income doctrine. Therefore, the total

disputed settlement amount of $135,000 must be included in

petitioners’ gross income.

3. Accuracy-Related Penalty

Respondent determined an accuracy-related penalty for

substantial understatement of income tax for the 2001 taxable

year. Section 6662 imposes a penalty of 20 percent on the

portion of an underpayment of tax attributable to any

“substantial understatement” of income tax. An understatement

(i.e., the excess of the amount of income tax required to be

shown on the return over the tax actually shown on the return,

less any rebate) is defined to be “substantial”, if it exceeds

the greater of 10 percent of the tax required to be shown on the

return or $5,000. Sec. 6662(d)(1)(A). A taxpayer is relieved of

the accuracy-related penalty “if it is shown that there was a

reasonable cause * * * and that the taxpayer acted in good

faith”. Sec. 6664(c)(1). The determination of whether the

taxpayer acted with reasonable cause and in good faith is made on

a case-by-case basis, taking into account all of the pertinent

facts and circumstances. Sec. 1.6664-4(b)(1), Income Tax Regs.

Generally, the most important factor is the extent of the

taxpayer’s efforts to assess the proper tax liability. Id.
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Petitioner contends that there was reasonable cause to rely

on the settlement’s explicit characterization of the disputed

settlement amount, particularly since a timely Form 1099 was not

provided to him. However, in qualifying the disputed settlement

amount as “non-taxable to the fullest extent permitted by law,”

the settlement contemplates that such allocation was not to be

conceived of as a definitive pronouncement for tax purposes.

(Emphasis added.) Additionally, petitioner presented no evidence

that he consulted with a professional tax adviser, or took any

other independent action, to confirm the treatment of the

disputed settlement amount under Federal tax law. In light of

our findings above concerning the nonadversarial nature of the

settlement negotiations and the dubious origin of petitioner’s

ailments, the mere fact that petitioner did not receive the Form

1099 does not establish the applicability of the reasonable cause

and good faith exception to the section 6662 penalty.

To the extent the parties’ Rule 155 computation reflecting

our findings above results in a recalculated tax satisfying

section 6662(d)(1), we hold petitioners liable for the

substantial understatement penalty.

4. Interest

Petitioners challenge respondent’s assessment of interest by

invoking section 6404(g), which mandates (in the case of a timely

filed return) the suspension of interest and penalties if
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respondent does not provide notice to the taxpayer identifying

the particular amount due and the basis for the liability within

a specified 18-month period. The applicable 18-month period

commences on the later of the due date of the return or the date

the return was filed (without regard to extensions). Sec.

6404(g)(1)(A). The temporary suspension of interest runs from

the day after the close of the 18-month period to the date which

is 21 days following respondent’s issuance of the explanatory

notice. Sec. 6404(g)(3).

Respondent argues that jurisdiction to consider petitioner’s

interest claim is not available here pursuant to section 6404(b),

which generally proscribes judicial review of claims for

abatement of an assessment of interest on income, estate or gift

tax. See Rev. Proc. 2005-38, 2005-28 I.R.B. 81.

It is respondent’s further contention that jurisdiction over

petitioner’s claim concerning suspension of interest under

section 6404(g) does not fall within the narrowly circumscribed

exception to section 6404(b) provided in section 6404(h).

Section 6404(h) authorizes jurisdiction over actions timely

brought by a taxpayer (who meets the requirements of section

7430(c)(4)(A)(ii)) challenging a final determination of

respondent concerning a claim for abatement of interest.

Respondent’s delegated scope of administrative review to consider

interest abatement claims under section 6404(e) is confined to
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those instances where respondent has made an interest assessment

and such assessment is attributable in whole or in part to “any

unreasonable error or delay” by respondent in performing a

“ministerial or managerial act”. Sec. 6404(e). Therefore,

according to respondent, because the limited exception to section

6404(b) set forth in section 6404(h) is predicated on the

issuance of a final determination concerning an interest

abatement claim, interest suspension claims under section 6404(g)

do not qualify because they are nondiscretionary. See Rev. Proc.

2005-38, supra.

The applicability of section 6404(b) to petitioner’s

interest suspension claim under section 6404(g) is not plainly

demonstrated by the statutory construction, since the

jurisdictional ban expressly governs abatement claims regarding

assessments of tax, and an assessment has yet to occur in this

case. However, irrespective of any perceived ambiguity inherent

in section 6404(b), it is a long-standing principle that this

Court generally lacks jurisdiction over issues involving

interest. Melin v. Commissioner, 54 F.3d 432, 434 (7th Cir.

1995); Bourekis v. Commissioner, 110 T.C. 20, 24-25 (1998); 508

Clinton St. Corp. v. Commissioner, 89 T.C. 352, 354 (1987).

Petitioners’ arguments comprise the bare assertion to their

entitlement to a suspension of interest under section 6404(g);

petitioners adduce no authority to override the well-established
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jurisdictional restrictions concerning interest matters.

Therefore, jurisdiction is not available to consider petitioners’

claims for suspension of interest pursuant to section 6404(g).

To reflect the foregoing and the concessions of the parties,

Decision will be entered

under Rule 155.