T.C. Summary Opinion 2006-51
UNITED STATES TAX COURT
JOHN BOTHE AND BARBARA BOTHE, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 6737-04S. Filed April 12, 2006.
Stanley Pressment, for petitioners.
Michelle L. Maniscalco, for respondent.
CARLUZZO, Special Trial Judge: This case was heard pursuant
to the provisions of section 7463 of the Internal Revenue Code in
effect at the time the petition was filed. Unless otherwise
indicated, subsequent section references are to the Internal
Revenue Code in effect for 1999. Rule references are to the Tax
Court Rules of Practice and Procedure. The decision to be
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entered is not reviewable by any other court, and this opinion
should not be cited as authority.
Respondent determined a $25,056 deficiency in petitioners’
1999 Federal income tax. All adjustments that give rise to the
deficiency have been agreed upon by the parties-–their dispute
involves an item reported on petitioners’ 1999 Federal income tax
return. John Bothe (petitioner) sued his former employer.
Petitioners included the settlement proceeds from that lawsuit in
the income reported on their 1999 return. They now take the
position that it was a mistake to have done so. The issue for
decision is whether those settlement proceeds are excludable from
income pursuant to section 104(a)(2).
Background
Some of the facts have been stipulated and are so found.
Petitioners are married to each other. They filed a timely joint
1999 Federal income tax return. At the time the petition was
filed in this case, they resided in Corfu, New York.
Years ago, at age 19, petitioner began working at the New
Jersey Sports and Exposition Authority, a.k.a. the Meadowlands
racetrack (the Meadowlands). In 1979, he became an assistant
race track announcer there. In 1990, petitioner became the
head race track announcer. Starting as teenager and continuing
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throughout his employment at the Meadowlands, petitioner suffered
from migraine headaches, a condition known to his supervisors at
the Meadowlands.
Over the years, petitioner’s migraine headaches have been so
severe that at times he required hospitalization. Petitioner’s
migraine headaches have caused panic attacks, as well as feelings
of anxiety and depression. In addition to other health problems,
petitioner’s migraine headaches also caused problems with his
voice.
Petitioner began betting on horse races as a teenager.
During his employment at the Meadowlands, petitioner “was running
to the window all the time in between races and making bets.”
After petitioner’s gambling habit began to affect his work
performance, he was told by Meadowlands management that he needed
professional help to deal with his gambling problem. In 1991,
petitioner began treatment for compulsive gambling. In 1992,
petitioner joined Gamblers Anonymous.
In February 1998, petitioner lost his voice and had trouble
with his eyesight. As a result, petitioner missed approximately
a month and a half of work. The Meadowlands placed petitioner on
paid temporary disability during this time and encouraged him to
seek treatment. After undergoing treatment from several doctors,
petitioner ultimately returned to work at the Meadowlands. The
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Meadowlands made special accommodations for petitioner which
included a custom binoculars stand and a larger television
monitor. According to petitioner, the Meadowlands was “really
being accommodating.”
In December 1998, the Meadowlands asked petitioner to
participate in a television program to report on various aspects
of the Meadowlands horse races. In addition to his duties as a
race track announcer, the Meadowlands requested that petitioner
interview horse owners and trainers and handicap the horse races.
Petitioner declined to participate in the television program
because he believed it would jeopardize the ongoing treatment for
his gambling addiction. Petitioner’s doctors also advised him
against any involvement in handicapping the horse races.
After petitioner declined to accept the additional job
duties, the Meadowlands informed petitioner that his salary would
be reduced. At that time, petitioner consulted an attorney. By
letter dated December 31, 1998, petitioner’s attorney notified
the Meadowlands that petitioner’s “addiction to gambling would be
considered a handicap” and that it is “unlawful for employers to
discriminate against persons on the basis of either a mental or
physical handicap.” Nevertheless, petitioner’s salary was
reduced as threatened.
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On February 8, 1999, petitioner filed a complaint against
the Meadowlands (the original complaint) in the Superior Court of
New Jersey, Morris County (the lawsuit). The original complaint
advances two causes of action: (1) Employment discrimination;
and (2) intentional infliction of emotional distress. Petitioner
sought the following relief with respect to the employment
discrimination: (1) Reinstatement of his previously-in-effect
employment conditions; (2) an injunction restraining the
Meadowlands from further violations of the New Jersey Law Against
Discrimination, N.J. Stat. Ann. 10:5-1 through 10:5-49 (West
2002); (3) damages for lost income and medical and fringe
benefits; (4) compensation for injury to petitioner’s
professional stature and loss of public esteem; (5) compensation
for petitioner’s reduced prospects for future employment; (6)
reasonable attorney’s fees and litigation costs; and (7) punitive
damages. With respect to the count alleging intentional
infliction of emotional distress, petitioner requested
compensatory and punitive damages. Petitioner remained employed
by the Meadowlands after he filed his complaint.
During March 1999, petitioner suffered severe migraines and
lost his voice. Sometime during or shortly before March 1999,
petitioner was placed on paid disability. On March 23, 1999,
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petitioner filed an amended complaint (the amended complaint) in
the lawsuit and included two executives/employees of the
Meadowlands as co-defendants. The amended complaint advances
three causes of action: (1) Employment discrimination; (2)
reprisal against petitioner by the Meadowlands for filing the
lawsuit; and (3) violation of the New Jersey Conscientious
Employee Protection Act, N.J. Stat. Ann. 34:19-1 through 34:19-8
(West 2000), by the two named executives/employees of the
Meadowlands.
With respect to the first two causes of action, petitioner
sought: (1) Damages for lost earnings, including medical and
fringe benefits; (2) damages for mental and emotional distress;
(3) compensation for injury to petitioner’s professional stature
and loss of public esteem; (4) compensation for petitioner’s
reduced prospects of future employment; (5) reasonable attorney’s
fees and litigation costs; and (6) punitive damages. Petitioner
also sought compensatory and punitive damages for mental and
emotional distress with respect to the third cause of action.
According to petitioner, “the whole basis of the lawsuit” was
that he “felt [he] was being discriminated because [he] was going
to Gamblers Anonymous.”
Ultimately, the lawsuit was settled. James H. Lockwood
(Mr. Lockwood), the Meadowlands’ associate counsel and longtime
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member of its legal department, participated in the settlement
negotiations. In order to settle the lawsuit, the Meadowlands
originally proposed that petitioner continue his employment with
the Meadowlands as a per diem employee, the common status of
other race track announcers at the Meadowlands, rather than a
full-time salaried employee. The Meadowlands further proposed a
5-year contract that would essentially pay petitioner his current
salary but provide no fringe benefits. In addition, petitioner
would work about 40 fewer nights during the year and not be
required to handicap the horse races. However, after petitioner
made negative comments about the Meadowlands to the local media,
the Meadowlands withdrew its proposal to allow petitioner to
continue in its employ as a per diem employee. The Meadowlands
resumed settlement negotiations with petitioner and his counsel
with the sole desire to end petitioner’s employment with the
Meadowlands. During the settlement negotiations, petitioner made
no request for compensation with respect to any physical injury
or physical sickness.
On June 30, 1999, petitioner and the Meadowlands entered
into a Settlement Agreement and General Release (the settlement
agreement). Under the terms of the settlement agreement,
petitioner generally released the Meadowlands from “all actions
or claims * * * arising out of [petitioner’s] employment with
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[the Meadowlands]” in exchange for: (1) Payments totaling
$225,000; and (2) his resignation as an employee of the
Meadowlands. The settlement agreement also states that the
Meadowlands and petitioner were entering into the settlement
agreement to avoid the costs of litigation. In the settlement
agreement, Meadowlands expressly denies any liability with
respect to the claims alleged by petitioner.
The settlement agreement makes no reference to a physical
injury or physical sickness resulting from the Meadowlands’
actions, nor does the settlement agreement specifically carve out
any portion of the settlement payment as a settlement on account
of personal physical injury or physical sickness.
Petitioner officially terminated his employment with the
Meadowlands on September 9, 1999. During 1999, petitioner
received settlement proceeds of $199,073 from the Meadowlands
(the settlement proceeds).
As previously noted, petitioners filed a timely joint 1999
Federal income tax return. The income reported on that return
includes the settlement proceeds. On April 23, 2001, petitioners
submitted a Form 1040X, Amended U.S. Individual Income Tax
Return, for the 1999 taxable year. On the 1999 amended return
petitioners excluded the settlement proceeds from their gross
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income.1 The 1999 amended return was treated as a claim for
refund and denied by respondent.
Discussion
Section 61(a) provides generally and broadly that gross
income includes all income from whatever source derived.
Exclusions from gross income must be specifically provided for
and 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 104(a) further provides that “emotional
distress shall not be treated as a physical injury or physical
sickness” for purposes of section 104(a)(2). “[T]he term
emotional distress includes 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.
Amounts are excludable from gross income under section
104(a)(2) only if: (1) The underlying cause of action giving
1
On the 1999 amended return, petitioners exclude
settlement proceeds of $199,702 from gross income and not
$199,073. The parties do not explain this difference. However,
this discrepancy is of no significance to our conclusion.
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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, supra at 336-337.2
We start our analysis with a focus on whether the settlement
proceeds were received on account of personal physical injuries
or physical sickness. According to petitioner, they were;
according to respondent, they were not. For the following
reasons, we agree with respondent.
The term “damages received”, as used in section 104(a)(2),
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. When damages are received
pursuant to a settlement agreement, as here, the nature of the
claim that was the actual basis for settlement, as opposed to the
validity of that claim, controls whether the amounts are
excludable under section 104(a)(2). United States v. Burke, 504
U.S. 229, 237 (1992); Bagley v. Commissioner, 105 T.C. 396, 406
2
Subsequent to Commissioner v. Schleier, 515 U.S. 323
(1995), Congress amended sec. 104(a) to provide that amounts are
excludable only if received “on account of personal physical
injuries or physical sickness”. Sec. 104(a)(2) (emphasis added);
Small Business Job Protection Act of 1996, Pub. L. 104-188, sec.
1605, 110 Stat. 1838, effective for amounts received after Aug.
20, 1996. Although the amendment narrows the scope of sec.
104(a)(2), it does not otherwise affect the analysis set forth in
Commissioner v. Schleier, supra. See Goode v. Commissioner, T.C.
Memo. 2006-48; Prasil v. Commissioner, T.C. Memo. 2003-100.
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(1995), affd. 121 F.3d 393 (8th Cir. 1997). Determining the
nature of the claim is a factual inquiry.3 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).
“[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, supra. An important factor in making
such determinations 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. Id.; Robinson v. Commissioner, supra
at 127.
Under the terms of the settlement agreement, petitioner
generally released the Meadowlands from “all actions or claims
* * * arising out of * * *[petitioner’s] employment with * *
*[the Meadowlands]” in exchange for the settlement proceeds and
his resignation as an employee of the Meadowlands. The
settlement agreement also states that the Meadowlands and
3
In their brief, petitioners take the position that sec.
7491(a) is applicable, and the burden of proof on this issue
rests with respondent. To the extent that it does, we find that
respondent has met that burden.
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petitioner were entering into the settlement agreement to avoid
the costs of litigation and that the Meadowlands expressly denied
any liability with respect to the claims alleged by petitioner.
The settlement agreement does not allocate any part of the
settlement payment to a personal physical injury or physical
sickness. Indeed, the settlement agreement makes no reference to
a physical injury or physical sickness resulting from the
Meadowlands’ actions, nor does the settlement agreement
specifically carve out any portion of the settlement payment as a
settlement on account of personal physical injury or physical
sickness. Although the settlement agreement provides that any
payment petitioner was to receive pursuant to the settlement “is
in the nature of compensation for any and all claims for alleged
personal injuries (pain and suffering) claimed by * * *
[petitioner]”, Mr. Lockwood testified that the Meadowlands did
not intend the settlement agreement to compensate petitioner for
any physical injury or physical sickness.
The amended complaint filed in the lawsuit also fails to
support petitioner’s position here. The amended complaint states
that “Specifically, the case involves discrimination against a
party afflicted with that species of mental and psychological
handicap commonly referred to as compulsive gambling.” The
complaint did not seek specific damages with respect to any
physical injury or physical sickness. Furthermore, petitioner
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testified that “the whole basis of the lawsuit” was that he “felt
[he] was being discriminated because [he] was going to Gamblers
Anonymous.”
Finally, we note that Mr. Lockwood testified that the
settlement payment was made to compensate petitioner for “lost
time” and so that “Mr. Bothe [would] cease to be employed by [the
Meadowlands] in any capacity”. Mr. Lockwood further testified
that at no time during the settlement negotiations did petitioner
allege that he had suffered any physical injury or physical
sickness as a result of his employment by the Meadowlands, nor
was it the Meadowlands’ intention to compensate petitioner for
any physical injury or physical sickness.
Mr. Lockwood’s testimony on these points is corroborated by
a statement in the settlement agreement that provides that, for
income tax purposes, the amount to be paid to petitioner is “in
the nature of compensation”.
Based upon the foregoing, we conclude that petitioner did
not receive the settlement payment on account of any personal
physical injury or physical sickness as those terms are used in
section 104(a)(2). Accordingly, we need not address whether the
underlying cause of action giving rise to the settlement was
based upon tort or tort-type rights. See Commissioner v.
Schleier, 515 U.S. at 337.
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We find that the settlement payment is not excludable from
petitioners’ 1999 income under the provisions of section
104(a)(2), and petitioners’ claim for a refund is denied.
Reviewed and adopted as the report of the Small Tax Case
Division.
To reflect the foregoing, and to ensure that any agreements
between the parties are properly taken into account,
Petitioners’ claim for refund
is denied, and decision will be
entered under Rule 155.