Green v. Comm'r

T.C. Memo. 2007-39

UNITED STATES TAX COURT

MARCIA S. GREEN, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 10906-05. Filed February 20, 2007.

David S. Eisenmann, for petitioner.

Jeremy L. McPherson, for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

KROUPA, Judge: Respondent determined a $909,044 deficiency

in petitioner’s Federal income tax for 2002 and a $181,809

accuracy-related penalty under section 6662(a).1 After

1
All section references are to the Internal Revenue Code in
effect for 2002, and all Rule references are to the Tax Court
(continued...)
 -2-

concessions,2 there are four issues for decision. The first

issue is whether a jury award from an employer-retaliation

lawsuit is excludable from petitioner’s income under section

104(a)(2) as damages received on account of personal physical

injury or physical sickness. We hold that it is not. The second

issue is whether petitioner must include in income the fee paid

from the jury award to the attorney who represented her in the

employer-retaliation lawsuit. We hold that she must. The third

issue is whether petitioner is liable for the accuracy-related

penalty under section 6662(a). We hold that she is. The fourth

issue is whether the jury award is community property under

California law. We hold that it is, and therefore one-half of

the jury award is not includable in petitioner’s income.

FINDINGS OF FACT

Some of the facts have been stipulated and are so found.

The stipulation of facts and the accompanying exhibits are

incorporated by this reference. Petitioner resided in Pacifica,

California, at the time she filed the petition.

Petitioner was a non-tenured lecturer in the Humanities

Department of San Francisco State University (the University) in

1
(...continued)
Rules of Practice and Procedure, unless otherwise indicated. All
dollar amounts are rounded to the nearest dollar.
2
Respondent conceded the accuracy-related penalty relating
to the underpayment of tax attributable to the portions of the
jury award petitioner included in income and paid her attorney.
 -3-

1996. The Humanities Department had an opening for a tenure

track position at that time. Petitioner applied but was not

selected for the position. Petitioner filed grievances against

the University with her union and with California’s Department of

Fair Employment and Housing alleging discrimination in the hiring

process, but her filing the grievances did not change the hiring

decision. The University then effectively terminated

petitioner’s employment, refusing to assign her any courses

beginning the fall 1997 semester. Petitioner retained attorney

Geoffrey Faust to represent her in a lawsuit against the

University.

Lawsuit and Jury Award for Damages

Petitioner filed a complaint against the University.

Petitioner alleged in the complaint that she had been denied the

tenure track position as a result of discrimination in violation

of the California Fair Employment and Housing Act (FEHA), Cal.

Govt. Code sec. 12900-12996 (West 2005). She also alleged that

the University retaliated against her for complaining about the

hiring process by effectively terminating her position, again in

violation of FEHA. Petitioner asserted in the complaint that she

“suffered emotional distress and injury to her professional

reputation” as a result of the University’s actions. Nowhere in

the complaint, however, did petitioner allege that she suffered

personal physical injury or physical sickness, and nowhere in the
 -4-

complaint did she allege that she was entitled to recover any

amount from the University for any such personal physical injury

or physical sickness.

The jury found, after a month-long trial, that the

University had not discriminated against petitioner, but that the

University had retaliated against her for complaining of

discrimination. The jury found that petitioner suffered $1.5

million of economic damages and $65,000 of non-economic damages

from the University’s retaliation. “Economic damages,” for

California juries, means objectively verifiable monetary losses

including loss of earnings, loss of employment, and loss of

employment opportunities. See California Jury Instructions,

Civil: Book of Approved Jury Instructions, 14.00 (9th ed. 2003).

“Non-economic damages,” for California juries, means subjective

non-monetary losses including, among other things, pain,

suffering, mental suffering, emotional distress, and injury to

reputation. Id. The jury’s verdict did not contain any

reference to personal physical injury or physical sickness.

The State of California appealed the decision but lost.

Nowhere in the opinion did the appellate court mention any claim

or damages awarded for personal physical injury or physical

sickness.
 -5-

Attorney’s Fees and Payment

The trial court granted petitioner’s attorney’s motions for

attorney’s fees under FEHA’s fee-shifting statute. The State of

California ultimately paid petitioner $2,349,039 (the jury award)

in 2002, which included the economic and non-economic damages,

statutory attorney’s fees, and interest. The attorney’s fees

under FEHA’s fee-shifting statute plus interest thereon totaled

$537,841. Petitioner agreed, however, to pay Mr. Faust a fee of

40 percent of the jury award, $928,576. The State of California

also issued petitioner Form 1099-MISC, Miscellaneous Income, to

report the $2,355,039 jury award.3

Petitioner and her husband met with attorney Robert Wood to

discuss the tax implications of the jury award. Mr. Wood is a

nationally renowned expert on the taxation of legal awards.

Before the meeting, Mr. Wood reviewed several documents related

to the trial and the Form 1099-MISC the State issued to

petitioner. The record is not clear what tax advice, if any, Mr.

Wood rendered.

The Income Tax Return for 2002 and the Deficiency Notice

Petitioner and her husband timely filed tax returns for 2002

as married persons filing separately. Petitioner and her husband

3
The amount of the check is $6,000 less than the amount on
the Form 1099-MISC, Miscellaneous Income. Respondent concedes
that petitioner did not actually receive, and is therefore not
taxable on, this $6,000.
 -6-

have been married since 1979 and have been living together in

California at all times relevant to this case.

Petitioner reported $437,368 of gross wages for 2002.

Petitioner did not attach a statement to the return describing

the jury award or any authority for excluding from income any

portion of the jury award. She attached only Form W-2, Wage and

Tax Statement, issued by the State reporting $11,508 of wages

paid to petitioner in 2002. There was no way to determine from

the return or from any attachment to the return the source of the

other $425,860 of wage income petitioner reported. Petitioner’s

husband did not include any portion of the jury award in his

income.

Respondent determined in a deficiency notice that petitioner

should have included the jury award in income4 and that

petitioner is liable for an accuracy-related penalty for

substantial understatement of income tax for 2002. Petitioner

timely filed a petition.

OPINION

We are asked to decide whether any portion of the jury award

is excludable from gross income and whether petitioner is liable

for an accuracy-related penalty. We are also asked to decide

whether the jury award is community property under California

law. We begin with the burden of proof.

4
Respondent has since conceded that petitioner did include
$425,860 of the jury award in income.
 -7-

I. Burden of Proof

In general, the Commissioner’s determinations in the

deficiency notice are presumed correct, and the taxpayer bears

the burden of proving that the Commissioner’s determinations are

in error. Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115

(1933). Petitioner did not assert that the burden shifted to

respondent under section 7491(a) and did not establish that she

fully complied with the requirements of section 7491(a)(2). We

therefore find that the burden of proof remains with petitioner,

except as otherwise conceded by respondent.5

II. Exclusion Under Section 104(a)(2)

We now consider whether petitioner may exclude the jury

award from gross income under section 104(a)(2).6 Gross income

generally includes all income from whatever source derived. Sec.

61(a). The definition of gross income is broad in scope.

Commissioner v. Glenshaw Glass Co., 348 U.S. 426, 430 (1955).

Exclusions from gross income, however, are narrowly construed.

Commissioner v. Schleier, 515 U.S. 323, 328 (1995).

5
Respondent concedes he has the burden of proof with respect
to the community property issue because he raised the issue for
the first time after petitioner filed the petition.
6
We apply sec. 104(a)(2) as amended in 1996 by the Small
Business Job Protection Act of 1996 (SBJPA), Pub. L. 104-188,
sec. 1605(a), 110 Stat. 1838, effective generally for amounts
received after Aug. 20, 1996. That amendment, in relevant part,
added the modifier “physical” after “personal” and before
“injuries,” to clarify that amounts received on account of
personal injuries must be received for physical injuries and not
solely for emotional distress. Id.
 -8-

A legal award may be excluded from income if two conditions

are met. Id. at 337. A legal award may be excluded if the

underlying cause of action is based upon tort or tort-type

rights, and if the proceeds were for damages received on account

of personal physical injury or physical sickness.7 Id.

Emotional distress is not a personal physical injury or physical

sickness. Sec. 104(a)(2) (flush language).

The parties agree that petitioner’s underlying cause of

action is based upon tort or tort-type rights. Accordingly, the

first condition is met. The parties dispute, however, whether

any portion of the economic or non-economic damages from the jury

award was for damages received on account of personal physical

injury or physical sickness.

Petitioner did not allege in the complaint against the

University that she suffered personal physical injury or physical

sickness as a result of its discrimination or retaliation, or

that she was entitled to recover any amount from the University

for any such personal physical injury or physical sickness. In

addition, the jury’s verdict did not contain any reference to

personal physical injury or physical sickness. The jury awarded

petitioner $1.5 million of economic damages to compensate her for

the loss of earnings, loss of employment, and loss of employment

7
The Supreme Court in Commissioner v. Schleier, 515 U.S. 323
(1995), analyzed sec. 104(a)(2) before its amendment by the SBJPA
sec. 1605(a), when the restrictive modifier “physical” was added
to limit the scope of “personal injuries”.
 -9-

opportunities caused by her former employer’s retaliation. The

jury also awarded petitioner $65,000 of non-economic damages to

compensate her for the emotional distress and the injury to her

reputation caused by her former employer’s retaliation. Neither

the economic nor the non-economic damages portion of the award

compensated petitioner for personal physical injury or physical

sickness. Moreover, petitioner did not offer any documentation

of medical expenses incurred for the treatment of her emotional

distress. Finally, the California appellate court did not

mention any claim or damages awarded for personal physical injury

or physical sickness.

We conclude that no portion of the jury award was for

damages received on account of personal physical injury or

physical sickness. Petitioner is therefore not entitled to

exclude any portion of the jury award from income for 2002 under

section 104(a)(2).

III. Exclusion of Attorney’s Fees

We now consider whether petitioner must include in income

the amount of the jury award paid to Mr. Faust as an attorney’s

fee. A litigant generally may not exclude the portion of a

recovery paid to his or her attorney where, as here, the

litigant’s recovery constitutes income. Commissioner v. Banks,

543 U.S. 426, 436-437 (2005). This is true whether the

attorney’s fee was paid on a contingent fee basis or under a fee-
 -10-

shifting statute. Sinyard v. Commissioner, 268 F.3d 756 (9th

Cir. 2001), affg. T.C. Memo. 1998-364; Vincent v. Commissioner,

T.C. Memo. 2005-95.

Petitioner agreed to pay Mr. Faust 40 percent of the jury

award, which percentage amounted to $928,576. Petitioner

stipulated that $537,841 of that amount represented the funds

received under FEHA’s fee-shifting statute. Subtracting $537,841

from $928,576 leaves a $390,735 remainder. Petitioner argues

that she is entitled to exclude from income the entire amount

paid to Mr. Faust. We disagree.

The $537,841 portion paid pursuant to FEHA’s fee-shifting

statute is not excludable under Sinyard v. Commissioner, supra,

and Vincent v. Commissioner, supra. Petitioner failed to

distinguish Sinyard or Vincent, both of which we find

controlling.

We next consider the $390,735 additional amount paid to Mr.

Faust. Petitioner admits that she did not enter into a written

fee agreement with her attorney at the start of the

representation. Petitioner also admits that, after the State of

California paid her the jury award, she orally agreed to pay Mr.

Faust 40 percent of the jury award. Petitioner argues that she

did not pay her attorney a contingent fee because the agreement

between her and Mr. Faust was reached after she received the jury

award. A contingent fee is present, however, if an attorney
 -11-

agrees to represent a client for compensation determined as a

percentage of the amount recovered. Black’s Law Dictionary 614

(6th ed. 1990). We find that the $390,735 additional amount was

a contingent fee.

We conclude that petitioner is not entitled to exclude any

of the attorney’s fee from income whether paid under FEHA’s fee-

shifting statute or on a contingent fee basis.

IV. Accuracy-Related Penalty

We next consider whether petitioner is liable for the

accuracy-related penalty under section 6662(a). Respondent

argues that the accuracy-related penalty should apply

to the $393,862 underpayment of income tax attributable to

$994,602 of the jury award that petitioner incorrectly excluded

from income. Respondent has the burden of production under

section 7491(c) and must come forward with sufficient evidence

that it is appropriate to impose the accuracy-related penalty.

See Higbee v. Commissioner, 116 T.C. 438, 446-447 (2001).

A taxpayer is liable for an accuracy-related penalty for any

portion of an underpayment attributable to, among other things, a

substantial understatement of income tax. Sec. 6662(a) and (b).

There is a substantial understatement of income tax under section

6662(b)(2) if the amount of the understatement exceeds the

greater of either 10 percent of the tax required to be shown on
 -12-

the return, or $5,000. Sec. 6662(a), (b)(1) and (2), (d)(1)(A);

sec. 1.6662-4(a), Income Tax Regs.

Respondent has met his burden of production with respect to

petitioner’s substantial understatement of income tax. The

record indicates that petitioner reported income tax of $152,689.

Petitioner’s underpayment for which respondent seeks to apply

the accuracy-related penalty is $393,862. The tax required to be

shown on the return, for purposes of determining if there was a

substantial understatement of income tax here, is the sum of

these two amounts, $546,551. Ten percent of the tax required to

be shown on the return is $54,655. Petitioner’s understatement

is greater than $54,655. Accordingly, petitioner’s underpayment

of income tax is a substantial understatement.

The accuracy-related penalty under section 6662(a) does not

apply to any portion of an underpayment if the taxpayer proves

that there was reasonable cause for his or her position and that

he or she acted in good faith with respect to such portion. Sec.

6664(c)(1); Higbee v. Commissioner, supra at 446; sec. 1.6664-

4(a), Income Tax Regs. The determination of whether a taxpayer

acted with reasonable cause and in good faith is made on a case-

by-case basis, taking into account all the pertinent facts and

circumstances, including the taxpayer’s reasonable reliance on a

professional tax adviser. Sec. 1.6664-4(b)(1), Income Tax Regs.
 -13-

A taxpayer reasonably relied on a professional tax adviser

if the adviser was a competent professional who had sufficient

expertise to justify the taxpayer’s reliance on him or her, the

taxpayer provided necessary and accurate information to the

adviser, and the taxpayer relied in good faith on the adviser’s

judgment. See Neonatology Associates, P.A. v. Commissioner, 115

T.C. 43, 99 (2000), affd. 299 F.3d 221 (3d Cir. 2002). A

taxpayer generally must prove each of these elements to show his

or her reliance on a professional tax adviser was reasonable.

Bowen v. Commissioner, T.C. Memo. 2001-47.

Petitioner argues that she reasonably relied on the advice

of a professional tax adviser, Mr. Wood. We disagree.

Petitioner proved that Mr. Wood is a competent professional who

had sufficient expertise to justify her reliance on him.

Petitioner did not show, however, that she provided all the

necessary and accurate information to Mr. Wood for him to

consider her situation and render tax advice. Moreover,

petitioner did not show that she relied in good faith on Mr.

Wood’s tax advice because she did not establish what tax advice,

if any, Mr. Wood rendered. We therefore do not find that

petitioner reasonably relied on a professional tax adviser.

After considering all the facts and circumstances, we find

that petitioner has failed to establish that she had reasonable

cause and acted in good faith with respect to the underpayment of
 -14-

income tax attributable to the portion of the jury award she

incorrectly excluded from income. Accordingly, we conclude that

the accuracy-related penalty applies to that portion.

V. Whether The Jury Award Is Community Property

We finally consider whether the jury award is community

property under California law, an issue that respondent raised

for the first time after petitioner filed the petition. Married

persons residing in California generally have a one-half interest

in all property acquired during their marriage. Cal. Fam. Code

sec. 760 (West 2004). Spouses residing in California filing

separate returns generally must each report on the returns one-

half of all income the married couple earned during the year.

United States v. Mitchell, 403 U.S. 190, 196-197 (1971).

A legal award is community property if it is in satisfaction

of a personal injury claim and if the cause of action arose

during the marriage. Cal. Fam. Code sec. 780 (West 2006). A

legal award is separate property only if it is in satisfaction of

a personal injury claim and if the cause of action arose after

the spouses were separated or divorced or while they were living

apart. Cal. Fam. Code sec. 781 (West 2006). A personal injury

claim arises from any tortious injury to a protected personal

interest. In re Marriage of Klug, 130 Cal. App. 4th 1389, 1397

n.3 (Ct. App. 2005) (finding legal malpractice a personal injury

claim).
 -15-

Spouses may change community property into separate property

of either spouse. Cal. Fam. Code sec. 850 (West 2004). The

change must be documented in a writing signed by the spouse whose

interest in the property is adversely affected. Cal. Fam. Code

sec. 852(a) (West 2006).

Petitioner’s retaliation claim is a personal injury claim

within the meaning of California community property law. The

claim arose from the University’s tortious injury to petitioner’s

protected interests in her emotional well-being and her

professional reputation. The record also establishes that

petitioner and her husband were married and living together when

her cause of action against the University arose, were residents

of California, and filed separate returns for 2002. Finally,

petitioner and her husband did not change the award from

community property to her separate property because, as

petitioner and her husband testified, there is no written

agreement signed by petitioner’s husband signifying the change.

We find that respondent proved the jury award is community

property. Petitioner, having filed a separate return from her

husband for 2002, has to include only one-half of the jury award
 -16-

in income.8 Petitioner’s deficiency should be reduced

accordingly, and the accuracy-related penalty adjusted as well.

To reflect the foregoing and respondent’s concessions,

Decision will be entered

under Rule 155.

8
We note that sec. 66 does not change this result because
the requirements of neither subsec. (a) nor (b) are
met. Specifically, petitioner and her husband were not living
apart, and petitioner’s husband knew of the jury award before
petitioner filed the return for 2002.