T.C. Summary Opinion 2007-106
UNITED STATES TAX COURT
REGINALD JAMES SMITH, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 8241-06S. Filed June 25, 2007.
Reginald James Smith, pro se.
Catherine G. Chang, for respondent.
PANUTHOS, Chief 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.
Pursuant to section 7463(b), the decision to be entered is not
reviewable by any other court, and this opinion shall not be
treated as precedent for any other case. Unless otherwise
indicated, subsequent section references are to the Internal
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Revenue Code in effect for the year in issue, and all Rule
references are to the Tax Court Rules of Practice and Procedure.
Respondent determined a deficiency in petitioner’s 2004
Federal income tax of $12,546. Respondent also determined an
accuracy-related penalty in accordance with section 6662(a) in
the amount of $2,509 for 2004. After concessions,1 the issues
for decision are: (1) Whether a settlement payment received by
petitioner is excludable from gross income under section 104(a);
and (2) whether petitioner is liable under section 6662(a) for an
accuracy-related penalty.
Background
Some of the facts have been stipulated and are so found.
The stipulation of facts and attached exhibits are incorporated
herein by this reference. At the time of the filing of the
petition, petitioner resided in Oakland, California.
Petitioner worked as a warehouse employee at Onyx
Environmental Services (hereinafter Onyx) from April 15, 2002
through November 2002 when he was terminated. On December 16,
2003, petitioner and another individual filed a complaint for
1
Respondent concedes that petitioner is not liable for
self-employment tax. Additionally, respondent introduced a Form
4340, Certificate of Assessments, Payments, and Other Specified
Matters, showing an assessment of tax on July 24, 2006, 2 months
after petitioner timely filed a petition with this Court.
Respondent was uncertain as to the basis for the assessment. We
presume that respondent has abated or will abate the assessment
and will make no further assessments until the decision of the
Court is final. See sec. 6213(a).
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damages for sexual and racial harassment, failure to take
reasonable steps to prevent and correct harassment, and
retaliation, against Onyx and petitioner’s former supervisor in
the Superior Court of the State of California, County of Contra
Costa. In his suit against Onyx, petitioner stated a prayer for
relief for compensatory damages, mental and emotional distress
damages, punitive damages, interest, attorney’s fees, and costs
of suit incurred.
In September 2004, petitioner reached a settlement agreement
with Onyx and petitioner’s former supervisor with respect to the
suit he filed on December 16, 2003. Pursuant to the settlement
agreement, Onyx paid petitioner $41,651.81 in 2004. Petitioner
timely filed his 2004 Federal income tax return, but he did not
report the amount received from the settlement on the return.
Respondent determined that $41,6512 was includable in
petitioner’s gross income and issued a notice of deficiency to
petitioner on March 13, 2006.
Discussion
In general, the Commissioner’s determinations set forth in a
notice of deficiency are presumed correct, and the taxpayer bears
the burden of proving that these determinations are in error.
Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933).
2
The 81-cent difference between the amount paid and listed
in the notice of deficiency is presumably due to rounding by
respondent.
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Pursuant to section 7491(a), the burden of proof as to factual
matters shifts to respondent under certain circumstances.
Because the facts are not in dispute, we decide this case without
regard to the burden of proof.
I. Taxability of Payment Petitioner Received
A taxpayer’s gross income includes all income from whatever
source derived unless excluded by a specific provision of the
Internal Revenue Code. Sec. 61(a). Gross income does not
include “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”. Sec. 104(a)(2). To qualify for this
exclusion, the taxpayer must demonstrate: (1) The underlying
cause of action giving rise to the recovery is based upon tort or
tort type rights; and (2) the damages were received on account of
personal physical injuries or physical sickness. Commissioner v.
Schleier, 515 U.S. 323, 337 (1995); Allum v. Commissioner, T.C.
Memo. 2005-177, affd. 99 AFTR 2d 2007-2527, 2007-1 USTC par 50489
(9th Cir. 2007). The terms “physical injury” and “physical
sickness” do not include emotional distress, except to the extent
of damages not in excess of the amount paid for medical care
attributable to emotional distress. Sec. 104(a); see also Prasil
v. Commissioner, T.C. Memo. 2003-100.
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When damages 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); Prasil v. Commissioner, supra. The 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). If the settlement agreement lacks express
language stating what the settlement amount was paid to settle,
we look to the intent of the payor, based on all the facts and
circumstances of the case, including the complaint that was filed
and the details surrounding the litigation. Knuckles v.
Commissioner, 349 F.2d 610, 613 (10th Cir. 1965), affg. T.C.
Memo. 1964-33; Allum v. Commissioner, supra.
Here, the settlement agreement provides that Onyx will pay
petitioner $41,651.81 in exchange for petitioner’s release and
discharge of all claims against Onyx. The settlement agreement
does not mention any physical injury or sickness. It refers
generally to “all issues and claims” surrounding petitioner’s
employment at Onyx, and releases Onyx from “all claims, rights,
demands, actions, obligations, and causes of action of any and
every kind, known or unknown” by petitioner.
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Looking beyond the settlement agreement, we likewise find no
indication that Onyx intended the $41,651.81 to compensate
petitioner for physical injury. As mentioned supra, the
complaint that petitioner filed in State court alleges sexual and
racial harassment, failure to take reasonable steps to prevent
and correct harassment, and retaliation, and the prayer for
relief requests compensatory damages, mental and emotional
distress damages, punitive damages, interest, attorney’s fees,
and costs incurred. The complaint says nothing about physical
injury or physical sickness sustained by petitioner. There is
nothing in the record linking the settlement proceeds to any
physical injury or sickness. Accordingly, respondent’s
determination on this issue is sustained. Based on our
resolution of this issue, we do not address whether the
underlying cause of the State court action was based upon tort or
tort type rights. See Allum v. Commissioner, supra.
II. Accuracy-Related Penalty Under Section 6662(a)
Section 6662(a) provides that a taxpayer may be liable for a
penalty of 20 percent of the portion of an underpayment of tax
attributable to negligence or disregard of rules or regulations.
Sec. 6662(a) and (b)(1). The term “negligence” includes any
failure to make a reasonable attempt to comply with the
provisions of the Internal Revenue Code. Sec. 6662(c). The term
“disregard” includes any careless, reckless, or intentional
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disregard. Id. The Commissioner bears the burden of production
with respect to the accuracy-related penalty. See sec. 7491(c);
Higbee v. Commissioner, 116 T.C. 438, 446 (2001).
An exception to the section 6662 penalty applies when the
taxpayer demonstrates: (1) There was reasonable cause for the
underpayment, and (2) the taxpayer acted in good faith with
respect to the underpayment. Sec. 6664(c). Whether the taxpayer
acted with reasonable cause and in good faith is determined by
the relevant facts and circumstances on a case-by-case basis.
See Stubblefield v. Commissioner, T.C. Memo. 1996-537; sec.
1.6664-4(b)(1), Income Tax Regs. “Circumstances that may
indicate reasonable cause and good faith include an honest
misunderstanding of fact or law that is reasonable in light of
all the facts and circumstances, including the experience,
knowledge, and education of the taxpayer.” Sec. 1.6664-4(b)(1),
Income Tax Regs. The most important factor is the extent of the
taxpayer’s effort to assess the proper tax liability.
Stubblefield v. Commissioner, supra; sec. 1.6664-4(b)(1), Income
Tax Regs.
As discussed above, petitioner worked for Onyx as a
warehouse employee, stocking and keeping inventory. After he was
terminated in 2002, petitioner had difficulty finding a new job.
Petitioner was evicted from his home and lived in his car for
several months because he could not pay the rent and had no other
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place to stay. Petitioner also fell behind on paying bills and
student loans. Although petitioner eventually found a new job,
it paid close to minimum wage and provided no health benefits.
Petitioner sustained at least one injury from an accident while
he was uninsured, and he had to pay the related expenses out of
pocket.
The record is unclear as to whether petitioner received the
Form 1099-MISC, Miscellaneous Income, issued by Onyx.3 Given the
circumstances described herein, it seems unlikely that petitioner
would have appreciated the significance of the Form 1099-MISC
even if he did receive it, even though failure to receive a Form
1099-MISC does not necessarily constitute reasonable cause for
failure to report income. See Goode v. Commissioner, T.C. Memo.
2006-48.
We find that petitioner’s termination from employment, his
eviction resulting in temporary homelessness, his health issues,
and the technical nature of the law as to the exclusion of income
under section 104 are factors that weigh in his favor. Viewing
all the facts and circumstances, including the experience,
knowledge, and education of the taxpayer, we conclude that
petitioner has demonstrated reasonable cause for failing to
3
The parties stipulated that petitioner received the
settlement proceeds, and that Onyx issued a Form 1099-MISC, which
was submitted as an exhibit. The record does not state that
petitioner actually received the Form 1099-MISC.
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report the settlement proceeds as income and that he acted in
good faith. See sec. 6664(c). Accordingly, he is not liable for
the accuracy-related penalty under section 6662(a).
To reflect the foregoing,
Decision will be entered
under Rule 155.