T.C. Summary Opinion 2007-126
UNITED STATES TAX COURT
JODY SCHOOLCRAFT-BURKEY, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 17437-06S. Filed July 24, 2007.
Jody Schoolcraft-Burkey, pro se.
Anita A. Gill and Cathy J. Horner, for respondent.
JACOBS, 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.1 Pursuant to section 7463(b),
1
Unless otherwise indicated, subsequent section references
are to the Internal Revenue Code in effect for the year in issue,
and Rule references are to the Tax Court Rules of Practice and
Procedure.
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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.
Respondent determined a $24,823 deficiency in petitioner’s
2003 Federal income tax and a $4,965 accuracy-related penalty
under section 6662. The issues for decision are: (1) Whether all
payments petitioner received from his former employer, Mahoning
Valley Economic Development Corp. (MVEDC), pursuant to the
settlement of a lawsuit are includable in income; (2) whether
petitioner may deduct attorney’s fees he paid in bringing a
lawsuit against MVEDC; (3) whether petitioner paid deductible
expenses which would offset income he received in the performance
of consulting services; and (4) whether petitioner is liable for
an accuracy-related penalty under section 6662.
Background
Some of the facts have been stipulated and are so found. The
stipulation of facts and the attached exhibits are incorporated
herein by this reference. At the time he filed his petition,
petitioner resided in Niles, Ohio.
Petitioner, as a married taxpayer filing separately, timely
filed a Form 1040, U.S. Individual Income Tax Return, for 2003 in
which he reported total income of $46,479, tax of $6,416, and tax
payments of $7,586. Both petitioner and his wife claimed the
standard deduction for 2003 in their separate returns.
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On the basis of third-party information reported to the IRS,
respondent determined that petitioner failed to report relatively
small amounts of capital gain/dividend income, interest income,
and pension/annuity income (investment income), as well as $17,818
of nonemployee consulting compensation and $58,000 of the $85,000
he received from MVEDC in connection with settlement of a lawsuit.
See infra. Petitioner concedes error in his failure to report the
various amounts of investment income, as well as the $17,818 of
nonemployee consulting compensation, but he disputes the
taxability of $58,000 of the $85,000 in settlement proceeds he
received from MVEDC, claiming that portion was nontaxable
compensation for personal injuries. Moreover, petitioner claims
entitlement to deductions for certain expenses in connection with
his lawsuit against MVEDC and in rendering his consulting
services.
From 1980 until he was dismissed on July 27, 2000, petitioner
was a loan officer for MVEDC. For several months before his
dismissal, petitioner had been cooperating with the FBI and the
U.S. Department of Justice in providing files, correspondence, and
other documents pertaining to certain of MVEDC’s activities. In
2003, petitioner brought suit against MVEDC2 for terminating his
2
Petitioner’s lawsuit, in addition to naming MVEDC, included
MVEDC’s executive director and treasurer and Mahoning Valley
Industrial Loan Fund as defendants.
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employment, alleging that his discharge was in retaliation for his
cooperation with Government officials.
In his complaint against MVEDC, petitioner claimed the
following: Breach of contract, intentional breach of contract,
infliction of emotional distress, promissory estoppel, principal
and agent relationship–-breach of fiduciary duty, breach of
fiduciary duty, equitable claim for unjust enrichment, public
policy and common law, tortious interference with contractual
relationship, and civil conspiracy. The complaint made no
reference to any State or Federal statute, such as a whistleblower
protection regime or civil rights legislation, as a possible basis
for relief. In his complaint, petitioner demanded, in addition to
equitable relief such as reinstatement, “compensatory damages in
an amount in excess of $25,000” and “punitive damages in an amount
in excess of $25,000.”
In connection with his claim based on intentional breach of
contract, petitioner alleged that he suffered “adverse health
effects”. In connection with his claim based on infliction of
emotional distress, petitioner alleged that he suffered “physical
injury in the form of adverse health effects.” In connection with
his claim based on public policy and common law, petitioner
alleged that he suffered “physical pain and distress”. The
complaint did not allege that petitioner sustained any other
personal physical injury or physical sickness, and it did not
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explain or describe the “adverse health effects”, “physical
injury”, or “physical pain” petitioner claimed to have suffered.
Petitioner entered into a settlement with MVEDC on or about
December 1, 2003, in which petitioner agreed to dismissal of his
lawsuit in exchange for $85,000. The settlement agreement
designated $27,000 of the $85,000 in settlement proceeds as “back
pay” or “lost wages”, and petitioner agrees that the $27,000 is
taxable.
The settlement agreement designated the remaining $58,000 of
the $85,000 as compensation for:
any emotional pain, suffering, inconvenience, mental anguish,
loss of enjoyment of life, fright, nervousness, indignity,
humiliation, embarrassment and other personal injuries that
Burkey claims to have suffered, as well as in exchange for
his release of any common law and statutory causes of action
for sexual harassment, sex or gender discrimination, age
discrimination, disability discrimination, personal injury,
retaliation, wrongful discharge, constructive discharge,
claims of discrimination or harassment on any basis, claims
alleging whistleblowing under state or federal law, claims of
breach of public policy, breach of fiduciary duty, breach of
express or implied contract, breach of any employment
agreement, conspiracy, interference with employment contract,
unjust enrichment, invasion of privacy, fraud, conversion,
intentional infliction of mental distress, promissory
estoppel, defamation, intentional interference with any
contract or business relationship and any other claims of any
kind that Burkey may possess against MVEDC.
The settlement agreement specified that MVEDC would not withhold
any taxes from the $58,000 portion of the $85,000 payment and that
MVEDC made “no representation or warranty whatsoever concerning
the tax consequences of Burkey’s receipt of any monetary payments
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from MVEDC”. MVEDC reported the $58,000 portion to the IRS by
means of Form 1099-MISC, Miscellaneous Income, as “other income”.
Petitioner did not report the $58,000 portion on his 2003 return.
At trial, petitioner continued to maintain that the $58,000
portion was compensation for personal injuries and not includable
in income. He further claimed that he was entitled to a deduction
for attorney’s fees he paid in connection with his lawsuit against
MVEDC. Additionally, petitioner claimed he paid deductible
expenses in connection with the production of the $17,818 in
consulting income. Finally, petitioner, who resided in a home
owned by his daughter and paid no rent to her in 2003, claimed
that rent he would have paid had he been required to pay rent,
together with an array of other expenses, was deductible and that
he should have deducted those expenses on a Schedule C, Profit or
Loss From Business,3 with his 2003 return.
3
Petitioner did not attach a Schedule C to his 2003 return.
At trial, petitioner submitted a handwritten page dated Apr. 14,
2007, captioned “Amended 2003 Schedule ‘C’”, on which deductions
totaling $14,498 for “rent, phone, advertising/ cards/supplies/
meals, mileage/travel, misc/membership” were listed. This
summary was revised during the trial to show a corrected total of
$11,065.50 of deductions for “rent, mileage/travel” and
“misc/membership”. In addition, at trial petitioner submitted a
statement in which he claimed a deduction for the “equivalent of
lost medical insurance coverage.”
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Discussion
Petitioner has neither claimed nor shown that he satisfied
the requirements of section 7491(a) to shift the burden of proof
to respondent. Hence, petitioner bears the burden of proving that
respondent’s deficiency determinations are incorrect. See Rule
142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933).
It is well established that, pursuant to section 61(a), gross
income includes all income from whatever source derived unless
otherwise excluded by the Internal Revenue Code. See Commissioner
v. Glenshaw Glass Co., 348 U.S. 426, 429-431 (1955). Exclusions
from gross income are construed narrowly. Commissioner v.
Schleier, 515 U.S. 323, 327-328 (1995). Generally, amounts
received for damages are excludable from gross income if: (1) The
taxpayer demonstrates that the underlying cause of action giving
rise to the recovery is based upon tort or tort type rights, and
(2) the taxpayer shows that the damages were received on account
of personal injuries or sickness. Id. at 336.
The specific exclusion upon which petitioner relies is found
in section 104. Section 104, as relevant here, provides:
SEC. 104. COMPENSATION FOR INJURIES OR SICKNESS.
(a) In General.--Except in the case of amounts
attributable to (and not in excess of) deductions
allowed under section 213 (relating to medical, etc.,
expenses) for any prior taxable year, gross income does
not include--
* * * * * * *
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(2) 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;
* * * * * * *
* * * For purposes of paragraph (2), emotional distress
shall not be treated as a physical injury or physical
sickness. * * * [4]
“Damages received” means amounts 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,
courts decide the purpose or purposes for which a payment was made
by considering, inter alia, the following: (1) The underlying
complaint and the nature of the claims; (2) the settlement
negotiations and settlement agreement; and (3) the intent of the
payor. See United States v. Burke, 504 U.S. 229, 237-239 (1992);
Thompson v. Commissioner, 866 F.2d 709, 711 (4th Cir. 1989), affg.
89 T.C. 632 (1987); Knuckles v. Commissioner, 349 F.2d 610, 612-
613 (10th Cir. 1965), affg. T.C. Memo. 1964-33; Bagley v.
4
Sec. 104 was amended by the Small Business Job Protection
Act of 1996, Pub. L. 104-188, sec. 1605, 110 Stat. 1838, to
provide, with respect to amounts received after Aug. 20, 1996,
that the personal injury or sickness for which the damages are
received must be physical in nature.
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Commissioner, 105 T.C. 396, 406 (1995), affd. 121 F.3d 393 (8th
Cir. 1997).
Petitioner’s complaint does not specify the physical injury
he suffered as a result of MVEDC’s conduct. There is nothing in
the record to indicate that petitioner either suffered a
particular physical injury or physical sickness or informed MVEDC
that he was suffering from a particular physical injury or
physical sickness as a result of his discharge. In fact, the
settlement agreement does not refer to physical injury or physical
sickness. Rather, it enumerates other types of injuries such as
emotional pain, suffering, inconvenience, mental anguish, etc., as
well as injuries that petitioner never alleged, such as sexual
harassment and discrimination. Hence, it appears that MVEDC’s
intent in entering into the settlement agreement was to secure a
broad, general release from petitioner, rather than to compensate
him for physical injury or sickness.
Petitioner did not submit any medical records showing that he
received treatment for physical injuries, and the record is devoid
of any detailed description of what those injuries might have
been.5 In sum, we do not find any basis in this record upon which
5
In a posttrial memorandum filed with the Court, petitioner
described having symptoms such as “anxiety, chronic pain (with
physical symptoms such as high blood pressure, increased pulse
and respiration), compulsions, delusions, denial and depression.”
Stress-related symptoms such as these relate to emotional
distress and not to physical sickness. See Lindsey v.
(continued...)
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we could make a rational allocation of MVEDC’s $58,000 payment to
compensation for physical harm, if indeed petitioner suffered
physical harm within the meaning of section 104. Therefore, the
entire $85,000 settlement payment is includable in petitioner’s
income.
In bringing his lawsuit against MVEDC, petitioner retained an
attorney whom he compensated on an hourly basis. Petitioner made
periodic payments to his attorney beginning in 2002, and he paid
$11,920 in legal fees during 2003. At trial, petitioner claimed
that his 2003 legal fees were deductible.
Generally, legal fees are deductible under section 162 only
if the matter with respect to which the fees were paid originated
in the taxpayer’s trade or business and only if the claim is
sufficiently connected with that trade or business. See United
States v. Gilmore, 372 U.S. 39 (1963); Biehl v. Commissioner, 118
T.C. 467, 479 (2002), affd. 351 F.3d 982, 985 (9th Cir. 2003);
Test v. Commissioner, T.C. Memo. 2000-362, affd. 49 Fed. Appx. 96
(9th Cir. 2002). Expenses not incurred in a trade or business
activity but in the production or collection of income are
deductible as miscellaneous itemized deductions on Schedule A,
Itemized Deductions. Secs. 67(b), 212(1). Further, it is well
established that even though a taxpayer’s employee status may be
5
(...continued)
Commissioner, T.C. Memo. 2004-113, affd. 422 F.3d 684 (8th Cir.
2005).
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regarded as a trade or business, legal fees stemming from a
taxpayer’s employee status are to be treated as miscellaneous
itemized deductions, subject to the 2-percent floor.6 See sec.
62(a)(1); see also Commissioner v. Banks, 543 U.S. 426, 432
(2005); McKay v. Commissioner, 102 T.C. 465, 493 (1994), vacated
on other grounds without published opinion 84 F.3d 433 (5th Cir.
1996); Test v. Commissioner, supra; Alexander v. Commissioner,
T.C. Memo. 1995-51, affd. 72 F.3d 938 (1st Cir. 1995).
It is undisputed that petitioner was an employee of MVEDC and
that the legal fees petitioner paid stemmed from that
relationship. Therefore, the legal fees of $11,920 petitioner
paid to his attorney relating to the settlement of petitioner’s
claims against MVEDC would have been deductible on Schedule A,
Itemized Deductions.
Petitioner did not file a Schedule A with his 2003 return but
instead claimed the standard deduction. Petitioner’s spouse also
filed a separate return for 2003 and claimed the standard
deduction. As a consequence, respondent contends that petitioner
6
The excess unreimbursed employee and other miscellaneous
expenses deduction is claimed on Schedule A, Itemized Deductions.
The amount of the deduction equals the sum of: (1) Unreimbursed
employee expenses--job travel, union dues, job education, etc.;
(2) tax preparation fees; and (3) other expenses--investment,
safe deposit box, etc., less an amount equal to 2 percent (the 2-
percent floor) of the taxpayer’s adjusted gross income. See sec.
67(a).
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is precluded from itemizing his deductions by the provisions of
section 63(e) and section 6013(b).
Section 63(e) provides that taxpayers must elect to itemize
deductions, and this election is to be made on the taxpayer’s
return. Sec. 63(e)(1) and (2). A taxpayer may change his
election after filing the return, but if the taxpayer’s spouse
filed a separate return for the same taxable year, section
63(e)(3) provides:
the change shall not be allowed unless * * *
(A) the spouse makes a change of election with respect
to itemized deductions, for the taxable year covered in such
separate return, consistent with the change of treatment
sought by the taxpayer, and
(B) the taxpayer and his spouse consent in writing to
the assessment (within such period as may be agreed on with
the Secretary) of any deficiency, to the extent attributable
to such change of election * * *
Petitioner did not elect to itemize deductions either on his
original return or by means of an amended return. Even were we to
construe petitioner’s submissions at trial as an attempt to elect
itemization under section 63(e), the statutory requirements of
that section have not been met. See Boyd v. Commissioner, T.C.
Memo. 2003-286. Therefore, petitioner is not entitled to itemize
his deductions for 2003; consequently, he cannot claim any
deduction for legal fees he paid.
Petitioner concedes that he received nonemployee compensation
of $17,818 for consulting services. Petitioner did not report
this income on his 2003 return, nor any expenses associated with
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the production of that income. The “Amended 2003 Schedule ‘C’”
that petitioner submitted at trial, see supra note 3, was prepared
shortly before trial and represents a reconstruction of expenses
petitioner believed he paid. Amounts shown on the Schedule C were
revised at trial to show a rent expense of $5,369,7 a
mileage/travel expense of $5,546.50, and a misc./membership
expense of $150.
Petitioner testified that although he used portions of his
dwelling for purposes of meeting clients for the first 9 months of
2003, he neither owned nor paid rent for the premises. Moreover,
he did not pay specifically for utilities, telephone, or Internet
services. Rather, he contributed to the general upkeep of the
home, where he resided with his wife. The amount he determined
deductible as rent was the amount that he theoretically would have
paid for that portion of the home he used for his consulting
activities had there been a third-party landlord, as well as a
portion of the utilities, telephone, and Internet services that
were allocable, in petitioner’s view, to his consulting
activities. Petitioner did not submit any documentary
substantiation (such as utility bills or telephone bills) in
support of his claimed deduction for expenses paid in using a
portion of his home for his consulting activities.
7
Petitioner clarified that $5,369 represents the total
amount for rent, utilities, telephone, and Internet services.
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While we accept that petitioner used a portion of his
dwelling for consulting activities, we are unable to determine the
amounts, if any, of expenses he paid in connection with that
activity. The fact that petitioner contributed to general
household expenses does not suffice to convert those personal
living expenses into home office business expenses. Moreover, it
is not clear that any transfer of funds actually took place in the
first 9 months of 2003, and no other taxpayer (i.e., petitioner’s
daughter, who held title to the home, or his wife) reported any
rental income from the dwelling. In sum, petitioner has not
proven entitlement to any deduction for rent for the first 9
months of 2003 or to a deduction for utilities, telephone, or
Internet services.
For the last 3 months of 2003, petitioner moved his place of
business to different premises. Petitioner credibly testified
(and substantiated) that he paid rent of $600 per month for the
last 3 months of 2003 to an unrelated third-party landlord.
Petitioner is therefore entitled to a $1,800 deduction for a rent
expense in carrying on his consulting activity in 2003.
Petitioner claimed a $5,546 deduction for “mileage/travel”
expenses paid in connection with his consulting activity. In
support of the claimed deduction, petitioner submitted records
showing the number of miles he traveled each month and a
description of the purpose of the travel. The records were
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prepared contemporaneously with the travel. Petitioner testified
that he kept the travel records in an effort to determine, during
2003, whether the income from his consulting activity was
sufficient to cover his expenses.
Section 274 provides that expenses paid or incurred with
respect to travel and certain listed property are deductible only
if the taxpayer meets the stringent substantiation requirements of
section 274(d). See sec. 280F(d)(4)(A). For these expenses, only
certain types of documentary evidence will suffice. Passenger
automobiles are listed property under section 280F, and therefore
strict substantiation for their use as transportation is required.
Sec. 274(d). No deduction is allowed for any travel or
transportation expense unless the taxpayer substantiates by
adequate records or by sufficient evidence corroborating the
taxpayer’s own statement the amount of the expense, the mileage
for each business use of the automobile and the total mileage for
all use of the automobile during the taxable period, the date of
the business use, and the business purpose for the use. Sec.
1.274-5T(b)(6), Temporary Income Tax Regs., 50 Fed. Reg. 46016
(Nov. 6, 1985). Adequate records include the maintenance of an
account book, diary, log, statement of expense, trip sheets,
and/or other documentary evidence, which, in combination, are
sufficient to establish each element of expenditure or use. Sec.
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1.274-5T(c)(2)(i), Temporary Income Tax Regs., 50 Fed. Reg. 46017
(Nov. 6, 1985).
Petitioner submitted a travel log consisting of 12 pages, one
for each month of 2003. The purpose for the claimed travel
expense is indicated on every page as “Travel from Niles to
Steubenville and return” or “Travel from Niles to
Steubenville/Lisbon et al and return”. The description of the
travel is shown on every page as “Client calls at
Chamber/Commerce” and/or “Client calls at One Stop Center”.
Actual travel on specific days is not shown; rather, monthly
totals are given. Specific client names are not provided (or
itemized with identifying information redacted). The nature of
the business discussions petitioner conducted is not shown. We
are unable to conclude from petitioner’s travel log that the
strict substantiation requirements of section 274 have been met.
Accordingly, the claimed mileage/travel expenses are not
deductible.
At trial, petitioner claimed that he is entitled to a
deduction for “lost medical insurance coverage”. Petitioner
testified that during 2003 he did not have insurance coverage and
did not pay any amounts for medical insurance. His claimed
deduction is based on amounts he estimated that he would have paid
if he had purchased such insurance. Because petitioner did not
pay this expense, he is not entitled to this deduction.
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Finally, petitioner claimed that he is entitled to a $150
deduction for the membership fee to join the Jefferson County
Chamber of Commerce. Petitioner testified, and we believe, that
he joined the Chamber of Commerce in order to achieve more
recognition for his business. This expense is deductible under
section 162.
As noted supra, respondent determined a section 6662(d)
penalty of $4,965 for 2003. Pursuant to section 6662(a) and
(b)(2), a taxpayer may be liable for a penalty of 20 percent of
the portion of an underpayment of tax attributable to a
substantial understatement of income tax. The term
“understatement” means the excess of the amount of tax required to
be shown on a return over the amount of tax imposed which is shown
on the return, reduced by any rebate (within the meaning of
section 6211(b)(2)). Sec. 6662(d)(2)(A). Generally, an
understatement is a “substantial understatement” when the
understatement exceeds the greater of $5,000 or 10 percent of the
amount of tax required to be shown on the return. Sec.
6662(d)(1)(A). The Commissioner has the burden of production with
respect to the accuracy-related penalty. Sec. 7491(c). To meet
this burden, the Commissioner must produce sufficient evidence
indicating that it is appropriate to impose the penalty. See
Higbee v. Commissioner, 116 T.C. 438, 446 (2001). Once the
Commissioner meets this burden of production, the taxpayer must
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come forward with persuasive evidence that the Commissioner’s
determination is incorrect. Rule 142(a); see Higbee v.
Commissioner, supra at 447. The taxpayer may meet this burden by
proving that he or she acted with reasonable cause and in good
faith. See sec. 6664(c)(1); see also Higbee v. Commissioner,
supra at 448; sec. 1.6664-4(b)(1), Income Tax Regs.
Respondent has met his burden of production under section
7491(c). Petitioner’s 2003 return contains an understatement of
tax greater than $5,000 (which is greater than 10 percent of the
amount of tax required to be shown on the return). See sec.
6662(d)(1)(A)(ii). Accordingly, petitioner bears the burden of
proving that the accuracy-related penalty should not be imposed
with respect to any portion of the underpayment for which he acted
with reasonable cause and in good faith. See sec. 6664(c)(1);
Higbee v. Commissioner, supra at 446. Petitioner did not carry
his burden of showing that his omissions from income which
resulted in the underpayment were made with reasonable cause and
in good faith. Accordingly, petitioner is liable for the section
6662(a) penalty.
Decision will be entered
under Rule 155.