T.C. Memo. 2007-295
UNITED STATES TAX COURT
PAUL E. BALLMER, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 11370-05. Filed September 27, 2007.
Derek L. Tabone, for petitioner.
Ron S. Chun, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
GOEKE, Judge: This petition arises from petitioner Paul E.
Ballmer’s receipt of $337,122.53 in the 2001 tax year from a
lawsuit he filed against the California Franchise Tax Board
(FTB). Respondent determined a deficiency of tax of $109,215, an
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addition to tax under section 6651(a)(1)1 of $27,303.75, and an
addition to tax under section 6654(a) of $4,364.63 for
petitioner’s 2001 tax year. Respondent has conceded the
allowance of a miscellaneous deduction for the attorney’s fees
petitioner incurred as part of his litigation against the FTB.
After concessions, the issues for decision are:
(1) Whether $337,122.53 received by petitioner in 2001
pursuant to a jury award is gross income that may be excluded
under section 104(a)(2). We hold that the award is gross income
and is not excluded.
(2) Whether petitioner is liable for an addition to tax
under section 6651(a)(1) for the 2001 tax year. We hold that he
is.
(3) Whether petitioner is liable for an addition to tax
under section 6654(a) for the 2001 tax year. We hold that he is
not.
FINDINGS OF FACT
Some of the facts have been stipulated and are so found.
The stipulations of facts and related exhibits are incorporated
herein by this reference. Petitioner lived in Los Angeles,
California, at the time his petition was filed.
1
Unless otherwise indicated, all section references are to
the Internal Revenue Code in effect for the year at issue, and
all Rule references are to the Tax Court Rules of Practice and
Procedure.
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In 1997, petitioner filed a complaint in the Los Angeles
County Superior Court against the FTB. Petitioner alleged that
the FTB violated the California Information Practices Act of
1977, Cal. Civ. Code secs. 1798.1, et seq. This Act provides a
legal remedy, including the award of damages for mental suffering
and emotional distress, to an individual harmed by a violation.
Petitioner’s lawsuit was tried before a jury, and in April
2001, the jury awarded petitioner $250,000 in damages for
emotional distress. Petitioner was also awarded costs of
$4,165.68 and attorney’s fees of $78,450. On July 20, 2001, the
FTB issued a check to petitioner in the amount of $337,122.53,
which included the $332,615.68 reflected in the judgment as well
as $4,506.85 of postjudgment interest.
In addition to the proceeds from the lawsuit, petitioner
received payments for Social Security benefits in 2001 totaling
$7,128. Petitioner did not file any Federal income tax return
for 2001, nor has he filed a return for any of the taxable years
1986 through 2003. For some of these years, respondent prepared
substitutes for returns and sought to collect the determined tax
liabilities from petitioner.
Petitioner testified that he had reviewed the Internal
Revenue Code for many years and could find nothing that made him
liable for Federal taxes or required him to file a return.
Petitioner further testified that he did not believe that the
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amount he received from the FTB was income. Petitioner did not,
however, seek advice from any tax professionals with respect to
these conclusions.
Respondent issued a notice of deficiency to petitioner on
March 16, 2005. Respondent adjusted petitioner’s income to
include the $337,122.53 received from the FTB and determined a
deficiency of $109,215. Respondent also asserted an addition to
tax under section 6651(a)(1) of $27,303.75, as well as an
addition to tax under section 6654(a) of $4,364.63.
OPINION
I. Unreported Income
The Commissioner’s determinations of deficiencies in tax
generally are presumed correct, and the taxpayer bears the burden
of proving that those determinations are erroneous. Rule 142(a);
Welch v. Helvering, 290 U.S. 111, 115 (1933); Durando v. United
States, 70 F.3d 548, 550 (9th Cir. 1995). The U.S. Court of
Appeals for the Ninth Circuit, to which an appeal of this case
would lie, has held that in order for the presumption of
correctness to attach to the notice of deficiency in unreported
income cases, the Commissioner must establish some evidentiary
foundation “demonstrating that the taxpayer received unreported
income.” Edwards v. Commissioner, 680 F.2d 1268, 1270 (9th Cir.
1982). Once there is some evidence, as there is here, that the
taxpayer received unreported income, the burden shifts to the
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taxpayer to prove that all or part of those funds is not taxable.
Hardy v. Commissioner, 181 F.3d 1002, 1004 (9th Cir. 1999), affg.
T.C. Memo. 1997-97. Accordingly, petitioner bears the burden of
proof. See Rule 142(a).
Section 61(a) provides that gross income includes all income
from whatever source derived. Section 61(a) broadly applies to
any accession to wealth, and 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) excludes from gross
income:
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––
* * * * * * *
(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;
* * * * * * *
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* * * For purposes of paragraph (2), emotional distress
shall not be treated as a physical injury or physical
sickness.[2] * * *
“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.
The parties stipulated that petitioner received the
$337,122.53 in question in 2001 and agree that no part of the
judgment would be excluded from income pursuant to section
104(a)(2). Petitioner, however, argues that the award of damages
to compensate for emotional distress is not gross income within
the meaning of section 61(a) regardless of the exclusions
contained in section 104. Petitioner, citing certain rulings
issued after the 16th Amendment was ratified, 31 Op. Atty. Gen.
304, 308 (1918) and T.D. 2747, 20 Treas. Dec. Int. Rev. 457
(1918), as well as a House report accompanying a bill that became
the Revenue Act of 1918, H. Rept. 767, 65th Cong., 2d Sess.
(1918), 1939-1 C.B. (Part 2) 86, argues that his recovery from
the FTB represents compensation for damage to human capital and
thus is not income.
2
Sec. 104 was so amended by the Small Business Job
Protection Act of 1996, Pub. L. 104-188, sec. 1605, 110 Stat.
1838, to provide, effective for amounts received after Aug. 20,
1996, that the personal injury or sickness for which the damages
are received must be physical.
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Petitioner’s argument is quite similar to that asserted
before and ultimately rejected by the Court of Appeals for the
District of Columbia Circuit. Murphy v. IRS, 493 F.3d 170 (D.C.
Cir. 2007).3 The Court of Appeals held that for the flush
language of section 104(a) to make sense, the definition of gross
income in section 61(a) must first include damages for
nonphysical emotional distress injuries. Id. Further, this
Court has held that compensation for nonphysical emotional
distress injuries is gross income not excluded pursuant to
section 104(a)(2). See, e.g., Goode v. Commissioner, T.C. Memo.
2006-48; Hawkins v. Commissioner, T.C. Memo. 2005-149.
We see no reason to depart from these decisions or the
statutory language. Accordingly, we conclude petitioner’s award
of compensatory damages for emotional distress is gross income
under section 61(a) and not excluded under section 104(a)(2).
Further, the award of attorney’s fees and litigation costs as
well as postjudgment interest are also gross income. Sec. 61(a);
Commissioner v. Banks, 543 U.S. 426, 429-430 (2005); Sinyard v.
3
At first, the Court of Appeals for the District of Columbia
Circuit agreed with a position similar to petitioner’s and held
that compensation for the loss of a personal attribute such as
well-being was not income within the meaning of the Sixteenth
Amendment. Murphy v. IRS, 460 F.3d 79 (D.C. Cir. 2006).
However, the Court of Appeals then vacated its decision, Murphy
v. IRS, 99 AFTR 2d 2007-396, 2007-1 USTC par 50,228 (D.C. Cir.
2006), and heard additional arguments before issuing its decision
rejecting that position, Murphy v. IRS, 493 F.3d 170 (D.C. Cir.
2007).
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Commissioner, 268 F.3d 756 (9th Cir. 2001), affg. T.C. Memo.
1998-364; Kovacs v. Commissioner, 100 T.C. 124, 128 (1993), affd.
without published opinion 25 F.3d 1048 (6th Cir. 1994). Finally,
$6,059 of the $7,128 petitioner received in Social Security
benefits in 2001 is also gross income pursuant to section 86(a).
Petitioner may, however, deduct the attorney’s fees and
litigation costs incurred in his litigation against the FTB as a
miscellaneous itemized deduction.
II. Additions to Tax
Respondent determined that petitioner was liable for
additions to tax under sections 6651(a)(1) and 6654(a). Under
section 7491(c), the Commissioner has the burden of production in
any court proceeding with respect to the liability of any
individual for a penalty or addition to tax. Higbee v.
Commissioner, 116 T.C. 438, 446-447 (2001). In order to meet
this burden, the Commissioner must come forth with sufficient
evidence indicating that it is appropriate to impose an addition
to tax. Id. at 446. Once the Commissioner has met this burden,
the taxpayer must come forward with evidence sufficient to
persuade the Court that the Commissioner’s determination is
incorrect or an exception applies. Id. at 447.
Section 6651(a)(1) imposes an addition to tax for failure to
file a Federal income tax return by its due date, including
extensions. The addition equals 5 percent for each month that
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the return is late, not to exceed 25 percent. Sec. 6651(a)(1).
The addition is imposed for the failure to file a return on time
unless the taxpayer establishes that the failure was due to
reasonable cause and not willful neglect. Sec. 6651(a)(1);
United States v. Boyle, 469 U.S. 241, 245 (1985).
Petitioner admits that he did not file a return for 2001 but
maintains that he had reasonable cause for not filing.
Petitioner testified that he had reviewed section 104 and could
not find a basis for distinguishing damages for physical injuries
from emotional injuries. Petitioner further testified that he
had reviewed the Internal Revenue Code for several years and
could find no provision that required him to file a return.
Finally, petitioner maintains that reasonable cause is
demonstrated by the D.C. Circuit’s initial conclusion that
damages for emotional distress did not constitute gross income.
On cross-examination, petitioner admitted that he had not
reviewed the flush language of section 104(a), which provides
“emotional distress shall not be treated as a physical injury or
physical sickness” for purposes of excluding damages received
from gross income under section 104(a)(2). Petitioner further
admitted that he had not sought the advice of a tax professional
in regard to his conclusions that no provision of the Code
required him to file a return or that the damages he received
were not income.
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Petitioner’s attempt to cloak his argument of reasonable
cause in the initial Murphy decision is also unpersuasive.
First, as discussed above, the Court of Appeals for the D.C.
Circuit vacated its initial decision and has since determined
that damages for emotional distress are gross income. Further,
there is no evidence before the Court that petitioner performed
an analysis similar to that of the D.C. Circuit, nor that he
received any advice from a competent tax professional, at the
time he chose not to file a return for 2001.
We find that petitioner has failed to meet his burden of
demonstrating that his failure to file a return was due to
reasonable cause and not willful neglect. Thus, petitioner is
liable for the addition to tax for failure to file under section
6651(a)(1).
Respondent also determined that petitioner is liable for an
addition to tax under section 6654(a) for failure to make
estimated tax payments for 2001. A taxpayer has an obligation to
pay estimated tax for a particular year only if he has a
“required annual payment” for that year. Sec. 6654(d). A
“required annual payment” is equal to the lesser of (1) 90
percent of the tax shown on the individual’s return for that year
(or, if no return is filed, 90 percent of his or her tax for such
year), or (2) if the individual filed a return for the
immediately preceding taxable year, 100 percent of the tax shown
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on that return. Sec. 6654(d)(1); Wheeler v. Commissioner, 127
T.C. 200, 210-212 (2006); Heers v. Commissioner, T.C. Memo.
2007-10. The addition to tax is not applicable if the taxpayer’s
liability for the preceding taxable year was zero. Sec.
6654(e)(2).
Respondent introduced evidence to show petitioner was
required to file a return for 2001 and failed to do so and that
petitioner failed to make any estimated tax payments for 2001.
The parties agree that petitioner did not file a return for the
2000 tax year. Thus, respondent has met his burden of production
with respect to the addition to tax under section 6654(a).
Petitioner, however, maintains that he did not have any
liability for the 2000 tax year and thus was not required to make
estimated tax payments for the 2001 tax year. In prior years
when petitioner did not file a return and respondent received
information concerning petitioner’s income, respondent prepared
substitutes for returns and sought to collect the determined
liabilities. The fact that respondent did not file a substitute
for return or seek to collect payment for 2000 supports
petitioner’s position that he did not have any liability for
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2000. Accordingly, we find petitioner is not liable for an
addition to tax under section 6654(a).
To reflect the foregoing,
Decision will be entered
under Rule 155.