T.C. Memo. 2008-158
UNITED STATES TAX COURT
JOYCE M. SANFORD, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket Nos. 20897-05, 1031-07. Filed June 23, 2008.
Michael T. Wells, for petitioner.
Valerie Makarewicz, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
KROUPA, Judge: Respondent determined a $15,505 deficiency
in petitioner’s Federal income tax and a $3,101 accuracy-related
penalty under section 6662(a) for 2003.1 Respondent determined a
1
All section references are to the Internal Revenue Code
(Code) in effect for the years at issue, and all Rule references
are to the Tax Court Rules of Practice and Procedure, unless
(continued...)
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$41,012 deficiency in petitioner’s Federal income tax and an
$8,202 accuracy-related penalty under section 6662(a) for 2004.
There are four issues for decision. The first issue is whether
compensation petitioner received for nonpecuniary damages and
future pecuniary losses in a legal action against her employer 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 compensation petitioner received for past medical
expenses and transportation in the legal action is excludable
from petitioner’s income under section 104(a)(2) under the
exception for amounts paid for medical care attributable to
emotional distress. We hold that it is not. The third issue is
whether the attorney’s fees paid to petitioner’s attorney under a
fee-shifting regulation regarding the legal action are excludable
from petitioner’s income. We hold that they are not. The fourth
issue is whether petitioner is liable for the accuracy-related
penalty. We hold that she is.
FINDINGS OF FACT
Some of the facts have been stipulated and are so found.
The stipulation of facts and the accompanying exhibits are
1
(...continued)
otherwise indicated. All dollar amounts are rounded to the
nearest dollar.
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incorporated by this reference. Petitioner resided in California
at the time she filed the petitions.2
Petitioner’s Legal Action
Petitioner was an employee of the U.S. Postal Service (USPS)
for several years continuing through 2004. Petitioner filed
complaints with the U.S. Equal Employment Opportunity Commission
(EEOC) in 1998 and 1999 alleging unlawful employment
discrimination. Specifically, petitioner alleged she was
discriminated against on the bases of race, national origin, sex,
religion, color, and age and that she was retaliated against for
previously participating in EEOC activity. Petitioner asserted
in the complaint that she was sexually harassed by a USPS
coworker.
The EEOC issued a decision in petitioner’s legal action in
September 2002. The EEOC found that petitioner was sexually
harassed at work and was discriminated against because of her
sex. The EEOC did not find that petitioner was discriminated
against because of her race, national origin, religion, or age,
or that she was retaliated against for previously participating
in EEOC activity. The EEOC awarded petitioner reasonable
attorney’s fees pursuant to 29 C.F.R. sec. 1614.501(e) (the fee-
shifting regulation).
2
These two cases were consolidated for trial, briefing, and
opinion in an Order from this Court dated Sept. 13, 2007.
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Once the EEOC issued its decision, the USPS then issued its
Final Agency Decision in the legal action. The USPS awarded
petitioner compensatory damages of $7,662 in past medical
expenses and transportation, $14,033 for past benefits lost
(leave without pay), and $12,000 in nonpecuniary compensatory
damages.3 The USPS paid petitioner the damages, totaling
$33,695, on March 28, 2003.
Petitioner’s Appeal
Petitioner appealed the $33,695 USPS Final Agency Decision
to the EEOC. The EEOC decided petitioner’s appeal in May 2004.
The EEOC found that petitioner was sexually harassed by her
coworker and that the USPS failed to take appropriate corrective
action. The EEOC noted that petitioner had provided sufficient
documentation to substantiate or justify her request for
additional compensatory damages, including a report from her
psychologist and statements from friends and coworkers. The EEOC
indicated that petitioner had suffered emotional distress due to
the sexual harassment and USPS’ failure to take action to stop
the harassment. The EEOC also noted that petitioner’s
psychologist reported petitioner had experienced physical
symptoms due to the psychiatric problems the harassment created.
3
The EEOC, the USPS, and the parties variously refer to
certain of the damages as nonpecuniary compensatory damages.
While the damages themselves are pecuniary, they compensated an
injury that was not. We shall use the terms the parties used in
referring to the damages as nonpecuniary compensatory damages.
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Petitioner’s friends and coworkers also indicated that petitioner
suffered from physical symptoms due to the stress of the long-
term harassment. These physical symptoms included
intensification of petitioner’s asthma, sleep deprivation, skin
irritation, appetite loss, severe headaches, and depression.
The Award
The EEOC determined on appeal that it was appropriate to
modify the USPS Final Agency Decision. The EEOC determined that
the USPS should pay petitioner a total of $115,000 in
nonpecuniary damages, $33,542 in future pecuniary losses, $7,662
for medical expenses, and $14,033 for use of annual leave, sick
leave and leave without pay. The EEOC again awarded petitioner
reasonable attorney’s fees pursuant to the fee-shifting
regulation.
The USPS had already compensated petitioner for the medical
expenses and the loss of leave in the Final Agency Decision.
Therefore, the USPS paid petitioner an additional $103,000 in
future pecuniary losses (in addition to the $12,000 it paid
petitioner a year earlier) and the $33,542 in future pecuniary
losses in June 2004.
Attorney’s Fees
The EEOC determined in both decisions, in September 2002 and
May 2004, that petitioner was entitled to reasonable attorney’s
fees pursuant to the applicable fee-shifting regulation. In
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accordance with this decision, the USPS paid $16,602 in
attorney’s fees in 2003 and $4,686 in 2004 on petitioner’s
behalf.
Petitioner’s Returns and the Deficiency Notices
Petitioner timely filed returns for 2003 and 2004.
Petitioner reported $43,050 of wages and $14,033 of other income
on the return for 2003. Petitioner failed to report any of the
income from the legal action other than the $14,033 of other
income for 2003. Petitioner reported $43,086 of wages and $1,500
of income from gambling winnings on the return for 2004.
Petitioner failed to report any of the income from the legal
action for 2004.
Respondent issued deficiency notices to petitioner for 2003
and 2004 (the years at issue). Respondent determined that
petitioner should have included the amounts she received in the
legal action in her income for 2003 and 2004.4 Respondent also
determined that the accuracy-related penalty applies to
petitioner’s tax liabilities for 2003 and 2004. Petitioner
timely filed petitions.
OPINION
We are asked to decide whether petitioner must include in
her income an award from a legal action against her employer. We
4
Respondent concedes that petitioner reported $14,033 on the
return for 2003, which corresponds to the portion of the award
compensating petitioner for annual leave, sick leave, and leave
without pay.
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are also asked to decide whether petitioner is liable for the
accuracy-related penalty. The funds awarded from the legal
action fall into three categories, each with different rules
governing when the funds must be included in income. We shall
consider each category separately, beginning with nonpecuniary
damages and future pecuniary losses.5
Nonpecuniary Damages and Future Pecuniary Losses
We now consider whether petitioner must include in income
the portion of the award for nonpecuniary damages and future
pecuniary losses.6 Gross income generally includes all income
from whatever source derived. Sec. 61(a). The definition of
gross income is broad in scope, while exclusions from income are
narrowly construed. Commissioner v. Schleier, 515 U.S. 323, 328
(1995); Commissioner v. Glenshaw Glass Co., 348 U.S. 426, 430
(1955).
Damages (other than punitive damages) received on account of
personal physical injuries or physical sickness may generally be
5
Petitioner does not claim that the burden of proof shifts
to respondent under sec. 7491(a). Petitioner also did not
establish that she satisfies the requirements of sec. 7491(a)(2).
We therefore find that the burden of proof remains with
petitioner.
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, 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. Id.
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excluded from gross income. Sec. 104(a)(2). For the damages to
be excludable under this provision, however, the underlying cause
of action must be based in tort or tort-type rights, and the
proceeds must be damages received on account of personal physical
injury or physical sickness. Commissioner v. Schleier, supra at
328, 337.7 Emotional distress is not treated as a personal
physical injury or physical sickness except for damages not in
excess of the amount paid for medical care attributable to
emotional distress. Sec. 104(a) (flush language).
Respondent concedes that the underlying cause of action in
this case is based in tort or tort-type rights. Respondent
argues, however, that the damages petitioner received were not on
account of personal physical injuries or physical sickness. We
agree. We find compelling the EEOC and USPS decisions and
orders.
It is evident from the EEOC and USPS decisions and orders
that none of the award was predicated on personal physical injury
or physical sickness as the statute requires. The EEOC decision
noted, and we acknowledge, that the sexual harassment petitioner
suffered caused her emotional distress. We further acknowledge,
as did the EEOC, that the emotional distress manifested itself in
7
The Supreme Court 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.” Commissioner v. Schleier, 515 U.S. 323, 328 n.3
(1995).
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physical symptoms such as asthma, sleep deprivation, skin
irritation, appetite loss, severe headaches, and depression.
These physical symptoms were not the basis of the award
petitioner received, however. Petitioner sought, and was
awarded, relief for sexual harassment, discrimination based on
sex, and the failure of the USPS to take appropriate corrective
action.
The EEOC and USPS decisions and orders compensated
petitioner for the emotional distress she suffered because of
the sexual harassment she experienced at work and her employer’s
failure to take appropriate corrective action. Despite her
argument to the contrary, petitioner was not compensated for the
physical symptoms she experienced as a result. Damages received
on account of emotional distress, even when resultant physical
symptoms occur, are not excludable from income under section
104(a)(2). Hawkins v. Commissioner, T.C. Memo. 2005-149.
We conclude that the nonpecuniary damages and future
pecuniary losses awarded to petitioner as a result of the legal
action were not received on account of personal physical injury
or physical sickness. Petitioner therefore must include these
damages in her income under section 104(a)(2) for the years at
issue.
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Past Medical Expenses and Transportation
We now turn to the portion of the award for petitioner’s
past medical expenses and transportation. While a taxpayer may
generally not exclude damages for emotional distress from income,
an exception applies for amounts paid for medical care for
emotional distress. Sec. 104(a). Damages for emotional distress
are treated as a personal physical injury or sickness, and thus
excludable from income, up to the amount paid for medical care
(as described in section 213(d)(1)(A) or (B)) attributable to
emotional distress. Id.
A reimbursement for medical expenses must be included in
income in the year it was received to the extent a deduction was
claimed on account of the medical expenses in a prior year. Sec.
1.213-1(g)(1), Income Tax Regs. If no deduction was claimed in
an earlier year, the taxpayer is not required to include the
reimbursement in income. Sec. 104(a); sec. 1.213-1(g)(2), Income
Tax Regs. To substantiate deductions for medical expenses under
section 213, the taxpayer must furnish the name and address of
each person to whom payment for medical expenses was made and the
amount and date of each payment. Sec. 1.213-1(h), Income Tax
Regs.
Petitioner received $7,662 for past medical expenses and
transportation in 2003. Petitioner failed to introduce evidence
that she had not deducted the medical expenses in a prior taxable
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year.8 Petitioner also failed to introduce evidence to
demonstrate her costs for treating her emotional distress.
Petitioner therefore cannot exclude the $7,662 reimbursement from
income for 2003.
Attorney’s Fees
We now consider whether petitioner must include in income
amounts paid to her attorney pursuant to the fee-shifting
regulation. A litigant generally may not exclude the portion of
recovery paid to his or her attorney where 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 pursuant to a fee-shifting
statute. Sinyard v. Commissioner, 268 F.3d 756 (9th Cir. 2001),
affg. T.C. Memo. 1998-364; Green v. Commissioner, T.C. Memo.
2007-39; Vincent v. Commissioner, T.C. Memo. 2005-95. A third
party’s discharge of a taxpayer’s obligation is income to the
taxpayer. Old Colony Trust Co. v. Commissioner, 279 U.S. 716,
729 (1929).
The USPS paid petitioner’s attorney $16,602 in 2003 and
$4,686 in 2004 on petitioner’s behalf.9 These funds paid
8
Petitioner did not claim any deductions for medical
expenses in 2003 or 2004. The record lacks any evidence
regarding medical expenses in prior years.
9
Petitioner did not make any arguments on brief regarding
why she should be entitled to exclude fees paid to her attorney
on her behalf. She also did not argue, and we do not find, that
(continued...)
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pursuant to the fee-shifting regulation are not excludable from
petitioner’s income. See Sinyard v. Commissioner, supra; Vincent
v. Commissioner, supra. That the funds were paid directly to
petitioner’s attorney and not to petitioner does not alter this
result. See Sinyard v. Commissioner, supra at 759. We conclude
that petitioner must include in income the attorney’s fees paid
to her attorney.
Accuracy-Related Penalty
We finally consider whether petitioner is liable for the
accuracy-related penalty under section 6662(a). 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,
9
(...continued)
she is entitled to any deduction for attorney’s fees paid or
incurred to prosecute unlawful discrimination under the
amendments to sec. 62(a) that became effective Oct. 22, 2004.
American Jobs Creation Act of 2004, Pub. L. 108-357, sec. 703,
118 Stat. 1546. The date the payments were made to petitioner’s
attorney is not evident from the record, and it is thus unclear
whether the payments would be within the effective date of the
amendments to sec. 62(a). Petitioner bears the burden of proof,
however, and made no argument that she is entitled to this
deduction. She is therefore deemed to have conceded it.
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negligence or disregard of rules and regulations.10 Sec. 6662(a)
and (b)(1). Negligence is defined as any failure to make a
reasonable attempt to comply with the provisions of the Code.
Sec. 6662(c). Negligence is the lack of due care or failure to
do what a reasonably and ordinarily prudent person would do under
the circumstances. Neely v. Commissioner, 85 T.C. 934, 947
(1985). Disregard is characterized as any careless, reckless, or
intentional disregard. Sec. 6662(c); sec. 1.6662-3(b)(2), Income
Tax Regs. Disregard of rules and regulations is careless if the
taxpayer does not exercise reasonable diligence to determine the
correctness of a return position that is contrary to the rule or
regulation. Kooyers v. Commissioner, T.C. Memo. 2004-281. We
have previously found a taxpayer negligent where the taxpayer
excluded a settlement amount relying solely on his attorney’s
statement that the settlement was for punitive damages. Corrigan
v. Commissioner, T.C. Memo. 2005-119.
Petitioner failed to report all but $14,033 of the funds she
received from the legal action in 2003 and 2004. Petitioner
testified that she consulted H&R Block to file the returns, but
her testimony was unclear as to what advice she received and when
she received it. Petitioner did not testify about any other
10
Respondent determined alternatively that petitioner is
liable for the accuracy-related penalty for substantial
understatements of income tax under sec. 6662(b)(2) for 2003 and
2004. Because of our holding on the negligence issue, we need
not consider whether the underpayments were also substantial
understatements.
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efforts she made to properly report the award. Petitioner did
not show she exercised reasonable diligence to determine that
excluding the payments from income was the correct treatment.
Nor has petitioner shown she had a reasonable basis for excluding
the award from income.11 Petitioner essentially argues that she
suffered physical injuries and therefore the award should be
excluded from her income. Petitioner misapplies the law because,
under section 104(a), awards for emotional distress are not
excludable from income, and the physical symptoms petitioner
suffered resulted from emotional distress. Petitioner makes no
argument why she should be entitled to exclude the attorney’s
fees from her income. She also did not support her exclusion of
the medical expense portion of the award with any documentary
evidence indicating that she incurred medical expenses and had
not deducted them in a prior year. We conclude that petitioner
was negligent in preparing her returns for 2003 and 2004.
The accuracy-related penalty under section 6662(a) does not
apply to any portion of an underpayment if the taxpayer proves
11
A return position generally has a reasonable basis if it
is reasonably based on one or more of the authorities that
constitute substantial authority for purposes of substantial
understatements under sec. 6662(b)(2). Sec. 1.6662-3(b)(3),
Income Tax Regs. These authorities include, among others, the
Code and other statutory provisions, proposed, temporary, and
final regulations construing the statutes, court cases, and
Congressional intent as reflected in Committee reports. Sec.
1.6662-4(d)(3)(iii), Income Tax Regs. The reasonable basis
standard is not satisfied by a return position that is merely
arguable or is merely a colorable claim. Sec. 1.6662-3(b)(3),
Income Tax Regs.
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there was reasonable cause for the taxpayer’s position with
respect to that portion and that he or she acted in good faith
with respect to that 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 pertinent facts and circumstances, including the
taxpayer’s reasonable reliance on a professional tax adviser, the
taxpayer’s efforts to assess his or her proper tax liability, and
the knowledge and experience of the taxpayer. Sec. 1.6664-
4(b)(1), Income Tax Regs.
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 H&R Block to
prepare the returns. We disagree. While petitioner testified at
trial that she sought advice from H&R Block regarding her taxes,
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petitioner was unclear in her testimony about when she received
advice and what advice she received. Petitioner’s tax preparer
did not testify. Petitioner has also failed to establish that
she provided her preparer with all the necessary and accurate
information concerning her legal action. 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 underpayments
of tax for the years at issue. Accordingly, we conclude that the
accuracy-related penalty applies.
To reflect the foregoing and respondent’s concession,
Decisions will be entered
under Rule 155.