T.C. Summary Opinion 2008-97
UNITED STATES TAX COURT
DARRIN F. AND PAMELA J. RUCH SUDER, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 3245-06S. Filed August 7, 2008.
Kevin J. Sommar, for petitioners.
Ronald S. Collins, Jr., for respondent.
THORNTON, Judge: This case was heard pursuant to the
provisions of section 7463 of the Internal Revenue Code in effect
when the petition was filed.1 Pursuant to section 7463(b), the
decision to be entered is not reviewable by any other court, and
1
Unless otherwise indicated, section references are to the
Internal Revenue Code of 1986, as amended and in effect for the
year in issue, and Rule references are to the Tax Court Rules of
Practice and Procedure.
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this opinion shall not be treated as precedent for any other
case.
The issues for decision are: (1) Whether petitioners are
entitled to exclude from their 2003 gross income certain proceeds
received in settlement of a wrongful termination lawsuit; and (2)
whether petitioners are liable for an accuracy-related penalty
pursuant to section 6662(a).
Background
The parties have stipulated some facts, which we incorporate
herein. When they petitioned this Court, petitioners resided in
Pennsylvania.
In 2000 Pamela J. Ruch Suder (petitioner) was hired as a
sales representative for Adelphia Business Solutions (Adelphia).
In 2001 Adelphia terminated her employment. Petitioner filed a
wrongful termination lawsuit against Adelphia, alleging breach of
contract, violation of Pennsylvania wage payment and collection
laws, and defamation and seeking compensatory and punitive
damages. Pursuant to a settlement, in 2003 Adelphia paid
petitioner $41,000, from which she paid $4,967.50 in attorney’s
fees and costs.
In the general release and settlement agreement, petitioner
agreed “to take full responsibility and liability for the payment
of any and all taxes related to the aforementioned payment.” On
their joint 2003 Federal income tax return petitioners excluded
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the settlement proceeds from gross income. In doing so,
petitioners did not seek professional tax advice.
In the notice of deficiency respondent determined that the
$41,000 settlement proceeds were includable in petitioners’ 2003
gross income, resulting in an $11,460 deficiency, and that
petitioners were liable for a $2,293 accuracy-related penalty
pursuant to section 6662(a).
Discussion
Taxability of Settlement Proceeds
Pursuant to section 61(a), gross income generally includes
income from all sources, including settlement payments. See,
e.g., Commissioner v. Glenshaw Glass Co., 348 U.S. 426 (1955).
As an exception to this general rule, section 104(a)(2) excludes
from gross income “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”.
Petitioners contend that although petitioner’s wrongful
termination lawsuit encompassed nontort claims, the settlement
proceeds were entirely for defamation, because during the
settlement negotiations she abandoned the other claims. The
evidence on this point is inconclusive. But even if we were to
assume, for sake of argument, that the settlement proceeds were
entirely for the defamation claim, petitioners cannot prevail.
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Petitioners have stipulated that petitioner “did not seek, or
receive, monetary damages for physical injury or sickness in the
underlying lawsuit.” Accordingly, the settlement proceeds are
not excludable under section 104(a)(2). See Polone v.
Commissioner, 505 F.3d 966 (9th Cir. 2007) (payment for
settlement of defamation claim was not excludable under section
104(a)(2)), affg. T.C. Memo. 2003-339.
Appearing tacitly to invoke the short-lived decision in
Murphy v. IRS, 460 F.3d 79 (D.C. Cir. 2006), vacated 99 AFTR 2d
2007-396, 2007-1 USTC par. 50,228 (D.C. Cir. 2006), petitioners
contend that the settlement proceeds were for “the loss of * * *
human capital”. Consequently, they contend, petitioner’s “award
is not income and §104(a)(2) is therefore unconstitutional
insofar as it would make the award taxable as income.”
Petitioners’ argument is a nonsequitur. If the settlement
proceeds were not includable in gross income under section 61,
then the constitutionality of section 104(a)(2) would be
irrelevant. As previously discussed, however, the settlement
proceeds are includable in gross income under section 61. In any
event, petitioners’ contentions as to the unconstitutionality of
section 104(a)(2) are without merit. See Murphy v. IRS, 493 F.3d
170 (D.C. Cir. 2007); Ballmer v. Commissioner, T.C. Memo. 2007-
295; Hawkins v. Commissioner, T.C. Memo. 2007-286.
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Respondent concedes that petitioners may deduct $4,967.50 of
attorney’s fees and costs paid in 2003 in connection with the
lawsuit, subject to the 2-percent limitation on itemized
deductions pursuant to section 67(a) and alternative minimum tax
limitations.
Section 6662 Accuracy-Related Penalty
Section 6662(a) and (b)(1) and (2) imposes a 20-percent
accuracy-related penalty on any portion of a tax underpayment
that is attributable to, among other things: (1) Negligence or
disregard of rules and regulations; or (2) any substantial
understatement of income tax. Negligence includes failure to
make a reasonable attempt to comply with the tax code, to
exercise ordinary care in preparing a tax return, or to
substantiate items properly on a tax return. Sec.
1.6662-3(b)(1), Income Tax Regs. The evidence shows that
petitioners’ underpayment is attributable to negligence and
disregard of rules and regulations. Moreover, even taking into
account respondent’s concession, petitioners clearly have a
substantial understatement of income tax. Accordingly,
respondent has met his burden of production pursuant to section
7491(c).
The section 6662 accuracy-related penalty is inapplicable to
the extent the taxpayer has reasonable cause and acted in good
faith. Sec. 6664(c)(1). This determination is made considering
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all relevant facts and circumstances. Sec. 1.6664-4(b)(1),
Income Tax Regs. “Generally, the most important factor is the
extent of the taxpayer’s effort to assess the taxpayer’s proper
tax liability.” Id. The taxpayer bears the burden of proving
that he or she falls within this exception. Higbee v.
Commissioner, 116 T.C. 438, 447 (2001).
Petitioners contend that they reasonably believed that the
settlement proceeds were excludable from gross income, consistent
with substantial legal authority. Petitioners did not consult
with a professional tax adviser, however; nor, insofar as the
record shows, did they take any other action to ascertain the
correct tax treatment of the settlement payment. Moreover, in
the settlement agreement petitioner agreed to take full
responsibility for any tax liability arising out of the
settlement. Petitioner testified that she believed the
settlement payment was nontaxable because she was involved in a
“lawsuit years and years ago due to a personal injury that was
not taxable.” Any such belief as to the nontaxability of a
long-ago personal injury payment does not establish reasonable
cause for petitioners’ failure to report the settlement proceeds
at issue here.
Petitioners contend that they received no Form 1099 with
respect to the settlement proceeds. The evidence on this point
is inconclusive; in any event, mere failure to receive a Form
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1099 does not establish reasonable cause or good faith. Goode v.
Commissioner, T.C. Memo. 2006-48.
We also reject as without merit petitioners’ contention that
they had substantial authority for excluding the settlement
proceeds from gross income.2 The plain language of section
104(a)(2) limits the exclusion to damages received on account of
“personal physical injuries or physical sickness”. As previously
discussed, petitioners’ ill-founded arguments as to the
unconstitutionality of section 104(a)(2) have no bearing on the
inclusion of the settlement proceeds in gross income pursuant to
section 61. We also note that Murphy v. IRS, 460 F.3d 79 (D.C.
Cir. 2006), ultimately vacated by the U.S. Court of Appeals for
the District of Columbia Circuit, had not been issued when
petitioners filed their 2003 return.
To reflect the foregoing and respondent’s concession as to
the deductibility of attorney’s fees and costs,
Decision will be entered under
Rule 155.
2
In making this argument, petitioners appear to invoke sec.
6662(d)(2)(B)(i), which provides for a reduction of the amount of
understatement of income tax under sec. 6662(b)(2) to the extent
the understatement is attributable to the taxpayer’s treatment of
an item if there is or was substantial authority for such
treatment.