Watts v. Comm'r

T.C. Memo. 2009-103

UNITED STATES TAX COURT

DEBORAH L. WATTS, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 6056-06. Filed May 18, 2009.

Robert M. Walsh, for petitioner.

Daniel P. Ryan, for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

GALE, Judge: Respondent determined a deficiency in

petitioner’s 2002 Federal income tax of $10,705 and additions to

tax under section 6651(a)(1) of $2,408, under section 6651(a)(2)

of $1,605, and under section 6654(a) of $357.

Unless otherwise noted, all section references are to the

Internal Revenue Code of 1986, as in effect for the year in
 - 2 -

issue, and all Rule references are to the Tax Court Rules of

Practice and Procedure. All dollar amounts have been rounded to

the nearest dollar.

After concessions,1 the issues for decision are:

(1) Whether a $52,896 payment petitioner received in 2002 in

connection with the settlement of a class action lawsuit against

her automobile insurer is includible in gross income; (2) whether

$9,396 petitioner received from the Social Security

Administration in 2002 is includible in gross income under

section 86(a); (3) whether petitioner was required to file a

Federal income tax return for 2002; (4) whether petitioner is

1
Respondent has conceded that petitioner is not liable for a
sec. 6654(a) addition to tax. Petitioner claimed entitlement to
a medical expense deduction in the petition but presented no
evidence relating to this issue and did not address it on brief.
We therefore deem it to have been abandoned. See Estate of
Atkinson v. Commissioner, 115 T.C. 26, 35 (2000), affd. 309 F.3d
1290 (11th Cir. 2002); Stringer v. Commissioner, 84 T.C. 693, 708
(1985), affd. without published opinion 789 F.2d 917 (4th Cir.
1986).
Respondent determined in the notice of deficiency that
petitioner had total unreported gross income for 2002 of $60,882
in connection with payments from State Farm Mutual Automobile
Insurance Co. (State Farm) and the Social Security
Administration. On brief respondent takes the position that
petitioner had unreported income of $52,896 from State Farm and
$9,396 from the Social Security Administration, for total
unreported income of $62,292. Respondent did not move to amend
his answer to assert an increased deficiency. In any event, the
discrepancy in the unreported income respondent asserted has no
significance, given that we have redetermined that petitioner had
unreported income from State Farm and the Social Security
Administration of only $2,896 and $6,455, respectively.
 - 3 -

entitled to a dependency exemption deduction under section

151(c); (5) whether petitioner is entitled to a child tax credit

under section 24(a); and (6) whether petitioner is liable for

additions to tax under section 6651(a)(1) and (2).

FINDINGS OF FACT

Some of the facts have been stipulated and are incorporated

by this reference. At the time the petition was filed,

petitioner resided in New Hampshire.

I. State Farm Settlement Payment

A. Petitioner’s Automobile Accident

Petitioner married on October 8, 1990. On February 22,

1992, while living in Tuscon, Arizona, with her husband,

petitioner was injured in an automobile accident, the fault of an

uninsured motorist. As a result of her injuries, petitioner was

unable to work for over a year.

At the time of the accident petitioner and her husband had

two vehicles insured under separate automobile liability

insurance policies through State Farm Mutual Automobile Insurance

Co. (State Farm). Both insurance policies were purchased by

petitioner and/or her husband and had endorsements for uninsured

and underinsured motorist (UM/UIM) coverage with policy limits of

$50,000.
 - 4 -

B. Petitioner’s Claim Against State Farm

Although petitioner filed a lawsuit against the motorist who

was at fault in her accident, her counsel ascertained that the

defendant had no significant assets nor any insurance.

Petitioner submitted a claim under her UM/UIM coverage to State

Farm for compensation for her injuries in the automobile

accident. State Farm took the position that petitioner was

entitled to recover under the UM/UIM coverage of only one of the

two policies held by her and her husband, resulting in an

effective policy limit on recovery of $50,000. In taking this

position State Farm relied on anti-stacking provisions in its

insurance contracts with petitioner and her husband, under which

the insured was purportedly precluded from aggregating or

“stacking”2 his or her UM/UIM coverages under multiple State Farm

policies. Petitioner thereafter agreed to settle her claim with

State Farm for $32,973 and, after satisfaction of attorney’s fees

and costs, she and her husband received a payment of $21,887 on

or about February 2, 1996.3 At the time she settled her claim,

petitioner anticipated incurring future medical expenses on

account of the automobile accident but concluded that the

2
“Stacking” is “the practice by which insureds may seek
indemnification from the same coverage under two or more
policies.” State Farm Mut. Auto. Ins. Co. v. Lindsey, 897 P.2d
631 (Ariz. 1995) (citing Widiss, Uninsured and Underinsured
Motorist Insurance, sec. 40.1, at 237 (2d ed. 1995)).
3
This 1996 payment is not at issue in this case.
 - 5 -

settlement was advisable in view of the costs of further

litigation and State Farm’s position that the limit on her

recovery was $50,000.

C. Class Action Lawsuit Against State Farm

After petitioner had agreed to settle with State Farm, the

Arizona Supreme Court decided State Farm Mut. Auto. Ins. Co. v.

Lindsey, 897 P.2d 631 (Ariz. 1995), in which it held that anti-

stacking provisions in certain other State Farm automobile

liability insurance policies, similar to those that State Farm

had invoked against petitioner, were ineffective to preclude

stacking. Id. at 331-332.

After the Lindsey decision petitioner became a member of the

plaintiff class in a class action lawsuit against State Farm that

had been filed on July 21, 1995, in Pima County Arizona Superior

Court (superior court). The class action plaintiffs alleged that

“State Farm’s refusal to allow Plaintiffs to ‘aggregate’ or

‘stack’ multiple uninsured and/or underinsured motorist coverages

provided by State Farm policies constitutes a breach of

contract.” The plaintiffs also raised claims for relief based on

breach of covenant of good faith and fair dealing in connection

with their contracts of insurance with State Farm, fraud in

connection with the denial of benefits under the plaintiffs’

policies, violation of the Arizona Consumer Fraud Act (A.R.S. 44-

1522(A)) in connection with the denial of stacking of uninsured
 - 6 -

coverage in multiple policies, breach of fiduciary duty, and

racketeering as proscribed by A.R.S. 13-2301(D)(4). The

plaintiffs requested as relief compensatory damages, treble

damages, punitive damages, attorney’s fees and costs, and

prejudgment interest.

D. Class Action Settlement Agreement

The class action lawsuit was settled on September 6, 2001,

by means of a written settlement agreement (settlement

agreement). Pursuant to the settlement agreement, State Farm

deposited into trust $45,062,945, of which $29,873,750

constituted “Class Member Settlement Funds” (settlement funds) to

be used to pay certain of the plaintiffs; namely, “Eligible Class

Members”.4 Under the settlement agreement, each Eligible Class

Member was entitled to receive a pro rata share of the settlement

funds (plus interest accruing before disbursement) provided the

Eligible Class Member executed and returned an individual release

to State Farm. Eligible Class Members included those plaintiff

class members whom the superior court had ruled met the following

criteria, as described in the settlement agreement:

Any person (and each person who has a claim for the
wrongful death of a person) who is, or was,

4
The remaining funds were allocated to (1) “Seventh Year
Class Members” whose claims apparently were subject to a greater
litigation hazard that State Farm would prevail in a statute of
limitations defense, and (2) attorney’s fees and costs.
 - 7 -

(A) insured under multiple automobile liability
insurance policies that: (i) were purchased by one
insured[5] on different vehicles; (ii) included
uninsured (“UM”) and/or underinsured (“UIM”) motorist
coverage; and (iii) were delivered or issued for
delivery in Arizona by State Farm with respect to a
motor vehicle registered or principally garaged in
Arizona;

(B) who sustained injury or death as a result of the
fault of an insured [sic6] and/or underinsured
motorist; and

(C) who was paid * * * the UM and/or UIM motorist
coverage limits on one automobile liability policy
issued by State Farm, but received no payment from any
other UM and/or UIM coverage provided by any other
automobile liability policy described above.

The settlement agreement excluded from the category of

Eligible Class Members: (1) “Identified Plaintiffs”; i.e., those

class members whom the superior court concluded had policies with

anti-stacking clauses that were valid and enforceable; and (2)

“Fully Compensated Plaintiffs”; i.e., those class members whom

the superior court concluded were fully compensated for their

injuries and not entitled to any recovery in the litigation.

5
We assume in deciding this case that petitioner was treated
by State Farm and the Pima County Arizona Superior Court
(superior court) as meeting the “one insured” requirement in
connection with the policies purchased by her and/or her husband
by virtue of Arizona’s community property laws. See State Farm
Mut. Auto. Ins. Co. v. Lindsey, 897 P.2d at 634.
6
Given the context, we find that the use of the term
“insured” in this clause of the settlement agreement was a
typographical error and that “uninsured” was intended by the
parties to the agreement.
 - 8 -

As noted, an Eligible Class Member was required to execute a

prescribed individual release in order to receive his or her pro

rata share of the settlement funds. The terms of the prescribed

individual release are not in the record. However, pursuant to

the settlement agreement, every Eligible Class Member, regardless

of whether he or she executed an individual release and received

settlement funds, became subject to a general class release which

released State Farm “from any and all claims, demands, suits,

causes of action, damages, costs, fees, expenses, and civil

liabilities of any nature whatsoever in law or equity arising

from the transaction or occurrence giving rise to the claims in

the [class action] Complaint”.

E. Receipt of Payment

Petitioner was one of 568 Eligible Class Members who

received pro rata disbursements from the settlement funds that,

with accrued interest, had grown to $30,041,902 as of January 31,

2002. Sometime in 2002 petitioner received a $52,896 payment

pursuant to the settlement agreement as her pro rata portion of

the settlement funds. During that year petitioner was issued a

Form 1099-MISC, Miscellaneous Income, reflecting the payment.

II. Social Security Administration Payments

During 2002 petitioner was disabled as a result of reflex

dystrophy syndrome. She received payments totaling $9,396 from

the Social Security Administration on account of this disability
 - 9 -

and was issued a Form SSA-1099, Social Security Benefit

Statement, reflecting the payments.

During 2002 petitioner and her husband were married but were

experiencing marital difficulties.

III. Dependency Exemption Deduction and Child Tax Credit

Petitioner and her husband had two children during their

marriage--TJM and TDM.7 Sometime around 2000 petitioner moved to

New Hampshire. As noted, petitioner remained married throughout

2002. She and her husband obtained a final decree of divorce in

2005. They had no written agreement concerning the custody of

TJM and TDM during 2002.

IV. Tax Advice

Petitioner consulted an accountant as to the proper tax

treatment of the $52,896 payment from State Farm. The accountant

advised petitioner that the payment might or might not be taxable

and that petitioner should make further inquiry into its tax

consequences.

V. Notice of Deficiency

Petitioner did not file a Federal income tax return for

2002. Respondent prepared a substitute for return and on

December 27, 2005, issued a notice of deficiency to petitioner

for 2002 in which he determined that petitioner had unreported

7
TJM was born on Sept. 13, 1993, and TDM was born on Dec.
17, 1996.
 - 10 -

income of $60,882 as disclosed by third-party payors.8 Respondent

further determined that petitioner’s filing status was single,

that petitioner was entitled to one personal exemption and no

credits, and that petitioner was liable for additions to tax

under section 6651(a)(1) and (2) as previously described.

Petitioner filed a timely petition for redetermination.

OPINION

Generally, the determinations in the notice of deficiency

are presumed correct, and taxpayers bear the burden of proving

that the determinations are in error. See Rule 142(a); Welch v.

Helvering, 290 U.S. 111, 115 (1933). Petitioner has not claimed

or shown entitlement to any shift in the burden of proof pursuant

to section 7491(a). As discussed infra, respondent bears the

burden of production with respect to the additions to tax he

determined, pursuant to section 7491(c).

Generally, gross income includes all income from whatever

source derived unless excluded by a specific provision of the

Internal Revenue Code. See sec. 61(a); sec. 1.61-1(a), Income

Tax Regs. Section 61(a) broadly applies to any accession to

wealth; statutory exclusions from income are to be 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). A

8
See supra note 1.
 - 11 -

taxpayer must demonstrate that he or she is within the clear

scope of any statutory exclusion. See Commissioner v. Schleier,

supra at 336-337; United States v. Burke, supra at 233.

I. Unreported Income

A. State Farm Settlement Payment

We first decide whether petitioner must include in her 2002

gross income the $52,896 payment she received pursuant to the

settlement agreement with State Farm.

1. Applicable Internal Revenue Code Provision

Petitioner contends that the settlement payment is

excludable from gross income under section 104(a)(2) because it

constitutes damages received on account of personal physical

injuries she suffered in an automobile accident. Respondent

counters that the payment was not to settle a tort claim or to

pay petitioner on account of personal physical injuries but

rather to redress contract claims. Thus, respondent argues the

payment fails the two-part test under Commissioner v. Schleier,

supra at 337, and therefore is not excludable from gross income

under section 104(a)(2).

We believe the parties have miscast the issue as governed by

section 104(a)(2). Section 104(a)(2) provides an exclusion from

gross income for “the amount of any damages (other than punitive

damages) received (whether by suit or agreement * * * ) on
 - 12 -

account of personal physical injuries or physical sickness”. The

regulations interpreting section 104(a)(2) provide:

Section 104(a)(2) excludes from gross income the amount
of any damages received[9] (whether by suit or agreement)
on account of personal injuries or sickness. The
[statutory] term “damages received (whether by suit or
agreement” means an amount 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.; emphasis added.]

Petitioner did not bring a suit, or settle one, based on tort or

tort type rights. The suit and settlement at issue were not

against the motorist whose fault caused her injury or against

that motorist’s insurer. Petitioner sued her own insurer

concerning a disagreement over the contractual terms of policies

she and her spouse had purchased--specifically, whether anti-

stacking clauses in those policies entitled State Farm to deny

coverage under the second policy. The settlement petitioner

reached with State Farm was therefore not a “settlement agreement

entered into in lieu of” a prosecution “based on tort or type

rights”; it was a settlement of a contract dispute concerning the

terms of an insurance policy she had purchased that purported to

indemnify her against injury caused by an uninsured motorist.

9
The regulations do not reflect the 1996 amendment of sec.
104(a)(2) wherein the phrase “(other than punitive damages)” was
added after “damages”. See Small Business Job Protection Act of
1996, Pub. L. 104-188, sec. 1605(a), 110 Stat. 1838.
 - 13 -

Section 104(a)(3) generally provides an exclusion10 from

gross income for

amounts received through accident or health insurance *
* * for personal injuries or sickness (other than
amounts received by an employee, to the extent such
amounts (A) are attributable to contributions by the
employer which were not includible in the gross income
of the employee, or (B) are paid by the employer) * * *

The regulations interpreting section 104(a)(3) provide:

Section 104(a)(3) excludes from gross income amounts
received through accident or health insurance for
personal injuries or sickness (other than amounts
received by an employee, to the extent that such
amounts (1) are attributable to contributions of the
employer which were not includible in the gross income
of the employee, or (2) are paid by the employer). * *
* If, therefore, an individual purchases a policy of
accident or health insurance out of his own funds,
amounts received thereunder for personal injuries or
sickness are excludable from his gross income under
section 104(a)(3). * * * [Sec. 1.104-1(d), Income Tax
Regs.]

Accordingly, under the regulations, where an individual has

purchased an accident or health insurance policy, the section

104(a)(3) exclusion applies to amounts “received thereunder for

personal injuries or sickness”.

The regulations under section 104(a)(3) do not address the

situation where the insured receives amounts only after

initiation and settlement of a lawsuit against the issuer of the

accident or health insurance policy. The parties apparently

believe that the interposing of a lawsuit between the insured and

10
The exclusion does not extend to amounts attributable to
deductions allowed under sec. 213 for any prior taxable year.
 - 14 -

the insurer in this case causes the payment petitioner received

from State Farm to constitute “damages” that may be excluded from

income only by satisfying the requirements of section 104(a)(2).

We disagree. As more fully discussed below, we conclude that

petitioner’s settlement payment from State Farm was received

“through” accident or health insurance “for” personal injuries or

sickness within the meaning of section 104(a)(3) and is therefore

excludable, up to the policy limits, under that section.

To decide whether the settlement payment petitioner received

is excludable under section 104(a)(3), we must determine whether

it constitutes an amount received (1) “through” (2) “accident or

health insurance” (3) “for” personal injuries or sickness. See

Marsh v. Commissioner, T.C. Memo. 2000-11, affd. 23 Fed. Appx.

874 (9th Cir. 2002).

2. Whether Petitioner’s Automobile Liability Policy
Was “Accident or Health Insurance”

We believe there can be no serious dispute that petitioner’s

automobile liability policy on which State Farm denied coverage

was “accident or health insurance” within the meaning of section

104(a)(3).11 In Marsh v. Commissioner, supra, we assumed that an

amount received in settlement of litigation over a claim under

the uninsured motorist coverage of an automobile liability

11
There is also no dispute in this case that the State Farm
policies at issue were purchased by petitioner or her spouse and
not by any employer of either.
 - 15 -

insurance policy was in theory excludable under section

104(a)(3).12 The Commissioner has taken a similar position in a

published revenue ruling that disability payments received under

a “no fault” automobile insurance policy are excludable under

section 104(a)(3). See Rev. Rul. 73-155, 1973-1 C.B. 50. We

accordingly hold that the uninsured motorist coverage in the

State Farm automobile liability insurance policies at issue is

“accident or health insurance” within the meaning of section

104(a)(3).

3. Whether the Payment Was an Amount Received
“Through” Accident or Health Insurance

Section 104(a)(3) requires that an excluded amount be

received “through” accident or health insurance. The regulations

further clarify that an amount is excludable if an individual has

purchased the policy and the amounts are received “thereunder”.

Sec. 1.104-1(d), Income Tax Regs. Marsh v. Commissioner, supra,

likewise involved a claim by an insured taxpayer for

indemnification for a personal injury under the uninsured

motorist coverage of his automobile liability policy. As in this

case, the insurer denied coverage on grounds subsequently found

invalid by the State’s highest court in other proceedings. The

12
In Marsh v. Commissioner, T.C. Memo. 2000-11, affd. 23
Fed. Appx. 874 (9th Cir. 2002), we held that an exclusion under
sec. 104(a)(3) was not available because the claim that had been
settled by the insurer was based on a false statement by the
insured.
 - 16 -

taxpayer thereupon sued, and the insurer ultimately settled with

the taxpayer for approximately $68,000, which the taxpayer sought

to exclude under section 104(a)(3) or (2).13 A key difference in

Marsh was our finding that the taxpayer’s claim of personal

injury was based on his false statement. As a result, we held

that the payment was not excludable under section 104(a)(3)

because it was not “for” personal injuries or sickness. We did

not suggest that the payment’s being a product of litigation with

the insurer raised an issue under the requirement that the

payment be received “through” accident or health insurance.

Indeed, we assumed that a payment in these circumstances would be

“under an insurance policy”.14

Petitioner received the $52,896 payment at issue as her

share of the settlement of a class action lawsuit against State

Farm. In order to be eligible to receive the payment, petitioner

was required to have been (1) insured under multiple (two or

13
We found the taxpayer’s position on brief unclear as
between the two subsections, but the Commissioner’s arguments
assumed that the taxpayer was claiming an exclusion under sec.
104(a)(3).
14
In this regard, we stated:

section 104(a)(3) provides an exclusion from gross
income of “amounts received through accident or health
insurance for personal injuries or sickness”.
(Emphasis added.) The mere fact that amounts in
question are paid by an insurance company under an
insurance policy does not establish that such amounts
were actually paid for injuries or sickness. * * *
[Marsh v. Commissioner, supra.]
 - 17 -

more) insurance policies purchased from State Farm with UM/UIM

coverage, (2) injured through the fault of an uninsured or

underinsured motorist, and (3) denied payment under one of the

foregoing policies while receiving payment under another.

We are satisfied that these prerequisites establish that

petitioner received the settlement payment “through” accident

insurance, or under such a policy, within the meaning of section

104(a)(3) and the regulations. Petitioner’s claim against State

Farm in the class action lawsuit was at its core a demand for

payment under the second of the two policies purchased by her and

her husband with respect to which State Farm had denied coverage.

That petitioner had to litigate to establish her rights to

payment under the second policy does not change the conclusion

that the payment was received “through” accident insurance. It

is apparent that a primary issue in the litigation was the proper

interpretation of the contractual terms of petitioner’s policies.

Certain members of the plaintiff class, the “Identified

Plaintiffs”, were excluded from any payment under the settlement

agreement because the anti-stacking provisions in their policies

had been found sufficient to support State Farm’s denial of

coverage. In these circumstances we are persuaded that State

Farm settled with petitioner because the company believed there

was a significant likelihood its denial of coverage under the

second policy would be found improper. We accordingly conclude
 - 18 -

that, but for her status as an insured under the second policy,

petitioner would not have received the settlement payment. We

therefore hold that the settlement payment was received “through”

accident or health insurance.

4. Whether the Payment Was Received “for” Personal
Injuries or Sickness

Petitioner was a member of a plaintiff class whose members

had sustained personal injury as the result of the fault of an

uninsured or underinsured motorist but had been denied coverage

under one or more of their State Farm policies with UM/UIM

coverage. Petitioner’s eligibility to receive the payment at

issue required, in addition to the foregoing, that she also not

have been classified as a “Fully Compensated Plaintiff”; namely,

a member of the plaintiff class whom the superior court had ruled

had been fully compensated for his or her injuries.15 Only by

meeting the foregoing requirements did petitioner become

qualified to receive a pro rata distribution of the $29,873,750

settlement funds.

On the basis of these terms of the settlement agreement, we

are satisfied that petitioner received her share of the

settlement funds in significant part because she had

15
In order to qualify as an “Eligible Class Member”,
petitioner also must not have been classified as a “Seventh Year
Class Member”; namely, a plaintiff class member whose claims
under a State Farm policy had been the subject of an unsuccessful
State Farm motion for summary judgment on the basis of the
statute of limitations.
 - 19 -

uncompensated personal injuries for which she had made a bona

fide claim against her insurer for indemnification, which was

settled.

Respondent argues, however, that the class action lawsuit

involved a multitude of claims beyond those premised on personal

injury (e.g., breach of contract, breach of covenant of good

faith and fair dealing, fraud, violation of the Arizona Consumer

Fraud Act, breach of fiduciary duty, and racketeering) and sought

compensatory damages, treble damages, punitive damages, and

prejudgment interest.16 Since the settlement agreement did not

expressly allocate any portion of the payment to personal injury

and petitioner became subject to a general release of all claims

against State Farm, it cannot be said, respondent argues, that

petitioner received the payment “for” personal injury.17 Rather,

the argument goes, the payment was made in exchange for release

of all claims against State Farm, and petitioner has failed to

prove that any portion is attributable to personal injury.

16
Although respondent’s argument was directed at sec.
104(a)(2), we consider it to the extent it may apply to
petitioner’s entitlement to an exclusion under sec. 104(a)(3).
17
Respondent also relies on Taggi v. United States, 35 F.3d
93 (2d Cir. 1994), and Morabito v. Commissioner, T.C. Memo. 1997-
315, but this reliance is misplaced. In both cases the taxpayers
had never advanced a claim of any kind before receiving payment.
Petitioner formally sued State Farm, and the litigation was
settled pursuant to a written settlement agreement. Taggi and
Morabito offer no guidance in this context.
 - 20 -

We disagree. While the general release may have

extinguished all of petitioner’s claims in the lawsuit, we find

more persuasive the fact that petitioner’s eligibility for a

share of the settlement funds depended upon her showing that she

had not been fully compensated for her injuries. Petitioner’s

injuries were extensive. She testified credibly that she was out

of work for a year and that she anticipated medical expenses in

future years as a consequence of her injuries when she settled

her claim under the first State Farm policy in 1996. In these

circumstances we are persuaded that State Farm’s payment to her,

up to the $50,000 limit on UM/UIM coverage in her policy, was

“for” personal injuries within the meaning of section 104(a)(3).

That leaves the excess of the settlement payment over the

$50,000 coverage limit of the second policy; i.e., $2,896. This

amount could not have been indemnification under the policy “for”

petitioner’s personal injuries because State Farm’s obligation

under the policy did not extend that far. Rather, we are

persuaded that $2,896 of the settlement payment was for something

else, either interest18 or resolution of any claims that

18
Petitioner has conceded that $302 of the $52,896 payment
is taxable interest. That concession is consistent with the
undisputed facts. State Farm initially deposited $29,873,750
into trust to be distributed pro rata to the 568 Eligible Class
Members. Petitioner’s share of the original deposit would have
been $52,595. Petitioner’s distribution was approximately $301
more than that.
 - 21 -

petitioner was entitled to recover damages on account of State

Farm’s wrongful denial of coverage.

Consequently, we conclude that petitioner has shown that

$50,000 of the payment at issue is excludable from gross income

pursuant to section 104(a)(3) and has failed to show any basis

for excluding the remainder.

B. Social Security Payments

We now consider whether petitioner must include in her 2002

gross income the $9,396 of payments she received from the Social

Security Administration, as respondent determined.

Petitioner’s unchallenged testimony was that she was

disabled in 2002 as a result of reflex dystrophy syndrome and

received the payments from the Social Security Administration at

issue as a result of that disability. We accordingly find that

the payments were Social Security disability insurance benefits.

Section 86 requires the inclusion in gross income of up to

85 percent of Social Security benefits received during the

taxable year, including Social Security disability insurance

benefits. See sec. 86(a), (d);19 see also Reimels v.

Commissioner, 123 T.C. 245, 247 (2004), affd. 436 F.3d 344 (2d

Cir. 2006); Joseph v. Commissioner, T.C. Memo. 2003-19; Thomas v.

Commissioner, T.C. Memo. 2001-120. Generally, under section

19
Sec. 86(d)(1)(A) defines Social Security benefits to
include amounts received under tit. II of the Social Security
Act, 42 U.S.C. secs. 401-434 (2000), as amended, which include
Social Security disability insurance benefits. Id. sec. 423.
 - 22 -

86(a)(1) Social Security benefits are includible in gross income

“in an amount equal to the lesser of--(A) one-half of the social

security benefits received during the taxable year, or (B) one-

half of the excess described in subsection (b)(1).” The excess

described in subsection (b)(1) is the sum of the taxpayer’s

modified adjusted gross income (MAGI) and one-half of the Social

Security benefits received during the taxable year, over the

taxpayer’s “base amount”. If the sum of the MAGI and one-half of

the Social Security benefits received exceed the taxpayer’s

“adjusted base amount”, then the amount of Social Security

benefits includible in gross income is equal to the lesser of:

(A) the sum of–-

(i) 85 percent of such excess, plus

(ii) the lesser of the amount determined under paragraph (1)
or an amount equal to one-half of the difference between the
adjusted base amount and the base amount of the taxpayer, or

(B) 85 percent of the social security benefits received
during the taxable year. [Sec. 86(a)(2).]

For purposes of section 86, a taxpayer’s MAGI is her

“adjusted gross income--(A) determined without regard to this

section and sections 135, 137, 221, 222, 911, 931, and 933, and

(B) increased by the amount of interest received or accrued by

the taxpayer during the taxable year which is exempt from tax.”

Sec. 86(b)(2). Section 86(c)(1)(C) defines the term “base

amount” to mean “zero in the case of a taxpayer who--(i) is

married as of the close of the taxable year (within the meaning
 - 23 -

of section 7703) but does not file a joint return for such year,

and (ii) does not live apart from his spouse at all times during

the taxable year.” Section 86(c)(2)(C) defines the term

“adjusted base amount” to mean “zero in the case of a taxpayer

described in paragraph (1)(C).”

Respondent determined that petitioner’s sole item of gross

income for 2002 other than her disability insurance benefits of

$9,396 was the $52,896 payment from State Farm. We have

redetermined that only $2,896 of the State Farm payment is

includible in petitioner’s 2002 gross income. As a consequence,

none of the adjustments in section 86(b)(2) applies; petitioner’s

gross income, “adjusted gross income”,20 and MAGI in 2002 were the

same--$2,896. Petitioner’s “base amount” and “adjusted base

amount” were both zero.21 See sec. 86(c)(1)(C), (2)(C).

20
Petitioner has not shown that she is entitled to any of
the deductions under sec. 62 that would cause “adjusted gross
income” to be less than “gross income”.
21
Petitioner’s base amount was zero because she was a
taxpayer described in sec. 86(c)(1)(C). Petitioner was married
at the end of 2002, has not shown she satisfied the requirements
of sec. 7703(b) to be treated as not married in 2002, and did not
file a joint return for the year. See sec. 86(c)(1)(C)(i); see
also Phillips v. Commissioner, 86 T.C. 433, 441 n.7 (1986), affd.
in part and revd. in part on another issue 851 F.2d 1492 (D.C.
Cir. 1988); Brunner v. Commissioner, T.C. Memo. 2004-187 (joint
filing status not allowable unless a joint return is filed and
made a part of the record before the case is submitted to the Tax
Court for decision), affd. per curiam 142 Fed. Appx. 53 (3d Cir.
2005). Further, petitioner has not shown that she lived apart
(continued...)
 - 24 -

Under section 86(b)(1), petitioner’s MAGI ($2,896) plus one-

half of the Social Security disability insurance benefits of

$9,396 ($4,698) equals $7,594, which exceeds her “adjusted base

amount” of zero. Accordingly, under section 86(a)(2) the amount

of Social Security benefits includible in petitioner’s gross

income is equal to the lesser of $6,455 (85 percent of the excess

of $7,594 ($6,455) plus zero22), or $7,987 (85 percent of the

Social Security benefits received).

Accordingly, petitioner must include in her gross income for

2002 $6,455 of the $9,396 of Social Security disability insurance

benefits she received during the year, pursuant to section 86.

II. Filing Requirement

We have redetermined that petitioner had gross income in

2002 totaling $9,351 (consisting of the $2,896 taxable portion of

the State Farm payment and the $6,455 taxable portion of the

Social Security benefits). As a consequence, the Court will

consider sua sponte whether petitioner had an obligation to file

a Federal income tax return for 2002.

21
(...continued)
from her former spouse “at all times” during 2002. See sec.
86(c)(1)(C)(ii). Petitioner’s adjusted base amount was also zero
because she is a taxpayer described in sec. 86(c)(1)(C). See
sec. 86(c)(2)(C).
22
One-half of the difference between the adjusted base
amount (zero) and the base amount (zero) is zero, which is less
than the amount determined under par.(1). See sec.
86(a)(2)(A)(ii).
 - 25 -

Section 6012(a)(1) requires the filing of an income tax

return by every individual having gross income for the taxable

year which equals or exceeds the “exemption amount” (i.e.,

$3,00023) with four exceptions. Petitioner does not satisfy the

first three exceptions (i.e., clauses (i), (ii) and (iii) of

section 6012(a)(1)(A), which apply to unmarried individuals,

(unmarried) heads of households, and surviving spouses,

respectively) because she was married as of the close of 2002.

Petitioner also fails to satisfy the fourth exception in clause

(iv) of section 6012(a)(1)(A), which applies to an individual

(iv) who is entitled to make a joint return and
whose gross income, when combined with the gross income
of his spouse, is, for the taxable year, less than the
sum of twice the exemption amount plus the basic
standard deduction applicable to a joint return, but
only if such individual and his spouse, at the close of
the taxable year, had the same household as their home.

Petitioner fails to satisfy the exception in clause (iv) in three

respects. First, she is not entitled to file a joint return,

since she had not filed such a return (or any return) as of the

submission of this case for decision. See Phillips v.

Commissioner, 86 T.C. 433, 441 n.7 (1986), affd. in part and

revd. in part on another issue 851 F.2d 1492 (D.C. Cir. 1988);

23
For purposes of sec. 6012, a taxpayer’s “exemption amount”
has the same meaning as provided in sec. 151(d). Sec.
6012(a)(1)(D)(ii). Sec. 151(d) provides that generally a
taxpayer’s “exemption amount” is $2,000 increased by a cost-of-
living adjustment. Sec. 151(d)(1), (4). For taxable years
beginning in 2002 the “exemption amount” under sec. 151(d)
adjusted for the cost of living was $3,000. See Rev. Proc. 2001-
59, sec. 3.11, 2001-2 C.B. 623, 626.
 - 26 -

Brunner v. Commissioner, T.C. Memo. 2004-187, affd. per curiam

142 Fed. Appx. 53 (3d Cir. 2005). Second, petitioner has

provided no evidence concerning her spouse’s gross income in

2002. Third, petitioner has not shown that she and her spouse

had the same household as their home at the close of 2002. The

available evidence suggests the contrary; namely, petitioner

testified that in 2002 her marriage was “dissolving” and that she

and her husband “weren’t really talking too much”. Because

petitioner did not satisfy any of the exceptions, she was

required to file an income tax return under section 6012(a)(1) in

that her gross income of $9,351 exceeded $3,000.

III. Dependency Exemption Deduction

We next consider whether petitioner is entitled to a

dependency exemption deduction for 2002. Petitioner contends

that she is entitled to a dependency exemption deduction for one

of her children, while respondent’s position is that she has

failed to show entitlement because there is no evidence of the

child’s whereabouts or source of support during 2002. We agree

with respondent.

Section 151(a) and (c) allows a taxpayer a deduction for

each individual who is a dependent of the taxpayer as defined in

section 152, including a child of the taxpayer who has not

reached age 19 by the close of the taxable year. The allowance

is conditional, however, on the taxpayer’s including the
 - 27 -

identifying number of the dependent on the return claiming the

exemption. See secs. 151(e), 7701(a)(41), 6109. Section 152(a)

defines a dependent in pertinent part to include a son of the

taxpayer over half of whose support for the year was received

from the taxpayer or is treated as received from the taxpayer

under subsection (c) or (e) of section 152.

Section 152(e) provides special rules for treating one

taxpayer as if he or she provided more than half the support of

his or her child in the case of divorced parents, which for this

purpose includes married individuals who, notwithstanding the

absence of a divorce, legal separation, or written separation

agreement, nonetheless “live apart at all times during the last 6

months of the calendar year”. Sec. 152(e)(1). Application of

section 152(e) also requires that the child receive over half of

his support during the calendar from his parents and be in the

custody of one or both of them for more than one-half of the

calendar year. Id. If these conditions are met, the child is

treated as receiving over half of his support from the parent

having custody for a greater portion of the calendar year, id.,

or from the parent having custody for the lesser portion if the

other parent releases his or her claim in a written declaration

attached by the claiming parent to his or her return, sec.

152(e)(2).
 - 28 -

Petitioner has failed to show that she satisfies any of the

section 152 requirements for claiming either of her children as

dependents. She has proven only that during her marriage she had

two children who were minors during 2002. Beyond that, there is

no evidence of the source of the children’s support in 2002 or of

which parent had custody over what period during that year.

Petitioner asserts on brief that she provided over half of the

support of one of her two children. However, statements on brief

are not evidence. See Rule 143(b); Neonatology Associates, P.A.

v. Commissioner, 115 T.C. 43, 92 (2000), affd. 299 F.3d 221 (3d

Cir. 2002).

Petitioner testified that she and her husband had an oral

agreement covering 2002 under which petitioner was entitled to

claim one of their children as a dependent. However, even a

formal written agreement, incorporated in a State court decree,

granting the dependency exemption deduction for a child to one

parent is ineffective if the requirements of section 152 are not

met. See Miller v. Commissioner, 114 T.C. 184, 193-194 (2000).

It follows that any oral understanding between petitioner and her

husband is likewise ineffective.

Given that the record does not establish the children’s

whereabouts in 2002, petitioner has failed to show either that

she provided over half of the support of either child, as

required under section 152(a), or that she should be treated as
 - 29 -

providing over half of that support under section 152(e) because

she had custody of the child for the greater portion of 2002 or

had a written declaration from her husband releasing any claim to

one of the dependency exemption deductions for their two

children.24 Respondent’s determination that petitioner is

entitled to only one personal exemption is therefore sustained.

IV. Child Tax Credit

We turn to petitioner’s claim of a child tax credit for

2002.

Subject to income limitations not pertinent here, a child

tax credit is allowed with respect to each “qualifying child” of

the taxpayer. Sec. 24(a) and (b). Section 24(c)(1) generally

defines a “qualifying child” as a child of the taxpayer for whom

the taxpayer is allowed a dependency exemption deduction under

section 151 and who has not attained age 17. Since we have

concluded that petitioner is not entitled to a dependency

exemption deduction for either TJM or TDM, neither child is

petitioner’s “qualifying child” under section 24(c).

Consequently, petitioner is not entitled to a child tax credit,

and we sustain respondent’s determination to that effect.

24
The exceptions in sec. 152(e)(3) and (4) also do not
apply. There is no evidence that there was a multiple support
agreement as defined in sec. 152(c) covering petitioner’s
children in 2002, and there was no pre-1985 instrument within the
meaning of sec. 152(e)(4) applicable to them.
 - 30 -

V. Additions to Tax

Finally, we consider whether petitioner is liable for

additions to tax under section 6651(a)(1) and (2).

Respondent bears the burden of production with respect to

petitioner’s liability for the additions to tax. See sec.

7491(c). In order to meet that burden, respondent must offer

sufficient evidence to indicate that it is appropriate to impose

the additions. See Higbee v. Commissioner, 116 T.C. 438, 446

(2001). Once respondent meets his burden of production,

petitioner bears the burden of proving error in the

determination, including establishing reasonable cause or other

exculpatory factors. Id. at 446-447.

A. Section 6651(a)(1) Addition to Tax

Section 6651(a)(1) imposes an addition to tax for any

failure to file a return by its due date. The addition is equal

to 5 percent of the amount required to be shown as tax on the

return for each month or portion thereof that the return is late,

up to a maximum of 25 percent. See id. The addition will not

apply if it is shown that the failure to file a timely return was

due to reasonable cause and not due to willful neglect. See id.;

see also United States v. Boyle, 469 U.S. 241, 245 (1985). A

failure to file timely is due to reasonable cause “If the

taxpayer exercised ordinary business care and prudence and was

nevertheless unable to file the return within the prescribed
 - 31 -

time”. Sec. 301.6651-1(c)(1), Proced. & Admin. Regs.; see United

States v. Boyle, supra at 246. Willful neglect is interpreted as

a “conscious, intentional failure or reckless indifference.”

United States v. Boyle, supra at 245.

As previously discussed, we have sustained respondent’s

determination that petitioner had gross income in 2002 to the

extent of $9,351, which exceeded her exemption amount. She was

therefore required to file a return for 2002. See sec.

6012(a)(1). Petitioner’s return for 2002 was due on April 15,

2003, in the absence of any extensions. See secs. 6072(a),

6081(a). The parties stipulated that petitioner did not file a

return for 2002. The foregoing satisfies respondent’s burden of

production under section 7491(c) and establishes petitioner’s

liability for the section 6651(a)(1) addition to tax unless

petitioner can establish reasonable cause for her failure to file

timely. See Higbee v. Commissioner, supra at 446.

Petitioner has not made an explicit claim that she had

reasonable cause for her failure to file. She testified,

however, that she consulted an accountant regarding the proper

tax treatment of the payment she received from State Farm and

that he advised her that it might or might not be taxable and

that she should make further inquiry. Assuming this testimony

should be treated as a claim of reasonable cause, it falls short.

While it is true that the receipt of professional advice to the
 - 32 -

effect that the taxpayer does not have a tax liability or filing

obligation may constitute reasonable cause for a failure to

timely file, see, e.g., United States v. Boyle, supra at 250-251

& n.9; Zabolotny v. Commissioner, 97 T.C. 385, 400-401 (1991),

affd. in part and revd. in part on other grounds 7 F.3d 774 (8th

Cir. 1993), petitioner received no such advice regarding her

obligations with respect to the State Farm payment and no advice

whatsoever regarding the Social Security payments. We

accordingly conclude that petitioner did not have reasonable

cause for her failure to file, and we sustain respondent’s

determination of the addition to tax under section 6651(a)(1),

with the “amount required to be shown as tax on * * * [the]

return” computed in a manner consistent with petitioner’s gross

income as redetermined herein.

B. Section 6651(a)(2) Addition to Tax

Section 6651(a)(2) imposes an addition to tax for any

failure to pay the tax shown on a return on or before the date

prescribed for payment of such tax. The addition is equal to 0.5

percent of the amount shown as tax on the return for each month,

or fraction thereof, during which the failure to pay continues,

up to a maximum of 25 percent.25 See id. The date prescribed for

25
The sec. 6651(a)(1) addition to tax is reduced by the
amount of the sec. 6651(a)(2) addition for any month (or fraction
thereof) to which an addition to tax applies under sec.
6651(a)(1) and (2). See sec. 6651(c)(1).
 - 33 -

payment of income tax is the due date for filing the return

determined without regard to any extension of time for filing.

See id.

The addition applies only when an amount of tax is shown on

a return. See Wheeler v. Commissioner, 127 T.C. 200, 208 (2006);

Cabirac v. Commissioner, 120 T.C. 163, 170 (2003). A substitute

for return (SFR) made by the Secretary under section 6020(b) is

treated as “the return filed by the taxpayer for purposes of

determining the amount of the addition” under section 6651(a)(2).

Sec. 6651(g)(2). For these purposes, an SFR “must be subscribed,

it must contain sufficient information from which to compute the

taxpayer’s tax liability, and the return form and any attachments

must purport to be a ‘return’.” Spurlock v. Commissioner, T.C.

Memo. 2003-124; see also Cabirac v. Commissioner, supra at

170-171.

The addition will not apply if it is shown that the failure

to pay timely was due to reasonable cause and not due to willful

neglect. See sec. 6651(a)(2). A failure to pay is due to

reasonable cause if the taxpayer “exercised ordinary business

care and prudence in providing for payment of his tax liability

and was nevertheless either unable to pay the tax or would suffer

an undue hardship * * * if he paid on the due date.” Sec.

301.6651-1(c)(1), Proced. & Admin. Regs.; see Merriam v.
 - 34 -

Commissioner, T.C. Memo. 1995-432, affd. without published

opinion 107 F.3d 877 (9th Cir. 1997).

As noted, petitioner did not file a return for 2002.

Respondent, pursuant to section 6020(b), prepared an SFR for 2002

showing tax due of $16,822.26 The SFR qualifies as a valid return

for purposes of section 6651(a)(2). Petitioner failed to pay

timely her 2002 tax liability as shown on the SFR. These

undisputed facts satisfy respondent’s burden of production under

section 7491(c) and establish petitioner’s liability for the

section 6651(a)(2) addition to tax unless petitioner can

establish reasonable cause for her failure to pay timely. See

Higbee v. Commissioner, 116 T.C. at 446.

Petitioner was disabled during 2002 and 2003. Although

petitioner testified at trial that she received Social Security

disability insurance benefits in 2002, there is no other evidence

of her financial circumstances at that time. On this record, we

are unable to conclude that petitioner was unable to pay her tax

due or that she would have suffered undue hardship if she had

paid the tax on its due date. See Guterman v. Commissioner, T.C.

Memo. 2008-283; Bray v. Commissioner, T.C. Memo. 2008-113; see

also sec. 301.6651-1(c)(1), Proced. & Admin. Regs.

26
The tax was calculated on the basis of the same
adjustments subsequently determined in the notice of deficiency.
 - 35 -

We therefore hold that petitioner has not shown reasonable

cause with respect to the section 6651(a)(2) addition to tax, and

we sustain respondent’s determination of the section 6651(a)(2)

addition to tax for 2002, reduced in accordance with section

6651(c)(2) to reflect our redetermination of petitioner’s gross

income for 2002.

To reflect the foregoing,

Decision will be entered

under Rule 155.