T.C. Memo. 2010-9
UNITED STATES TAX COURT
JULIE LEIGH DOMENY, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 6975-08.1 Filed January 13, 2010.
Brett L. Gibbs and Barbara N. Morrison, for petitioner.
Matthew A. Williams, for respondent.
MEMORANDUM OPINION
GERBER, Judge: Respondent determined a $9,543 deficiency in
petitioner’s Federal income tax for 2005 and a $1,909 accuracy-
1
This case was originally docketed as “small tax case” in
accord with petitioner’s designation. At trial petitioner moved
without objection from respondent that this case be removed from
the small tax case category. The Court granted petitioner’s
motion, and the docket number has been changed accordingly.
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related penalty under section 6662(a). The parties have resolved
all issues other than whether $16,933 petitioner received from
her employer was excludable from gross income under section
104(a)(2).2
Unless otherwise indicated, all section references are to
the Internal Revenue Code in effect for 2005, the taxable year in
issue, and all Rule references are to the Tax Court Rules of
Practice and Procedure.
Background
Petitioner resided in California at the time her petition
was filed. After completing high school petitioner obtained a
degree in visual merchandising, cost, and design. She worked in
theater and visual merchandising for approximately 20 years in
the San Francisco area. Following those positions, petitioner
became involved in professional fundraising for nonprofit
organizations. After approximately 2½ years as a professional
fundraiser petitioner was employed by the Pacific Autism Center
for Education (PACE) in 2000.
During 1996 before her employment with PACE petitioner was
diagnosed with multiple sclerosis (MS). At the onset of her MS
2
Petitioner conceded that she failed to report a $799 State
income tax refund and $59 of interest income. Petitioner also
conceded that she failed to report $7,050 of wage compensation
for 2005. Respondent conceded that petitioner acted in good
faith and with reasonable cause and that she is not liable for
any penalty under sec. 6662(a).
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she experienced numbness from the waist down. The numbness
receded to her feet, leaving them numb. She also experienced
fatigue, lightheadedness, vertigo, and sometimes a burning
sensation behind her eyes. Petitioner found the prescribed
treatment (which did not ameliorate the symptoms of her
condition) more profoundly troublesome than her symptoms, so she
chose to “manage” her symptoms without medication. She left her
position as a professional fundraiser before being hired by PACE,
because she was seeking a job situation were she would not have
to spend as much time on her feet.
Petitioner’s duties with PACE included community
development, fund raising, and writing grants. Petitioner
enjoyed her work with PACE, and she was motivated by the children
and parents who were involved with PACE’s autism program. The
fact that petitioner was ill with MS motivated her involvement
with the cause of autism and the underlying fundraising
activities.
After a while PACE appointed a new executive director who
was to be petitioner’s supervisor. The new executive director
did not want petitioner to socialize or be involved with parents
of autistic children, although she was required to somehow
approach them for fundraising purposes. Petitioner had a
strained relationship with her supervisor, who restricted her
duties. By 2004 these concerns and conditions in petitioner’s
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workplace caused her MS symptoms to flare up. In November 2004
it came to petitioner’s attention that the director was
embezzling funds from PACE’s students’ personal accounts.
Petitioner went to PACE’s board members with this information,
and she was told that they would take care of the situation.
Petitioner felt tension concerning her supervisor’s alleged
embezzlement. In particular she was upset that PACE sent her out
to raise funds from parents, knowing that funds were being
embezzled by her supervisor. Petitioner advised her superiors on
several occasions of her unhealthful work environment, including
her stress from the embezzlement and PACE’s failure to take any
action. The series of events involving the embezzlement and
resulting severance of the residential director caused petitioner
much distress, and during that time her MS symptoms intensified.
Petitioner’s symptoms continued to worsen, and on March 7,
2005, she left work. On the next day she visited her primary
care physician, Dr. Chris E. Chung. At that time Dr. Chung
determined that petitioner was too ill, because of her MS
symptoms, to return to work and that she should not return to
work until after March 21, 2005. Petitioner’s March 7, 2005,
symptoms from MS included: Vertigo, shooting pain in both legs,
difficulty walking due to numbness in both feet, a burning
sensation behind her eyes, and extreme fatigue. On or about
March 8, 2005, petitioner notified PACE by facsimile of Dr.
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Chung’s diagnosis and of the doctor’s instructions that she not
return to work until after March 21, 2005. After sending the
facsimile on March 8, 2005, petitioner received a telephone call
from PACE’s executive director, who notified her that her
employment would be terminated effective March 15, 2005. After
that telephone conversation petitioner’s physical MS symptoms
were “spiking”, including shooting pain up her legs, fatigue,
burning eyes, spinning head, vertigo, and lightheadedness.
During the taxable year 2005 petitioner was employed by PACE from
January 1 through March 15.
Because of these circumstances, petitioner contacted a
lawyer to seek redress from PACE. She explained the
circumstances of her employment, illness, and dismissal to the
lawyer, who agreed that she had a cause of action, and petitioner
retained the lawyer to pursue PACE. Petitioner’s lawyer
negotiated with PACE lawyers, and a settlement was reached. The
settlement agreement was entitled “Severance Agreement and
Release of Claims” (the agreement). In the agreement petitioner
released the following list of numerous possible causes of action
or rights:
(a) any and all rights and claims relating to or in
any manner arising from the * * * [petitioner’s]
employment or the termination of her employment;
(b) any and all rights and claims arising under the
California Fair Employment and Housing Act * * *;
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(c) any and all claims arising under the Civil Rights
Act of 1964 * * *;
(d) any and all rights and claims arising under the
Americans with Disabilities Act;
(e) any and all rights and claims arising [sic] the Age
Discrimination in Employment Act of 1967 * * *;
(f) any and all rights and claims arising under the
Family and Medical Leave Act or the California
Family Rights Act;
(g) any and all claims for violation of the Fair Labor
Standards Act, the California Labor Code, or the
California Wage Orders; and
(h) any and all claims for breach of contract, breach
of the covenant of good faith and fair dealing,
invasion of privacy, infliction of emotional
distress, defamation and misrepresentation.
Under the agreement $33,308 was the total amount PACE agreed
to pay. Of the $33,308, $8,187.50 was compensation due to
petitioner, which PACE agreed to send directly to petitioner’s
attorney. Petitioner reported the $8,187.50 on her 2005 Federal
income tax return as wage compensation. Another $8,187.50 was
sent directly to petitioner’s attorney, and petitioner was not
issued a Form 1099-MISC, Miscellaneous Income, or Form W-2, Wage
and Tax Statement, by PACE for that amount. PACE paid the
remaining $16,933 to petitioner without withholding
deductions and issued a Form 1099-MISC reflecting that the amount
was “Nonemployee compensation”.
Petitioner did not attend the negotiations between her
lawyer and PACE’s lawyer. At the time petitioner received her
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$16,933 settlement it was her understanding that it was to
compensate her for physical injuries that occurred in a hostile
work environment which PACE allowed to exist over an extended
time. Petitioner’s intense MS symptoms, which occurred during
her PACE employment, prevented her from working until sometime in
2006.
Discussion
The sole question to be considered is whether the $16,933
settlement amount petitioner received is excludable from her
gross income under section 104(a)(2). More specifically, the
parties disagree about whether petitioner received the settlement
for her physical condition. Section 104(a) provides in pertinent
part:
SEC. 104(a). * * * 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;
* * * * * * *
* * * For purposes of paragraph (2), emotional distress
shall not be treated as physical injury or physical
sickness. The preceding sentence shall not apply to an
amount of damages not in excess of the amount paid for
medical care (described in subparagraph (A) or (B) of
section 213(d)(1)) attributable to emotional distress.
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To prevail, petitioner must show3 that her claim against
PACE was based on tort or tort type rights and that the damages
were received on account of physical4 injuries or sickness.
Commissioner v. Schleier, 515 U.S. 323, 337 (1995); see also
Commissioner v. Banks, 543 U.S. 426 (2005). The agreement,
pursuant to which the $16,933 was paid, contains a list of
numerous possible causes of action or rights that petitioner was
releasing in exchange for the payment. In all respects, the
settlement agreement is ambiguous5 regarding any specific reason
for the payment. Respondent relies on that ambiguity as showing
that PACE had no specific intent when making the settlement
payment. When a settlement agreement lacks express language
stating the specific purpose of the settlement payment, the most
important factor for courts to consider is the intent of the
payor. See Kurowski v. Commissioner, 917 F.2d 1033, 1036 (7th
Cir. 1990), affg. T.C. Memo. 1989-149. Accordingly, we must
3
Petitioner acknowledges on brief that she bears the burden
of going forward with evidence and the ultimate burden of proof.
No question concerning the shifting of the burden under sec. 7491
was raised by either party.
4
The requirement that to be excludable the compensation must
be for “physical injuries or physical sickness” was added to sec.
104 by the Small Business Job Protection Act of 1996, Pub. L.
104-188, sec. 1605, 110 Stat. 1838.
5
During trial respondent conceded that petitioner is in no
way limited from showing the specific intent for the payment
because of the ambiguity of the settlement agreement.
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decide the reason or intent for the payment. This is a purely
factual inquiry.
There can be no doubt that petitioner’s claim against PACE
was based on tort or tort type rights. The parties do not dwell
on this requirement. The focus of the parties’ arguments is on
the second requirement of the Schleier test, that the damages be
received on account of physical injury or sickness. It has been
held that the second test “can only be satisfied if there is ‘a
direct causal link’ between the damages and the personal
injuries sustained.” Banaitis v. Commissioner, 340 F.3d 1074,
1080 (9th Cir. 2003) (quoting Fabry v. Commissioner, 223 F.3d
1261, 1270 (11th Cir. 2000), revg. 111 T.C. 305 (1998)), affg.
in part and revg. in part T.C. Memo. 2002-5, revd. on other
grounds sub nom. Commissioner v. Banks, supra.
When damages are paid in connection with a settlement
agreement we first look to the underlying agreement to determine
whether it expressly states that the damages compensate for
“personal physical injuries or physical sickness” under sec.
104(a)(2). See Pipitone v. United States, 180 F.3d 859, 863
(7th Cir. 1999). If the agreement is ambiguous or lacks express
language specifying the purpose of the compensation, courts then
proceed to examine the intent of the payor. Id. at 864;
Kurowski v. Commissioner, supra at 1036; Knuckles v.
Commissioner, 349 F.2d 610, 613 (10th Cir. 1965), affg. T.C.
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Memo. 1964-33. The payor’s intent can be “based on all the
facts and circumstances of the case, including the complaint
that was filed and the details surrounding the litigation.”
See, e.g., Allum v. Commissioner, T.C. Memo. 2005-177, affd. 231
Fed. Appx. 550 (9th Cir. 2007).6
Petitioner’s exposure to a hostile and stressful work
environment exacerbated her MS symptoms to a point where she was
unable to work. This fact was confirmed by her doctor, who
prescribed 2 weeks off. Petitioner notified her employer of her
condition and faxed to her employer her doctor’s diagnosis
together with his instructions that she take time off from work
because of illness. A short time later the executive director
advised petitioner by telephone that her employment would be
terminated effective March 15, 2009.
Petitioner obtained the services of an attorney and
explained (in greater detail) the circumstances of her
employment, illness, and termination from employment. The
attorney met with petitioner’s employer’s attorney and worked
out a settlement of petitioner’s claim against her employer.
The agreement contained a blanket release from any and all
6
Petitioner’s failure to bring suit or make formal
allegations against PACE “is not necessarily detrimental to * * *
[her] efforts to establish the existence of an underlying tort-
type cause of action.” Pipitone v. United States, 180 F.3d 859,
863 (7th Cir. 1999).
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claims that petitioner might have had, but had no specific or
express statement of the payor’s intent.
An inference can be drawn, however, from the terms of the
settlement agreement. The manner in which PACE agreed to pay out
the settlement compensation reveals some recognition of
petitioner’s claim and condition. The $33,308 settlement was
segregated into three separate and distinct payments. One amount
($8,187.50) was reflected as employee compensation due to
petitioner which PACE agreed to pay directly to petitioner’s
attorney. Petitioner reported that $8,187.50 on her 2005 Federal
income tax return as wage compensation. Another $8,187.50 was
sent directly to petitioner’s attorney, and no Form 1099-MISC or
Form W-2 was issued to petitioner by PACE for that amount. The
remaining $16,933 was paid by PACE to petitioner, and the payment
was not reduced by withholding. PACE issued a Form 1099-MISC
reflecting that the $16,933 was “Nonemployee compensation”.
The differing tax and reporting treatments used for the
three payments show that PACE was aware that at least part of
petitioner’s recovery may not have been subject to tax; i.e., was
due to physical illness. Coupled with that inference is the fact
that petitioner advised PACE of her illness before her employment
was terminated and the likelihood that her attorney represented
petitioner’s circumstances to PACE in the course of the
settlement negotiations. Petitioner made no other claim. We
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find that PACE intended to compensate petitioner for her acute
physical illness caused by her hostile and stressful work
environment.
In summary, petitioner has shown that her work environment
exacerbated her existing physical illness.7 Petitioner’s
condition and her MS flareup caused by her working conditions was
intense and long lasting. Petitioner was physically unable to
work until sometime in 2006, more than 1 year following her
termination. She has shown that the only reason for the $16,933
payment was to compensate her for her physical injuries.
To reflect the foregoing and to account for concessions of
the parties,
Decision will be entered
under Rule 155.
7
It is of no consequence that petitioner had the MS
condition before the flareup caused by her hostile work
environment.