T.C. Memo. 2011-263
UNITED STATES TAX COURT
MIGUEL A. AND ANTONIA GUTIERREZ, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 21671-08. Filed November 7, 2011.
Miguel A. and Antonia Gutierrez, pro sese.
John Chinnapongse and Matthew D. Carlson, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
GALE, Judge: Respondent determined a deficiency in
petitioners’ 2005 Federal income tax of $3,249 and an addition to
tax under section 6651(a)(1)1 of $53.
1
Unless otherwise noted, all section references are to the
Internal Revenue Code of 1986, as in effect for the taxable year
in issue, and all Rule references are to the Tax Court Rules of
Practice and Procedure.
-2-
After concessions,2 the remaining issues for decision are:
(1) Whether petitioners are entitled to exclude from gross income
$35,000 that petitioner wife received pursuant to a settlement of
several claims against her former employer, and (2) whether
petitioners are liable for an addition to tax under section
6651(a)(1).
FINDINGS OF FACT
Some of the facts have been stipulated and are so found.
The stipulation of facts and the attached exhibits are
incorporated herein by this reference. At the time the petition
was filed, petitioner husband resided in California and
petitioner wife resided in Mexico.
Petitioner Wife’s Lawsuit
During 2000, 2001, and 2002 petitioner wife worked as a
vineyard worker for R.H. Phillips, Inc. (Phillips), performing a
variety of tasks including pruning and tying vines, training new
plants, harvesting, and other agricultural tasks. In 2004
petitioner wife and three other female vineyard workers
(plaintiffs) sued Phillips, among others, on several grounds in
2
Petitioners concede that they failed to report $53 in
taxable wage income and $1,113 in taxable unemployment
compensation for 2005.
-3-
the Superior Court for the State of California (lawsuit). Among
other counsel, the plaintiffs were represented in the lawsuit by
the law firm of Talamantes, Villegas, Carrera LLP.
The complaint in the lawsuit listed the following causes of
action: (1) Unlawful employment discrimination based on sex, (2)
unlawful failure to prevent harassment, (3) unlawful failure to
prevent discrimination, (4) retaliation for opposing employment
discrimination, (5) aiding, abetting, and inciting
discrimination, (6) misrepresentation preventing former employee
from obtaining employment, (7) wrongful termination/failure to
rehire in violation of public policy, (8) failure to pay minimum
wages, (9) liquidated damages for failure to pay minimum wages,
(10) failure to provide rest periods, (11) failure to provide
meal periods, (12) failure to provide employees with necessary
and required tools and equipment, and (13) restitution and
injunctive relief on the grounds of, inter alia, loss of money,
loss of property, and personal injuries attributable to Phillips’
failure to provide potable water at the worksite or adequate
restroom breaks. The complaint does not allege that emotional
distress resulted from the alleged physical injuries but does
allege that emotional distress such as anxiety and stress
resulted from other grounds in the complaint (e.g., emotional
distress attributable to unlawful employment discrimination based
on sex).
-4-
Settlement Agreement
On or around August 12, 2005, petitioner wife and the other
plaintiffs settled all of the grounds of the lawsuit by entering
into a settlement agreement negotiated by their counsel and
counsel for Phillips. Pursuant to the settlement agreement,
Phillips paid $180,000 to an attorney-client trust established by
Talamantes, Villegas, Carrera LLP and the plaintiffs agreed to
release Phillips from all claims in the lawsuit and any other
claims the plaintiffs might have against Phillips. The
settlement agreement stated that the $180,000 was paid “as
compensation to the Plaintiffs for emotional distress damages
only and for attorneys’ fees”. The plaintiffs were all
monolingual Spanish speakers. A declaration accompanying the
settlement agreement states that the settlement agreement was
orally translated into Spanish in the presence of the plaintiffs
and that the plaintiffs acknowledged that they understood the
translation of the settlement agreement.
In 2005 petitioner wife received $35,000 from the settlement
agreement through the attorney-client trust.
Petitioners’ 2005 Return
Petitioners received an extension of time until October 15,
2006, to file their 2005 Federal income tax return. Petitioners
filed their 2005 return on November 21, 2006. Petitioners did
not include in gross income on their 2005 return the $35,000 that
-5-
petitioner wife had received pursuant to the settlement
agreement.
Notice of Deficiency and Petition
In a timely notice of deficiency, respondent determined that
the $35,000 petitioner wife received pursuant to the settlement
agreement in 2005 was includable in petitioners’ gross income for
that year and that petitioners were liable for an addition to tax
under section 6651(a)(1) for the late filing of the return. In
their timely petition, petitioners alleged, inter alia, that
during her work for Phillips petitioner wife suffered physical
injuries as a result of exposure to pesticides (namely
respiratory damage, constant headaches, and loss of vision) and
emotional distress (including mental trauma and memory loss)
attributable to such physical injuries.
OPINION
Unreported Income
We must first decide whether petitioners must include in
gross income for 2005 the $35,000 that petitioner wife received
pursuant to the settlement agreement. Petitioners contend that
the settlement is excludable from gross income under section
104(a)(2), which provides an exclusion from gross income for
damages received on account of personal injuries or physical
sickness. Respondent contends that petitioners are not entitled
to exclude the settlement from gross income under section
-6-
104(a)(2), because the settlement agreement indicates that the
settlement was not paid on account of personal physical injuries
or physical sickness.
Respondent’s determinations in the notice of deficiency are
presumed to be correct, and petitioners bear the burden of
proving that the determinations are in error. See Rule 142(a);
Welch v. Helvering, 290 U.S. 111, 115 (1933).3
Section 61(a) provides that gross income means all income
from whatever source derived except as otherwise provided.
Exclusions from gross income must be narrowly construed.
Commissioner v. Schleier, 515 U.S. 323, 327-328 (1995); Kovacs v.
Commissioner, 100 T.C. 124, 128 (1993), affd. without published
opinion 25 F.3d 1048 (6th Cir. 1994). One such exclusion is
found in section 104(a)(2), which provides that gross income does
not include the amount of any 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.
The requirement that the injuries or sickness be physical
dates from 1996, when Congress amended section 104(a)(2) to add
that limitation. Effective generally for damages received after
August 20, 1996, in tax years ending after such date, damages for
emotional distress are not excludable from gross income (1)
3
Petitioners have not established that the burden of proof
has shifted to respondent with respect to any factual issue in
this case. See sec. 7491(a).
-7-
unless the emotional distress is attributable to a personal
physical injury or physical sickness, or (2) except to the extent
the damages do not exceed amounts paid for medical care
attributable to emotional distress. See sec. 104(a) (flush
language); Small Business Job Protection Act of 1996, Pub. L.
104-188, sec. 1605, 110 Stat. 1755, 1838; see also Lindsey v.
Commissioner, 422 F.3d 684, 687-688 (8th Cir. 2005), affg. T.C.
Memo. 2004-113; Mayberry v. United States, 151 F.3d 855, 858 n.2
(8th Cir. 1998).
When damages are received pursuant to a settlement
agreement, the nature of the claim underlying the settlement
agreement, not its validity, controls whether a payment is
excludable under section 104(a)(2). United States v. Burke, 504
U.S. 229, 237 (1992); Bagley v. Commissioner, 121 F.3d 393, 395
(8th Cir. 1997), affg. 105 T.C. 396, 406 (1995). The
determination of the nature of the claim is a factual inquiry and
is generally made by reference to the settlement agreement in the
light of the surrounding circumstances. Robinson v.
Commissioner, 70 F.3d 34, 37-38 (5th Cir. 1995), affg. in part
and revg. in part on another issue 102 T.C. 116, 126 (1994);
Knuckles v. Commissioner, 349 F.2d 610, 613 (10th Cir. 1965),
affg. T.C. Memo. 1964-33. An express allocation in the
settlement agreement is generally binding for tax purposes
provided the agreement was entered into by adversarial parties
-8-
acting at arm’s length and in good faith. Bagley v.
Commissioner, supra at 396; Robinson v. Commissioner, supra at
37-38; Allum v. Commissioner, T.C. Memo. 2005-177, affd. 231 Fed.
Appx. 550 (9th Cir. 2007). However, an express allocation will
not be respected if it does not reflect the intent of the
parties. Bagley v. Commissioner, supra at 396; Delaney v.
Commissioner, 99 F.3d 20, 24 (1st Cir. 1996), affg. T.C. Memo.
1995-378. The intent of the payor, and not the recipient, is
critical in determining the validity of an express allocation in
a settlement agreement. Robinson v. Commissioner, supra at 37;
Knuckles v. Commissioner, supra at 613; Agar v. Commissioner, 290
F.2d 283, 284 (2d Cir. 1961), affg. T.C. Memo. 1960-21; Metzger
v. Commissioner, 88 T.C. 834, 847-848 (1987), affd. without
published opinion 845 F.2d 1013 (3d Cir. 1988).
The petition alleges that petitioner wife was exposed to
pesticides during her work for Phillips and that she suffered
both physical injuries, including respiratory damage and
headaches, and emotional distress, including mental trauma and
memory loss, as a result. However, there is no allegation of
harm caused by pesticides in the complaint in the lawsuit.
Accordingly, we find that the settlement payment could not have
constituted compensation for any pesticide-related injury,
whether physical or emotional.
-9-
Petitioner husband testified that his wife suffered physical
injuries attributable to her work for Phillips and did not
understand when she signed the settlement agreement that the
settlement was for emotional distress only (notwithstanding that
the agreement expressly so provided and was translated into
Spanish for her). Respondent contends that the settlement
payment is not excludable from petitioners’ gross income because
it was not received on account of personal physical injuries or
physical sickness.
The complaint alleges that petitioner wife suffered personal
injury as a result of Phillips’ failure to provide potable water
at the worksite or adequate restroom breaks. The complaint does
not allege that the foregoing resulted in any emotional distress.
The settlement agreement expressly allocates the damages paid to
emotional distress and attorney’s fees. The settlement agreement
on its face, as well as other evidence in the case, establishes
that petitioner wife was represented by counsel when she entered
the settlement agreement.
We are persuaded by the evidence that the settlement
agreement was entered into by adversarial parties acting at arm’s
length and in good faith. Petitioner husband’s contention that
his wife did not understand that she was receiving damages only
on account of emotional distress does not, in these
circumstances, persuade us that the settlement agreement fails to
-10-
reflect the intent of the parties, given that petitioner wife was
represented by counsel. The fact that the settlement agreement
does not reference any physical injury (related to potable water,
restroom breaks, or otherwise) persuades us that there was no
intention to compensate for physical injury.4 Instead, the
settlement agreement evidences Phillips’ intent to pay damages
only for emotional distress (and attorney’s fees). In these
circumstances, we conclude that the allocation in the settlement
agreement controls.
Finally, there is no evidence that petitioner wife incurred
any expenses in 2005 for medical care attributable to emotional
distress.
Consequently, there is no basis to exclude any portion of
the $35,000 from gross income under section 104(a)(2). We
accordingly sustain respondent’s determination that petitioners
had unreported income in that amount for 2005.
Section 6651(a)(1) Addition to Tax
Respondent determined a section 6651(a)(1) addition to tax
for failure to timely file. As the parties have stipulated that
petitioners’ 2005 return was filed on November 21, 2006,
4
As the complaint did not even allege emotional distress
arising from inadequate access to potable water or restroom
breaks, we are satisfied that no portion of the settlement could
have been compensation for emotional distress attributable to
such claims. We note in this regard that the complaint did
allege emotional distress as a result of other allegations in the
complaint (e.g., unlawful discrimination based on sex).
-11-
respondent has satisfied his burden of production with respect to
the addition and petitioners are therefore liable unless they can
establish reasonable cause for the late filing. See sec.
7491(c); Higbee v. Commissioner, 116 T.C. 438, 446-448 (2001).
Petitioner husband testified that he filed late because he was
preoccupied with petitioner wife’s immigration problems.
“Selective inability” to file a timely tax return--i.e., while
attending to other matters--does not demonstrate reasonable
cause. Wright v. Commissioner, T.C. Memo. 1998-224, affd.
without published opinion 173 F.3d 848 (2d Cir. 1999); see also
Bear v. Commissioner, 19 F.3d 26 (9th Cir. 1994), affg. without
published opinion T.C. Memo. 1992-690; Dustin v. Commissioner,
467 F.2d 47, 50 (9th Cir. 1972), affg. 53 T.C. 491, 507 (1969);
Tabbi v. Commissioner, T.C. Memo. 1995-463; Kemmerer v.
Commissioner, T.C. Memo. 1993-394; Fambrough v. Commissioner,
T.C. Memo. 1990-104. Accordingly, we sustain respondent’s
imposition of an addition to tax under section 6651(a)(1).
To reflect petitioners’ concessions and the foregoing,
Decision will be entered
for respondent.