T.C. Summary Opinion 2016-46
UNITED STATES TAX COURT
RICHARD G. BRADDOCK, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 590-14S. Filed August 24, 2016.
Peter G. McGrath, for petitioner.
Johnny Craig Young and Corey R. Clapper, for respondent.
SUMMARY OPINION
LEYDEN, Special Trial 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
1
All section references are to the Internal Revenue Code in effect for the
(continued...)
-2-
reviewable by any other court, and this opinion shall not be treated as precedent
for any other case.
In a notice of deficiency dated December 2, 2013, respondent determined a
deficiency of $9,981 and an accuracy-related penalty of $1,996 with respect to
petitioner’s 2011 Federal income tax. Respondent has conceded the accuracy-
related penalty and agreed to allow petitioner a deduction for attorney’s fees. As a
result, the deficiency is decreased to $7,969.
After the concessions, the issues for decision are: (1) whether a settlement
payment petitioner received is excludable from his gross income under section 105
or (2) in the alternative, whether the settlement payment is excludable from
petitioner’s gross income under section 104(a)(2).
Background
This case was submitted fully stipulated by the parties pursuant to Rule 122.
The first stipulation of facts filed September 11, 2015, and the attached exhibits
are incorporated herein by this reference. At the time the petition was filed,
petitioner resided in South Carolina.
1
(...continued)
year 2011, and all Rule references are to the Tax Court Rules of Practice and
Procedure, unless otherwise indicated.
-3-
At some point before 2009, petitioner was employed by Endress & Hauser.
Petitioner was provided with long-term disability coverage through the Lincoln
National Life Insurance Co. (Lincoln National). The stipulated record does not
indicate who paid the long-term disability premiums.2
Petitioner submitted an “Affadvit [sic] of Petitioner Richard G. Braddock”
with his simultaneous opening brief in which he attests: “In 2009 I was working
for Endress & Houser [sic] and they payed [sic] money into my Lincoln National
Life Insurance Company Policy for long term [sic] disability.”
Petitioner does not assert that he paid the premiums for the long-term
disability insurance. The record does not support any finding that petitioner paid
the premiums for the long-term disability insurance.
During petitioner’s employment with Endress & Hauser he was diagnosed
with, among other things, a progressive musculoskeletal and neuromuscular
syndrome, including progressive musculoskeletal pain. The pain was based on a
combination of severe degenerative arthritis and neuromuscular disease.
2
In a complaint petitioner filed with the U.S. District Court for the District
of South Carolina, he stated: “Until 2009, Plaintiff was employed with Endress &
Hauser and as an employee of Endress & Hauser, Plaintiff was provided with long
term [sic] disability coverage via a plan which was fully insured by [Lincoln
National].” The complaint does not indicate who paid the premiums for the long-
term disability coverage.
-4-
Sometime in 2009 petitioner left Endress & Hauser. The record does not
indicate why. Petitioner filed a claim for long-term disability benefits with
Lincoln National. Lincoln National denied petitioner’s claim.
Petitioner appealed the denial by Lincoln National and exhausted his
administrative remedies. Lincoln National also denied the appeal and the
subsequent requests for administrative remedies.
On October 8, 2010, petitioner filed a complaint against Lincoln National in
the U.S. District Court for the District of South Carolina, Charleston Division. In
the complaint, petitioner sought long-term disability benefits under an ERISA plan
pursuant to 29 U.S.C. sec. 1132(a)(1)(B). Lincoln National did not file an answer
to petitioner’s complaint.
In the complaint petitioner requested long-term disability benefits and
attorney’s fees and costs.3 The only mention of petitioner’s condition is the
following: “[Petitioner] became disabled because of certain problems from which
he suffered.” Petitioner alleged in the complaint that he was “forced to cease
working and * * * [I] filed a claim for long term [sic] disability benefits.”
3
Respondent is allowing petitioner a deduction for attorney’s fees related to
settlement of the complaint.
-5-
On January 4, 2011, petitioner signed a Settlement and Release (agreement)
with Lincoln National. Under the agreement petitioner accepted $45,000 as a
settlement payment in consideration for settling his case and releasing Lincoln
National generally. The agreement did not reference petitioner’s health problems.
The agreement required petitioner to do whatever was necessary to see that the
suit was dismissed immediately with prejudice.
The agreement specifically provided, in pertinent part, as follows:
SETTLEMENT AND RELEASE
THIS SETTLEMENT AND RELEASE (“Agreement”) is
entered into as of January 4, 2011 by Richard Braddock (“Plaintiff”)
in favor of The Lincoln National Life Insurance Company (“LNL”).
WHEREAS, Plaintiff instituted an action in the United States
District Court for the District of South Carolina, Charleston Division,
(the “Lawsuit”) seeking damages therein relating to the denial of long
term [sic] disability benefits; and
* * * * * * *
WHEREAS, without admitting any liability, the parties wish
now to amicably resolve all disputes between them so as to avoid the
expense and uncertainty of litigation;
* * * * * * *
1. Payment. LNL has agreed to make payment to Plaintiff
and his counsel in the sum of $45,000, to be paid within 10 days of
LNL’s receipt of this document executed by Plaintiff.
-6-
2. Release. Plaintiff hereby releases, acquits and forever
discharges LNL * * * of and from any and all manner of actions,
causes of action, debts, accounts, promises, variances, damages,
claims and demands whatsoever, in law or in equity, that Plaintiff
may now have against [LNL] for, upon or by reason of any matter,
cause or issue arising out of or related in any way to the subject
matter of the Lawsuit referenced above, including, but not limited to,
any and all claims for insurance or ERISA benefits, costs, attorneys
fees, interest, extracontractual damages or bad faith, and any and all
other claims or actions of any kind. Plaintiff hereby agrees that he
has no further group insurance coverage (whether disability or life)
issued by LNL and no basis for any further claims against [LNL].
Plaintiff further agrees that he will never apply for, and never attempt
to obtain insurance coverage, including, but not limited to, individual
or group disability insurance, from any of the following insurers: The
Lincoln National Life Insurance Company or The Lincoln Life and
Annuity Company of New York or any of the affiliated Lincoln
National companies.
In addition, LNL hereby releases, acquits and forever
discharges [Plaintiff] from any alleged claim, lien, or cause of action
related to reimbursement, subrogation, and/or recovery of
overpayment of benefits or other income whether in law or in equity,
arising out of the Lawsuit or the Policy. LNL forever releases and
discharges [Plaintiff] from any and all claims, whether in law, or in
equity, it has or may have relating to the Policy and any claims that
were or could have been raised regarding the Lawsuit.
3. Dismissal of Lawsuit. Following Plaintiff’s receipt of
the payment referenced in paragraph 1 hereof, Plaintiff shall promptly
execute and file with the court a Stipulation for Dismissal With
Prejudice or equivalent pleading with respect to the Lawsuit, forward
a copy of the same to LNL’s counsel, and do any and all other things
necessary to see that the Lawsuit is dismissed immediately with
prejudice.
* * * * * * *
-7-
6. Tax Obligations. Plaintiff agrees that he is solely
responsible for any tax payment obligations that may arise as a
consequence of the settlement. Plaintiff also acknowledges that none
of the Releasees or their respective attorneys has offered the Plaintiff
any tax advice with respect to the tax aspects of any portion of this
settlement or any other matters. Plaintiff agrees not to seek or to
make any claim against any of the Releasees for any loss, cost,
damage or expense if a claim or adverse determination is made in
connection with the non-withholding or the tax treatment of any of
the proceeds of this settlement or any portion thereof. Plaintiff
understands and agrees that none of the Releasees have any duty to
defend against any claim or assertion in connection with the non-
withholding or the tax treatment of the proceeds of this settlement or
any portion thereof, and Plaintiff agrees to assume full responsibility
for defending against any such claim or assertion.
The agreement was signed by petitioner and his counsel.4
The settlement payment was reported to the IRS through a 2011 Form W-2,
Wage and Tax Statement, as “Wages, Tips and Other Compensation”. Petitioner
timely filed his Federal income tax return, Form 1040, U.S. Individual Income Tax
Return, for the taxable year 2011. Petitioner did not report the $45,000 settlement
payment on his 2011 tax return.
The IRS mailed petitioner a notice of deficiency for the 2011 taxable year
dated December 2, 2013. Respondent determined an increase in petitioner’s
4
The agreement, which was included as an exhibit to the first stipulation,
does not contain a signature of a representative for Lincoln National. The parties
have not raised the lack of a signature by Lincoln National as affecting the validity
of the agreement. The Court assumes, without finding, that the agreement was
binding on both petitioner and Lincoln National.
-8-
income by the $45,000 of unreported wage income. Respondent also determined
an increase in the amount of taxable Social Security income as a result of the
increase in petitioner’s income.
Discussion
Generally, determinations made in a notice of deficiency are presumed
correct, and the taxpayer bears the burden of proving that those determinations are
erroneous. Rule 142(a); see INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84
(1992); Welch v. Helvering, 290 U.S. 111, 115 (1933).
Under certain circumstances the burden of proof with respect to relevant
factual issues may shift to the Commissioner under section 7491(a). Petitioner has
neither alleged that section 7491(a) applies nor established his compliance with
the requirements of section 7491(a)(2)(A) and (B) to substantiate items, maintain
records, and cooperate fully with respondent’s reasonable requests. Therefore, the
burden does not shift to respondent under section 7491(a). See Higbee v.
Commissioner, 116 T.C. 438, 442-443 (2001).
1. Settlement Agreement Payment Includable as Gross Income Under Section
61(a)
The term “income” as used in the Internal Revenue Code means income
from any source, including any accretion to the taxpayer’s wealth. See sec. 61(a);
-9-
Commissioner v. Glenshaw Glass Co., 348 U.S. 426 (1955). The settlement
payment is includable in petitioner’s income under section 61(a) unless petitioner
proves that an exclusion applies.
Certain accretions to a taxpayer’s wealth are, by statute, made excludable
from the taxpayer’s income, but those statutory exclusions are narrowly construed.
See, e.g., O’Gilvie v. United States, 519 U.S. 79 (1996); Commissioner v.
Schleier, 515 U.S. 323, 328 (1995). Petitioner asserts that the settlement payment
of $45,000 is excludable from his gross income on the following grounds: (1) the
settlement payment is excludable from his gross income under section 105(c) or
(2) in the alternative, the settlement payment is excludable from his gross income
under section 104(a) (2).
2. Exclusion From Income Under Section 105
Section 105 governs amounts received under accident and health plans. See
Dzioba v. Commissioner, T.C. Memo. 1989-203. While the statutory framework
is admittedly confusing, section 105 works as follows. First, section 105(a)
provides a more specific rule than the general income inclusion rule under section
61 for when amounts received by an employee through an accident or health
- 10 -
insurance plan will be included in gross income.5 If a payment meets the
requirements of section 105(a) and, therefore, is includable in gross income, a
taxpayer may be able to exclude it from gross income if the requirements of
section 105(c) are met.
Petitioner asserts that the settlement payment is excludable from his gross
income for 2011 because it meets the requirements of section 105(a) and qualifies
for the exclusion under section 105(c). However, for reasons explained below, the
Court determines that petitioner has not proven that the settlement payment meets
the requirement of section 105.
a. Section 105(a)
Section 105(a) provides as follows:
SEC. 105(a). Amounts Attributable to Employer Contri-
butions.-- Except as otherwise provided in this section, amounts
received by an employee through accident or health insurance for
personal injuries or sickness shall be included in gross income to the
extent such amounts (1) are attributable to contributions by the
employer which were not includible in the gross income of the
employee, or (2) are paid by the employer.
Petitioner bears the burden of proving that the contributions to the disability
insurance plan were attributable to contributions by his employer that were not
5
The Court assumes, without deciding, that the settlement payment
constitutes an amount received by an employee through accident or health
insurance for purposes of sec. 105(a).
- 11 -
included in his gross income or were paid by his employer. Petitioner has not
proven that his employer paid the disability insurance premiums and/or that his
employer made contributions to the disability insurance plan and those
contributions were not included in his income.
The stipulations filed by the parties do not address who paid the
contributions to the disability insurance plan. Petitioner filed an affidavit with his
opening brief in which he attests: “In 2009 I was working for Endress & Houser
[sic] and they payed [sic] money into my Lincoln National Life Insurance
Company Policy for long term [sic] disability.”
Section 7463 generally allows disputes in small tax cases to be decided in
proceedings in which the normally applicable procedural and evidentiary rules are
relaxed. For example, Rule 174(b) provides: “Trials of small tax cases will be
conducted as informally as possible consistent with orderly procedure, and any
evidence deemed by the Court to have probative value shall be admissible.” In
this case, however, the parties agreed to submit the case fully stipulated under
Rule 122. The affidavit attached to petitioner’s opening brief was not part of the
stipulated record. Further, the Court does not find the assertion to be probative as
it appears to be based solely on petitioner’s recollection and is not supported by
anything in the stipulated record. Thus, because petitioner has failed to sustain his
- 12 -
burden of proof, the Court concludes that the settlement payment does not meet
the requirements of section 105(a).
b. Section 105(c)
Petitioner has not met his burden of proof as to the requirements of section
105(a). Accordingly, the Court need not consider whether the settlement payment
is excludable under section 105(c). However, because petitioner has premised
much of his case on an exclusion under section 105(c), the Court addresses his
assertions.
Payments that are includable in income under section 105(a) may
nevertheless be excludable from income under section 105(c) if they meet two
requirements. Under section 105(c)(1) the payments must be made for the
permanent loss of a member or function of the body, or the permanent
disfigurement of the taxpayer. Under section 105(c)(2) the payments must be
computed with reference to the nature of the injury and without regard to the
period the employee is absent from work. If either requirement is not met, the
income is not excludable under section 105(c). For reasons discussed below, the
Court determines that petitioner has not proven that the settlement payment is
excludable under section 105(c)(1) and thus is not excludable under section
105(c).
- 13 -
The intent of Congress in enacting section 105(c) was to “provide a tax
benefit to one who receives a severe physical injury which permanently and
significantly lessens the quality of life which he had enjoyed prior to the injury.”
Hines v. Commissioner, 72 T.C. 715, 718-719 (1979).
We have long held that insurance payments for injuries qualifying the
payments for exclusion from gross income under section 105(c)(1) must fall into
one of three categories: (1) payments for the permanent loss or loss of use of a
member of the body; (2) payments for the permanent loss or loss of use of a
function of the body; or (3) payments for permanent disfigurement. Id.; Green v.
Commissioner, T.C. Memo. 2008-130, 2008 Tax Ct. Memo LEXIS 133, at *35,
aff’d, 322 F. App’x 412 (5th Cir. 2009). Petitioner does not argue that his injuries
constitute a permanent loss or loss of a member of his body or that they constitute
permanent disfigurement. Rather, petitioner argues that his injuries constitute the
permanent loss of use of a function of his body.
The Court has held that a loss of a function exists if it leaves a taxpayer
“effectively without the use of his hands, legs, and feet, as opposed to whether his
use is partially impaired.” Stolte v. Commissioner, T.C. Memo. 1999-271, 1999
Tax Ct. Memo LEXIS 311, at *10 (peripheral nerve damage in hands, legs and
feet caused by chemotherapy was loss of function where the condition led to
- 14 -
atrophy of the muscles and permanent nerve damage); cf. Dorroh v.
Commissioner, T.C. Memo. 1994-373, 1994 Tax Ct. Memo LEXIS 383, at *12
(arthritis that prevented a pilot from flying a commercial airplane not a loss of
bodily function because taxpayer still able to perform many other activities and
still eligible to fly a private airplane), aff’d without published opinion, 74 F.3d
1255 (11th Cir. 1996).
Petitioner was diagnosed with a progressive musculoskeletal and
neuromuscular syndrome, including progressive musculoskeletal pain, which is a
combination of severe degenerative arthritis and neuromuscular disease. While
petitioner attests in his brief that his injuries “include paralysis, chronic cramping,
and chronic pain”, he has not provided proof of those assertions or that the
settlement payment was for the permanent loss of his arms, legs, or feet or a
function of such.
Petitioner has failed to prove that his injuries satisfy the requirements of
section 105(c)(1). Therefore, the Court concludes that petitioner has not met his
burden of proving that the settlement payment is excluded from income under
section 105(c).
- 15 -
3. Exclusion From Income Under Section 104(a)(2)
Section 104(a)(2) allows for the exclusion from a taxpayer’s income of “the
amount of any damages (other than punitive damages) received (whether by suit or
agreement and whether as lump sums or periodic payments) on account of
personal physical injuries of physical sickness”. See, e.g., Espinoza v.
Commissioner, 636 F.3d 747, 749-750 (5th Cir. 2011), aff’g T.C. Memo. 2010-53;
sec. 1.104-1(c), Income Tax Regs. In O’Gilvie, 519 U.S. at 83, the Supreme Court
read the phrase “on account of” to require a “strong[] causal connection”, thereby
making section 104(a)(2) “applicable only to those personal injury lawsuit
damages that were awarded by reason of, or because of, the personal injuries.”
See also Murphy v. IRS, 493 F.3d 170, 175 (D.C. Cir. 2007). The Supreme Court
specifically rejected a “but for” formulation in favor of a “stronger causal
connection”. O’Gilvie, 519 U.S. at 82-83.
The relief petitioner sought in his complaint was strongly causally
connected with the denial by Lincoln National of his claim for long-term disability
payments. Petitioner’s action against Lincoln National filed in the U.S. District
Court was based on the cause of action under 29 U.S.C. sec. 1132(a)(1)(B). That
statute allows a person who is a beneficiary of or participant in a plan covered by
ERISA to bring an action “to recover benefits due him under the terms of his plan,
- 16 -
to enforce his rights under the terms of the plan, or to clarify his rights to future
benefits under the terms of the plan”. Id. Essentially, this section allows a person
who participates in or benefits from a plan (including disability insurance) that is
subject to ERISA to bring a civil action to enforce the participant’s or
beneficiary’s rights under the plan. Such rights may include payment of benefits.
See Corsini v. United Healthcare Corp., 51 F. Supp. 2d 103, 106 (D.R.I. 1999).
In filing a complaint under 29 U.S.C. sec. 1132(a)(1)(B) petitioner was
seeking to recover benefits he claimed Lincoln National owed him under the long-
term disability insurance plan. The lawsuit was not in the nature of a claim for
recovery for physical injuries or physical sickness.
When a taxpayer receives a payment under a settlement agreement, as is the
case here, the nature of the claim that was the actual basis for settlement guides the
Court’s decision whether the payment is excludable from income under section
104(a)(2). See United States v. Burke, 504 U.S. 229, 237 (1992); Simpson v.
Commissioner, 141 T.C. 331, 339-340 (2013); Molina v. Commissioner, T.C.
Memo. 2013-226, at *10. Thus, whether the settlement agreement payment is
excludable from gross income depends on the nature and character of the claims
asserted and not upon the validity of those claims. Bent v. Commissioner, 87 T.C.
236, 244 (1986), aff’d, 835 F.2d 67 (3d Cir. 1987); Church v. Commissioner, 80
- 17 -
T.C. 1104, 1105-1106 (1983); Kees v. Commissioner, T.C. Memo. 1999-41, 1999
Tax Ct. Memo LEXIS 38, at *11. The Court looks to the specific claims for which
the settlement was paid. Bagley v. Commissioner, 105 T.C. 396, 406 (1995),
aff’d, 121 F.3d 393 (8th Cir. 1997); Kees v. Commissioner, 1999 Tax Ct. Memo
LEXIS 38, at *11 (citing Allen v. Commissioner, T.C. Memo. 1998-406).
Whether the settlement is achieved through a judgment or by a compromise
agreement, the question to be asked is: “In lieu of what were the damages
awarded?”. Raytheon Prod. Corp. v. Commissioner, 144 F.2d. 110, 113 (1st Cir.
1944), aff’g 1 T.C. 952 (1943); Fono v. Commissioner, 79 T.C. 680, 692 (1982),
aff’d without published opinion, 749 F.2d 37 (9th Cir. 1984). To prove that the
settlement payment is excluded from income under section 104(a)(2), petitioner
must show that his settlement payment was in lieu of damages for physical injuries
or physical sickness. See Green v. Commissioner, 507 F.3d 857, 867 (5th Cir.
2007), aff’g T.C. Memo. 2005-250; Ahmed v. Commissioner, T.C. Memo. 2011-
295, 2011 Tax Ct. Memo LEXIS 291, at *7, aff’d, 498 F. App’x 919 (11th Cir.
2012).6 The determination of the nature of the underlying claim is factual. Bagley
6
See Espinoza v. Commissioner, T.C. Memo. 2010-53, aff’d, 636 F.3d 747
(5th Cir. 2011); Save v. Commissioner, T.C. Memo. 2009-209, 2009 Tax Ct.
Memo LEXIS 211, at *5 n.5 (stating that although cases were decided under sec.
104(a)(2) before it was amended in 1996, their holding regarding the
(continued...)
- 18 -
v. Commissioner, 105 T.C. at 406; Robinson v. Commissioner, 102 T.C. 116, 126
(1994), aff’d in part, rev’d in part, and remanded on another issue, 70 F.3d 34 (5th
Cir. 1995).
Ultimately, the character of the payment hinges on the payor’s dominant
reason for making the payment. Green v. Commissioner, 507 F.3d at 868. The
Court looks first to the language of the agreement itself for indicia of purpose. Id.
at 867; Knuckles v. Commissioner, 349 F.2d 610, 613 (10th Cir. 1965), aff’g T.C.
Memo. 1964-33; Robinson v. Commissioner, 102 T.C. at 126. If the agreement
lacks express language stating what the amount paid pursuant to the agreement
was to settle or is otherwise not clear, the Court looks to the intent of the payor,
considering all of the facts and circumstances. Knuckles v. Commissioner, 349
F.2d at 613; Robinson v. Commissioner, 102 T.C. at 127; Ahmed v.
Commissioner, 2011 Tax Ct. Memo LEXIS 291, at *7-*8; Kees v. Commissioner,
1999 Tax Ct. Memo LEXIS 38, at *11. Where the agreement does not mention its
purpose, the Court may look at other facts that reveal the payor’s intent, such as
the amount paid and the factual circumstances that led to the agreement. Green v.
Commissioner, 507 F.3d at 868. Although the belief of the payee is relevant to
6
(...continued)
characterization of settlement proceeds in lieu of damages remains good law).
- 19 -
that inquiry, the character of the payment hinges ultimately on the dominant
reason of the payor in making the payment. Agar v. Commissioner, 290 F.2d 283,
284 (2d Cir. 1961), aff’g per curiam T.C. Memo. 1960-21; Fono v. Commissioner,
79 T.C. at 696.
Petitioner asserts that the intent of the payor, Lincoln National, was to avoid
the expense and uncertainty of litigation and to settle in lieu of paying damages at
trial. Even assuming that was the intent of Lincoln National, the damages which it
hoped to avoid were not damages due to physical injuries or physical sickness of
petitioner. The damages were for nonpayment of disability insurance payments.
The complaint expressly stated that petitioner “seeks long term [sic] disability
benefits” and makes only passing reference to “certain problems from which he
suffered”. It did not identify petitioner’s physical injuries or physical sickness.
Neither the complaint nor the agreement shows that the $45,000 settlement
payment was made on account of physical injuries or physical sickness. The
record shows that the payor’s intent was to satisfy petitioner’s claim for long-term
disability benefits. Section 104(a)(2) does not allow the settlement income to be
excluded from petitioner’s income.7
7
The parties have not raised whether the agreement payment is excludable
under sec. 104(a)(3). Sec. 104(a)(3) excludes amounts received through accident
(continued...)
- 20 -
For reasons discussed herein, the Court concludes that petitioner’s
settlement payment does not qualify for exclusion from gross income under either
section 105(c) or section 104(a)(2). Respondent properly determined that
petitioner’s settlement payment is gross income under section 61(a).
To reflect the foregoing,
Decision will be entered
under Rule 155.
7
(...continued)
or health insurance for personal injuries or sickness if the taxpayer paid for the
insurance or the amounts were attributable to contributions by the taxpayer’s
employer that were includable in the taxpayer’s gross income. Sec. 104(a)(3);
Hayden v. Commissioner, T.C. Memo. 2003-184, aff’d, 127 F. App’x 975 (9th
Cir. 2005). As the Court has determined, petitioner has not proven that the
disability insurance premiums were paid by his employer. Petitioner has not
asserted that the premiums were attributable to contributions by his employer that
were taxable to him or that he paid the premiums. Accordingly, sec. 104(a)(3)
does not provide a basis for exclusion of the settlement payment.