Connolly v. Comm'r ( 2007 )

T.C. Memo. 2007-98
UNITED STATES TAX COURT
CHRISTINA CONNOLLY, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 8224-05. Filed April 24, 2007.
Christina Connolly, pro se.
Michelle L. Maniscalco, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
DEAN, Special Trial Judge: Respondent determined for 2002 a
deficiency in petitioner’s Federal income tax of $16,582, an
addition to tax under section 6651(a)(1) of $3,332, and an
accuracy-related penalty under section 6662(a) of $3,316.
The issues for decision are: (1) Whether petitioner
improperly excluded from gross income proceeds from the
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settlement of a charge of discrimination filed with the Equal
Employment Opportunity Commission (EEOC),1 (2) whether petitioner
is liable for the section 6651(a)(1) addition to tax for failure
to file timely a Federal income tax return, and (3) whether
petitioner is liable for the section 6662 accuracy-related
penalty.
Unless otherwise indicated, all section references are to
the Internal Revenue Code in effect for the year at issue, and
all Rule references are to the Tax Court Rules of Practice and
Procedure.
The stipulated facts and exhibits received into evidence are
incorporated herein by reference. At the time the petition in
this case was filed, petitioner resided in New York, New York.
FINDINGS OF FACT
Petitioner is employed as a real estate sales agent, working
as an independent contractor. Petitioner was employed by J.L.
Shapiro Associates, Inc. (Associates), for the period 1989-90 and
was rehired in 1998 as the director of client services. In
December 2001, petitioner filed with the EEOC Newark area office
a “Charge of Discrimination” against Associates. A “Notice Of
Charge Of Discrimination” dated January 4, 2002, was issued to
Associates. The alleged bases of employment discrimination were
1
Computations based on the Court’s resolution of this issue
will determine whether petitioner is entitled to claim the child
tax credit and the additional child tax credit.
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sex, age, and retaliation under “Title VII of the Civil Rights
Act of 1964” and under “The Age Discrimination in Employment Act
of 1967”.
As a result of participating in the mediation program of the
EEOC, completed on February 5, 2002, petitioner and Associates
entered into a Settlement Agreement and General Release and a
Mediation Settlement Agreement (collectively, settlement
agreement). Under the settlement agreement, petitioner was to
receive a payment of $75,000 in 18 biweekly installments.
According to the settlement agreement, the $75,000 “includes all
vacation pay and monies owed to you by * * * [Associates].” The
agreement also provided that the settlement paid to petitioner
“represents the sum to compensate Christina Connelly [sic] for
the alleged emotional distress suffered by her” and that the
$75,000 would be reflected on an “IRS Form 1099” as “other
income”. In return, petitioner agreed to give up all claims,
known and unknown, that were asserted or could have been asserted
against Associates under Federal or State law.
On October 6, 2003, petitioner filed a Federal income tax
return for 2002 that failed to report as income any of the
payments received from Associates under the settlement agreement.
On November 25, 2003, petitioner’s primary care physician
referred her to a psychiatrist with a diagnosis of anxiety
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disorder and “panic attack”. Petitioner was still receiving
treatment for anxiety disorder at the time of trial.
OPINION
The Commissioner’s deficiency determinations are presumed
correct, and taxpayers generally have the burden of proving these
determinations are incorrect. Rule 142(a); Welch v. Helvering,
290 U.S. 111, 115 (1933). Under certain circumstances, however,
section 7491(a) may shift the burden to the Commissioner with
respect to a factual issue affecting liability for tax. This
shifting of the burden, however, applies only where the taxpayer
has introduced “credible evidence” regarding facts affecting the
liability that, if no contrary evidence were submitted, would
show by a preponderance of the evidence that the Commissioner’s
determination is erroneous. Petitioner has not introduced such
evidence. In any event, the Court decides this case on the
record before it and without regard to the burden of proof.
Taxpayers are required, under section 61(a), to include in
gross income “all income from whatever source derived” unless any
income has been specifically excepted from inclusion. See
Commissioner v. Glenshaw Glass Co., 348 U.S. 426, 430 (1955)
(Congress’s intent under section 61(a) was to tax income unless
specifically excluded). Exclusions from gross income must be
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narrowly construed. Commissioner v. Schleier, 515 U.S. 323, 328
(1995) (citing United States v. Burke, 504 U.S. 229, 233 (1992)).
Exclusion of Certain “Damages”
Section 104(a)(2) allows taxpayers to exclude from income
“the amount of any damages (other than punitive damages) received
(whether by suit or agreement * * *) on account of personal
physical injuries or physical sickness”. The flush language of
section 104(a) specifies that “emotional distress shall not be
treated as a physical injury or physical sickness.”
Regulations provide that the term “damages” means amounts
received (aside from workmen’s compensation) through litigation
or settlement of an action that is based on “tort or tort type
rights”. Sec. 1.104-1(c), Income Tax Regs.
The Court in Commissioner v. Schleier, supra, held that
damages are excludable from income under section 104(a)(2) if
they meet a two-pronged test. First, the taxpayer must
demonstrate that the underlying cause of action giving rise to
the recovery is “based upon tort or tort type rights”, and
second, the taxpayer must show that the damages were received “on
account of personal injuries or sickness.” Id. at 335-337. Both
requirements must be satisfied for the damages to be excluded
from income. Id. at 333.
Section 104(a)(2) was amended in 1996 to include the
requirement that damages be received for personal physical
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injuries or physical sickness. Small Business Job Protection Act
of 1996, Pub. L. 104-188, sec. 1605, 110 Stat. 1838. However,
this does not otherwise alter the analysis of Schleier. See
Tamberella v. Commissioner, T.C. Memo. 2004-47, affd. 139 Fed.
Appx. 319 (2d Cir. 2005).
Nature of the Claim
To determine whether the settlement payment is excludable
under section 104(a)(2) and Schleier, the Court must determine
the nature of the claim that was the basis of the settlement.
United States v. Burke, supra at 237. The “key question” to be
answered is “‘In lieu of what were the damages awarded?’”.
Robinson v. Commissioner, 102 T.C. 116, 126 (1994) (quoting
Raytheon Prod. Corp. v. Commissioner, 144 F.2d 110, 113 (1st Cir.
1944), affg. 1 T.C. 952 (1943)), affd. in part, revd. in part on
another ground and remanded 70 F.3d 34 (5th Cir. 1995). This
“determination is factual and is generally made by reference to
the settlement agreement in light of surrounding circumstances.”
Id. Both parts of the Schleier test are applied in the light of
the nature of the claim underlying the settlement. United States
v. Burke, supra at 237.
The Court will assume here, without deciding, that
petitioner’s claims were “based upon tort or tort type rights”.
The next step in the analysis is to examine the second part of
the Schleier test.
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Personal Physical Injuries or Physical Sickness
To be excludable under section 104(a)(2) and to satisfy the
second part of the Schleier test, the damages must have been
received “on account of personal physical injuries or physical
sickness.” This analysis is also guided by the “nature of the
claim underlying” the settlement. United States v. Burke, supra
at 237. The Court must therefore decide whether the amounts
Associates paid petitioner were for personal physical injuries or
physical sickness.
The flush language of section 104(a) makes it clear that
emotional distress shall not be treated as a physical injury or
physical sickness. “[M]ental anguish, humiliation, and
embarrassment are not personal physical injuries or physical
sickness * * * but are most akin to emotional distress.” Shaltz
v. Commissioner, T.C. Memo. 2003-173. Anxiety is also part of
emotional distress. 4 Restatement, Torts 2d, sec. 905 (1979).
Physical manifestations of emotional distress such as fatigue,
insomnia, and indigestion do not transform emotional distress
into physical injury or physical sickness. See Goode v.
Commissioner, T.C. Memo. 2006-48.
Neither the charging document nor the settlement agreement
references any personal physical injuries. The settlement
agreement specifically states that the amount paid includes
vacation pay and money owed to petitioner by Associates and
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“represents the sum to compensate Christina Connelly [sic] for
the alleged emotional distress suffered by her”. (Emphasis
supplied.)
The settlement agreement also released Associates from all
claims known or unknown that were asserted or could have been
asserted against Associates under Federal or State law. The
nature of underlying claims cannot be determined by a general
release that is broad and inclusive. Taggi v. United States, 835
F. Supp. 744, 746 (S.D.N.Y. 1993), affd. 35 F.3d 93, 96 (2d Cir.
1994).
Under the flush language of section 104(a), amounts paid for
medical care attributable to emotional distress, however, may be
treated as damages received on account of personal physical
injuries or physical sickness. Petitioner has provided evidence
that 21 months after the signing of the settlement agreement, she
was referred to a psychiatrist with a diagnosis of anxiety
disorder and “panic attack”. However, she has failed to prove
any connection between the discrimination charges and the
disorder. See Goode v. Commissioner, supra. Even if the Court
were to assume, which the Court does not, that there is a causal
relationship between the event and the disorder, petitioner has
not shown that any of the amounts paid to her by Associates was
for the cost of her medical care. See id.
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Where a settlement agreement does not address “what portion,
if any, of a settlement payment should be allocated towards
damages excludable under * * * [section 104(a)(2)], the courts
will not make that allocation for the parties.” Taggi v. United
States, supra at 746. If the “settlement agreement lacks express
language” regarding what the payment was for, “then the most
important fact in determining how section 104(a)(2) is to be
applied is ‘the intent of the payor’ as to the purpose in making
the payment.” Metzger v. Commissioner, 88 T.C. 834, 847-848
(1987) (quoting Knuckles v. Commissioner, 349 F.2d 610, 613 (10th
Cir. 1965), affg. T.C. Memo. 1964-33), affd. without published
opinion 845 F.2d 1013 (3d Cir. 1988); see also Whitehead v.
Commissioner, T.C. Memo. 1980-508 (general release found to
indicate that payor “regarded the settlement payment as
compensation for all of the claims which may have been brought by
petitioner rather than as compensation for one particular type of
claim”).
The ultimate character of the proceeds depends on the
payor’s “dominant reason” for making the payment. Commissioner
v. Duberstein, 363 U.S. 278, 286 (1960); accord Agar v.
Commissioner, 290 F.2d 283, 284 (2d Cir. 1961), affg. per curiam
T.C. Memo. 1960-21. Here, the intent of the payor is evidenced
in the settlement agreement. Associates, by referring to the
amounts as income to be reported on Form 1099, and by making the
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statement that the agreement included the settlement of all
claims without specific allocation to any particular claim,
demonstrated that its dominant reason for the payment was not as
damages on account of physical injury or physical sickness.
From the evidence in the record, the Court finds that the
settlement amounts were not paid “on account of personal injuries
or sickness”, see Commissioner v. Schleier, 515 U.S. at 337, and
are not excludable from gross income under section 104(a)(2).
Respondent’s determination that the settlement payment is
includable in petitioner’s income for 2002 is sustained.
Penalties and Additions to Tax
Section 7491(c) imposes on the Commissioner the burden of
production in any court proceeding with respect to the liability
of any individual for penalties and additions to tax. Higbee v.
Commissioner, 116 T.C. 438, 446 (2001); Trowbridge v.
Commissioner, T.C. Memo. 2003-164, affd. 378 F.3d 432 (5th Cir.
2004). In order to meet the burden of production under section
7491(c), the Commissioner need only make a prima facie case that
imposition of the penalty or the addition to tax is appropriate.
Higbee v. Commissioner, supra.
Addition to Tax Under Section 6651(a)(1)
Once the Commissioner meets his burden of production
regarding the addition to tax, the burden of proof remains on the
taxpayer, who must prove that the failure to file was: (1) Due
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to reasonable cause and (2) not due to willful neglect. Sec.
6651(a); United States v. Boyle, 469 U.S. 241, 245 (1985); Higbee
v. Commissioner, supra at 446-447.
A failure to file a timely Federal income tax return is due
to reasonable cause if the taxpayer exercised ordinary business
care and prudence and nevertheless was unable to file the return
within the prescribed time. Barkley v. Commissioner, T.C. Memo.
2004-287; sec. 301.6651-1(c)(1), Proced. & Admin. Regs. Willful
neglect means a conscious, intentional failure or reckless
indifference. United States v. Boyle, supra at 245.
The parties agree that petitioner’s 2002 return was due on
April 15, 2003, and was not filed until October 6, 2003.
Therefore, respondent has met his burden of production.
Petitioner introduced no evidence or any legally sufficient
reason for her failure to file a timely return. The Court finds
that petitioner did not have reasonable cause for her failure to
file timely as required by section 6651(a)(1). Accordingly,
respondent’s determination of an addition to tax under section
6651(a)(1) is sustained.
Section 6662(a) Accuracy-Related Penalty
Respondent determined that petitioner is liable for an
accuracy-related penalty under section 6662(a). Section 6662(a)
imposes a 20-percent penalty on the portion of an underpayment
attributable to any one of various factors, including negligence
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or disregard of rules or regulations and a substantial
understatement of income tax. See sec. 6662(b)(1) and (2).
“Negligence” includes any failure to make a reasonable attempt to
comply with the provisions of the Internal Revenue Code,
including any failure to keep adequate books and records or to
substantiate items properly. See sec. 6662(c); sec.
1.6662-3(b)(1), Income Tax Regs.
A “substantial understatement” includes an understatement of
tax that exceeds the greater of 10 percent of the tax required to
be shown on the return or $5,000. See sec. 6662(d); sec.
1.6662-4(b), Income Tax Regs. The Commissioner bears the burden
of production. Sec. 7491(c).
Section 6664(c)(1) provides that the penalty under section
6662(a) shall not apply to any portion of an underpayment if it
is shown that there was reasonable cause for the taxpayer’s
position and that the taxpayer acted in good faith with respect
to that portion. The determination of whether a taxpayer acted
with reasonable cause and in good faith is made on a case-by-case
basis, taking into account all the pertinent facts and
circumstances. Sec. 1.6664-4(b)(1), Income Tax Regs. The most
important factor is the extent of the taxpayer’s effort to assess
his proper tax liability for the year. Id.
Petitioner had a substantial understatement of tax for 2002
since the understatement amount exceeded the greater of 10
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percent of the tax required to be shown on the return or $5,000.
The Court concludes that respondent has produced sufficient
evidence to show that the accuracy-related penalty under section
6662 is appropriate.
The settlement agreement advised petitioner that the
payments were going to be made as “other income” and reported on
a Form 1099. Petitioner’s income tax return for 2002 was
prepared by a paid preparer, but there is no evidence that
petitioner revealed to him the facts concerning her settlement
payments. Petitioner has not shown that her failure to report
the payments from Associates as income was an action taken with
reasonable cause and in good faith. Respondent’s determination
of an accuracy-related penalty under section 6662(a) is
sustained.
To reflect the foregoing,
Decision will be entered
for respondent.