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JAMES D. KTSANES, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, RespondentKtsanes v. Comm'rDocket No. 21592-11S
United States Tax Court T.C. Summary Opinion 2014-85; 2014 Tax Ct. Summary LEXIS 87;September 2, 2014, FiledPURSUANT TO
INTERNAL REVENUE CODE SECTION 7463(b) , THIS OPINION MAY NOT BE TREATED AS PRECEDENT FOR ANY OTHER CASE.Decision will be entered for respondent.
2014 Tax Ct. Summary LEXIS 87">*87 James D. Ktsanes, Pro se.Rachel L. Paul , for respondent.ARMEN, Special Trial Judge.ARMENSUMMARY OPINION ARMEN,
Special Trial Judge : This case was heard pursuant to the provisions ofsection 7463 of the Internal Revenue Code in effect when the petition was filed.section 7463(b) , the decision to be entered is not reviewable by any other court, and this opinion shall not be treated as precedent for any other case.Respondent determined a deficiency in petitioner's Federal income tax for 2009 of $3,634. The issue for decision is whether any portion of the $65,000 that petitioner received in 2009 in settlement of a dispute with Union Security Insurance Co. (Union Security) is excludable from his gross income under section 104(a)(2) on account of personal physical injuries or physical sickness. If not, then alternatively whether any portion of such amount is excludable under either section 104(a)(1) as an amount received under a workmen's compensation act or section 104(a)(3) as an amount received through accident or health2014 Tax Ct. Summary LEXIS 87">*88 insurance. We hold that no portion of the $65,000 is excludable under any of these paragraphs of section 104(a).
Background Some of the facts have been stipulated, and they are so found. We incorporate by reference the stipulated facts and the related exhibits.2014 Tax Ct. Summary LEXIS 87">*89 an employee of CCCD, petitioner was covered under a group long-term disability insurance policy issued by Union Security to CCCD for the benefit of its employees. The insurance premiums for the long-term disability policy were paid by CCCD. Petitioner did not pay any portion of the premiums on the policy, and the monetary value of the payments for coverage under the policy was not includible in his gross income.
On or around February 22, 2006, petitioner was diagnosed with Bell's palsy, which led to his inability to work. On March 2, 2006, petitioner filed a claim for short-term disability benefits. Petitioner received short-term disability payments from Union Security from May through June 2006. Petitioner's employment with CCCD ended in June 2006.
In or around November 2006, presumably after the applicable "elimination period" provided by the policy had ended, petitioner filed a claim with Union Security for long-term disability benefits. In or around March 2007 Union Security denied petitioner long-term disability benefits on the ground that he was not totally disabled.
Petitioner then entered into extended correspondence, principally with CCCD, attempting to establish his entitlement2014 Tax Ct. Summary LEXIS 87">*90 to long-term disability benefits. When his attempts proved unsuccessful, petitioner filed a complaint on October 17, 2008, against Union Security and multiple unknown parties (identified as "Does 1 through 20" in the complaint) with the Superior Court of the State of California County of Orange. The complaint alleged in relevant part:
7. At all relevant times, there was in full force and effect a policy of insurance providing long term [sic] disability benefits, underwritten and issued by defendant, UNION SECURITY, to the Coast Community College District, which covered plaintiff as an employee (Assistant Director, Workforce & Economic Development [a federally funded program to help displaced workers]), and which promised to pay certain long term [sic] disability benefits should he become totally disabled (as defined by California law) and unable to perform the substantial and material duties of his occupation in the usual and customary way. Long Term Disability Benefits were to be paid for the duration of disability, with a monthly benefit (subject to certain offsets) of 60% of plaintiff's monthly income of approximately $6100.00 per month, for a monthly benefit of approximately $3660.00,2014 Tax Ct. Summary LEXIS 87">*91 following an initial elimination period of approximately 100 days. A true and correct copy of the Certificate of Insurance, Policy No. 403456 (hereinafter "the Policy"), originally issued by and through the Fortis Benefits Insurance Company, and subsequently underwritten by UNION SECURITY and administered by ASSURANT Employee Benefits, is attached as Exhibit "A" and incorporated herein by this reference.
8. All premiums due under the Policy have been paid to UNION SECURITY by plaintiff and/or on his behalf, at all relevant times, and plaintiff has performed all obligations under the Policy on his part to be performed.
9. On or about February 22, 2006, plaintiff became totally disabled from his occupation due to a condition of Bell's Palsy, a neuro-muscular disorder causing, among other symptoms, facial paralysis. Plaintiff became unable to work at that time and remained totally disabled through approximately August of 2007. After receiving short-term disability benefits from approximately May through June of 2006, plaintiff filed his claim for long-term disability benefits in approximately November of 2006. On March 14, 2007, by way of a letter from ASSURANT of that date from Claims2014 Tax Ct. Summary LEXIS 87">*92 Specialist Nell Horstman, defendant denied all long-term disability benefits to plaintiff, asserting that plaintiff was not totally disabled. In fact, from February 2006 through August of 2007, plaintiff's injuries and medical condition prevented him from performing the substantial and material duties of his regular occupation in the usual and customary way, and thus was totally disabled under construing California law.
10. Following the submission of his claim for benefits, UNION SECURITY has paid no long-term disability benefits to plaintiff. For several months following his claim, and despite knowledge of his existing and on-going disability, documented by appropriate medical testing (for example, a positive MRI), defendant undertook little or no investigation of the claim, conducted no IME (independent medical examination), made no claims determinations until March of 2007, and paid no benefits to plaintiff, instead summarily denying benefits.
The complaint alleged two causes of action: breach of contract and breach of covenant of good faith and fair dealing. With respect to the breach of contract cause of action, the complaint alleged:
12. UNION SECURITY breached the subject insurance2014 Tax Ct. Summary LEXIS 87">*93 contract by refusing without just cause to pay long-term disability benefits to plaintiff as required under the Policy.
13. As a direct and proximate result of defendant's breach of the insurance contract, plaintiff has suffered contractual damages under the terms and conditions of the Policy, and other incidental damages and out-of-pocket expenses, all in a sum to be determined at the time of trial.
With respect to the breach of the covenant of good faith and fair dealing cause of action, the complaint alleged:
15. UNION SECURITY has breached its duty of good faith and fair dealing owed to plaintiff in the following respects:
(a) unreasonable and bad faith failure to pay long-term disability benefits to plaintiff at a time when defendant knew that plaintiff was entitled to such benefits under the terms of the Policy;
(b) unreasonable and bad faith withholding of disability benefits from plaintiff knowing his claim to be valid;
(c) unreasonable and bad faith failure to pay long-term disability benefits to plaintiff at a time when the medical information available to defendant, including a positive MRI, showed his entitlement to benefits and at time when defendant had insufficient information2014 Tax Ct. Summary LEXIS 87">*94 within its possession to justify the denial of benefits;
(d) unreasonably denying benefits to plaintiff without adequately investigating the claim;
(e) unreasonably denying benefits at a time when defendant had conducted no independent medical examination;
(f) failing to reasonably investigate and process plaintiff's claim for long-term disability benefits;
(g) unreasonably failing to attempt to effectuate a prompt, fair, and [sic] settlement of plaintiff's claim for disability benefits at a time when liability had become reasonably clear; and
(h) unreasonably failing to adhere to California law applicable to plaintiff's claim for benefits by its failure to consider the real world marketplace for employment for plaintiff, and instead asserting that plaintiff was not disabled from "a group of jobs" which plaintiff was allegedly able to perform, as opposed to his own occupation.
* * * *
17. As a proximate result of the aforementioned wrongful conduct of defendant, plaintiff has suffered, and will continue to suffer in the future, damages under the Policy, plus interest, for a total amount to be shown at the time of trial.
18. As a further proximate result of the aforementioned wrongful conduct2014 Tax Ct. Summary LEXIS 87">*95 of UNION SECURITY, plaintiff has suffered, and will continue to suffer, anxiety, worry, mental and emotional distress, and other incidental damages and out-of-pocket expenses, all to his general damages in a sum to be determined at the time of trial.
19. As a further proximate result of the aforementioned wrongful business practices and conduct of defendant, plaintiff has been required to retain legal counsel to obtain the benefits and coverage due him under the Policy. Therefore, defendant is liable to plaintiff for those attorneys fees incurred by him in order to obtain the benefits under the Policy in a sum to be determined at the time of trial.
The complaint ended with a prayer for relief, wherein petitioner sought the following:
1. damages for failure to provide long-term disability insurance benefits contractually owed to plaintiff under the Policy, plus interest, including pre-judgment interest, in a sum to be determined at the time of trial;
2. general damages for mental and emotional distress and other incidental damages in a sum to be determined at the time of trial (Second Cause of Action);
3. punitive and exemplary damages in an amount appropriate to punish or set an example2014 Tax Ct. Summary LEXIS 87">*96 of defendant (Second Cause of Action);
4. consequential damages and out-of-pocket expenses related to the denial of benefits in an amount which will compensate for all the detriment proximately caused by defendant;
In sum, both the relief sought by petitioner and the $65,000 payment ultimately agreed to by Union Security in the parties' settlement agreement contemplated a resolution of his claim for long-term disability benefits. The settlement agreement did not allocate any part of such payment to physical injuries or physical sickness; rather, the settlement agreement provided that Union Security's payment to petitioner would be reported to the IRS as long-term2014 Tax Ct. Summary LEXIS 87">*102 disability benefits under the policy.
The settlement agreement was never submitted to the California Workers' Compensation Appeals Board (WCAB) for approval, nor did petitioner obtain approval of the settlement from the WCAB.
Union Security subsequently paid petitioner $65,000 in 2009 consistent with the settlement agreement. Union Security issued a Form W-2, Wage and Tax Statement, which reported that petitioner received $65,000 of third-party sick pay in 2009.
Petitioner timely filed a Form 1040, U.S. Individual Income Tax Return, for 2009. On it petitioner acknowledged receipt of $65,000 from Union Security but excluded such amount from taxable income.
Respondent issued a notice of deficiency in June 2011. In it respondent adjusted petitioner's taxable income to include the $65,000 that petitioner had previously excluded.
Petitioner timely filed a petition for redetermination of the deficiency. Ultimately the case was recently tried before the Court.
Discussion We decide the issues in this case without regard to the burden of proof. Accordingly, we need not decide whether the general rule of section 7491(a)(1) is applicable in this case.
See Higbee v. Commissioner , 116 T.C. 438">116 T.C. 438Gross income generally includes all income2014 Tax Ct. Summary LEXIS 87">*103 from whatever source derived, unless specifically excluded. Sec. 61(a);
Commissioner v. Glenshaw Glass Co. , 348 U.S. 426">348 U.S. 426see Commissioner v. Schleier , 515 U.S. 323">515 U.S. 323Dobra v. Commissioner , 111 T.C. 339">111 T.C. 339Forste v. Commissioner , T.C. Memo. 2003-103, 2003 WL 1889626">2003 WL 1889626Section 104(a)(2) excludes from gross income the amount of any damages (other than punitive damages) received (by suit or agreement) on account of personal physical injuries or physical sickness. In addition, under section 104(a)(1) amounts received under workmen's compensation acts that compensate for occupational personal injuries or sickness are excludable from income. Finally, under section 104(a)(3), amounts received through accident or health insurance for personal injuries or sickness are excludable from gross income unless such amounts are either (1) attributable to contributions by the employer that were not includible in the gross income of the employee or (2) paid by the employer.
Petitioner argues that the entire settlement amount in issue, $65,000, is excludable from gross income under section 104(a)(2) as an amount received on account of physical injuries2014 Tax Ct. Summary LEXIS 87">*104 or physical sickness, or, alternatively, that it is excludable under section 104(a)(1) as an amount received under California's workers' compensation laws. Although petitioner does not expressly invoke section 104(a)(3), the Court nonetheless considers whether that section might apply.
A. Section 104(a)(2) 1. Requirements for Exclusion The Supreme Court has held that for a recovery to be excludable under section 104(a)(2), a taxpayer must "demonstrate that the underlying cause of action giving rise to the recovery is 'based upon tort or tort-type rights'; * * * [in addition], the taxpayer must show that the damages were received 'on account of personal injuries or sickness.'"
Commissioner v. Schleier , 515 U.S. 323">515 U.S. at 337See Simpson v. Commissioner , 141 T.C. 331">141 T.C. 331United States v. Burke , 504 U.S. 229">504 U.S. 229T.D. 6500, 25 Fed. Reg. 11402, 11490 (Nov. 26, 1960));see also sec. 1.104-1(c), Income Tax Regs. (before amendment byT.D. 9573, 2012-12 I.R.B. 498 ).In 20122014 Tax Ct. Summary LEXIS 87">*105 the Secretary amended the regulations and abandoned the "based upon tort or tort-type rights" requirement so long as recovery is on account of physical injuries or physical sickness even if recovery is under a statute that does not provide for a broad range of tort remedies.
See sec. 1.104-1(c), Income Tax Regs. The parties do not dispute the applicability of the new regulations, and in the instant case the Court applies them as written.See
Simpson v. Commissioner , 141 T.C. 331">141 T.C. 3462. Payment Received "On Account Of" Union Security's Denial of Petitioner's Claim for Long-Term Disability Benefits In
O'Gilvie v. United States , 519 U.S. 79">519 U.S. 79See also Murphy v. IRS , 493 F.3d 170">493 F.3d 170O'Gilvie v. United States , 519 U.S. 79">519 U.S. at 82-83The relief that petitioner sought in his complaint was causally connected (and strongly so) to the denial by Union Security of his claim for long-term disability benefits. Although petitioner's complaint alleged that he became disabled as a result of physical injuries or sickness, this "but for" connection is insufficient to satisfy the "on account of" relationship discussed in
O'Gilvie for purposes of the exclusion under section 104(a)(2). Petitioner would not have filed his complaint if Union Security had not denied his claim but instead paid him the long-term disability payments that he sought. In other words, petitioner sought compensation "on account of" the denial of his long-term disability benefits, not for any physical injuries or physical sickness.See O'Gilvie v. United States , 519 U.S. 79">519 U.S. 793. Complaint, Settlement Agreement, and the Payor's Intent In addition to the foregoing, when a taxpayer2014 Tax Ct. Summary LEXIS 87">*107 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 such payment is excludable from income under section 104(a)(2).
See United States v. Burke , 504 U.S. 229">504 U.S. at 237Simpson v. Commissioner , 141 T.C. 331">141 T.C. 339-340Molina v. Commissioner , T.C. Memo. 2013-226, at *10Bent v. Commissioner , 87 T.C. 236">87 T.C. 236aff'd ,835 F.2d 67">835 F.2d 67 (3d Cir. 1987);Church v. Commissioner , 80 T.C. 1104">80 T.C. 1104Bagley v. Commissioner , 105 T.C. 396">105 T.C. 396aff'd ,121 F.3d 393">121 F.3d 393 (8th Cir. 1997);Kees v. Commissioner , T.C. Memo. 1999-41, 1999 WL 54695">1999 WL 54695Allen v. Commissioner , T.C. Memo. 1998-406Thus, whether a 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">144 F.2d 110aff'g 1 T.C. 952">1 T.C. 952 (1943);Fono v. Commissioner , 79 T.C. 680">79 T.C. 680aff'd without published opinion ,749 F.2d 37">749 F.2d 37 (9th Cir. 1984). To justify the exclusion from income under section 104(a)(2), petitioner must show that his settlement proceeds were in lieu of damages for physical injuries or physical sickness.See Green v. Commissioner , 507 F.3d 857">507 F.3d 857aff'g T.C. Memo. 2005-250 ;Ahmed v. Commissioner , T.C. Memo. 2011-295, 2011 WL 6440130">2011 WL 6440130aff'd ,498 Fed. Appx. 919">498 Fed. Appx. 919 (11th Cir. 2012).2014 Tax Ct. Summary LEXIS 87">*108 The determination of the nature of the underlying claim is factual.Bagley v. Commissioner , 105 T.C. 396">105 T.C. 406Robinson v. Commissioner , 102 T.C. 116">102 T.C. 116aff'd in part, rev'd in part, and remanded on another issue ,70 F.3d 34">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 857">507 F.3d at 868507 F.3d 857"> ;Id. at 867Knuckles v. Commissioner , 349 F.2d 610">349 F.2d 610aff'g T.C. Memo. 1964-33 ;Robinson v. Commissioner , 102 T.C. 116">102 T.C. 126Knuckles v. Commissioner , 349 F.2d 610">349 F.2d at 613Robinson v. Commissioner , 102 T.C. 116">102 T.C. 127Ahmed v. Commissioner , 2011 WL 6440130">2011 WL 6440130Kees v. Commissioner , 1999 WL 54695">1999 WL 54695Green v. Commissioner , 507 F.3d 857">507 F.3d at 868Agar v. Commissioner , 290 F.2d 283">290 F.2d 283aff'g per curiam T.C. Memo. 1960-21 ;Fono v. Commissioner , 79 T.C. 680">79 T.C. 696Petitioner contends that the payment he received from the settlement agreement was to compensate him for physical injuries or physical sickness, i.e., his Bell's palsy, which ultimately led to him being unable to work and to filing a claim2014 Tax Ct. Summary LEXIS 87">*109 for long-term disability. Although the complaint mentioned petitioner's Bell's palsy, the complaint did not specifically seek relief for any physical injuries or physical sickness. Instead, it sought damages for failure to provide long-term disability insurance benefits, general damages for mental and emotional distress, punitive and exemplary damages, consequential and out-of-pocket damages, attorney's fees, prejudgment interest, and the cost of the suit.
Neither the complaint nor the settlement agreement tends to show that the $65,000 settlement amount was paid on account of physical injuries or physical sickness, nor does the record show that the payor's intent was to make the payment for anything other than to satisfy petitioner's claim for long-term disability benefits.
Additionally, the settlement agreement did not allocate any portion of the $65,000 to physical injuries or physical sickness. Rather, the settlement amount was paid to satisfy petitioner's claim for long-term disability benefits. Not only does the settlement agreement not mention any physical injuries or physical sickness, it specifically states that Union Security would "report the Payment to the Internal Revenue2014 Tax Ct. Summary LEXIS 87">*110 Service in the same manner as any periodic long-term disability benefits received under the Policy". And Union Security did so by issuing a Form W-2 to petitioner reporting a payment of $65,000.
Granted, the settlement agreement's boilerplate list of claims from which petitioner agreed to release Union Security included "any and all claims * * * arising out of any alleged disabling conditions(s)". But, as just mentioned, the settlement agreement did not allocate any portion of the payment to any claim for physical injuries or physical sickness.
See Molina v. Commissioner , T.C. Memo. 2013-226Ahmed v. Commissioner , 2011 WL 6440130">2011 WL 6440130Espinoza v. Commissioner , T.C. Memo. 2010-53aff'd ,636 F.3d 747">636 F.3d 747 (5th Cir. 2011);Evans v. Commissioner , T.C. Memo. 1980-142see Connolly v. Commissioner , T.C. Memo. 2007-98see Evans v. Commissioner , T.C. Memo. 1980-142In view of the foregoing, on the evidence the Court holds that section 104(a)(2) does not serve to exclude the $65,000 settlement from petitioner's income.
B. Section 104(a)(1) Section 104(a)(1) excludes from gross income2014 Tax Ct. Summary LEXIS 87">*111 amounts received by an employee under a workmen's compensation act or under a statute in the nature of a workmen's compensation act that provides compensation to employees for occupational personal injuries or sickness.
Sec. 1.104-1(b), Income Tax Regs. To qualify for the exclusion, a taxpayer must show that benefits were received under a statute or a regulation.See Rutter v. Commissioner , 760 F.2d 466">760 F.2d 466aff'g T.C. Memo. 1984-525 (1984) ;see also Wallace v. United States , 139 F.3d 1165">139 F.3d 1165California workers' compensation laws provide that generally the WCAB must approve any release or agreement to compromise an employer's liability for workers' compensation benefits before the release or agreement becomes valid.
Cal. Lab. Code. sec. 5001 (West 2011). Furthermore, the parties must file the signed release or compromise with the WCAB for the Board to enter the award on the basis of the release or agreement.Id. sec. 5002.In the instant case, petitioner admits that he never submitted the settlement agreement to the WCAB for approval, nor did he obtain approval of the settlement from the WCAB. The settlement2014 Tax Ct. Summary LEXIS 87">*112 agreement thus fails to meet the express requirement of California's workers' compensation laws that settlement approval be obtained from the WCAB. Consequently, the $65,000 payment that petitioner received pursuant to the settlement agreement was not received under the State's workers' compensation act.
See Simpson v. Commissioner , 141 T.C. 331">141 T.C. 341-342Steller v. Sears, Roebuck & Co. , 116 Cal. Rptr. 3d (Ct. App. 2010)). Accordingly, section 104(a)(1) does not serve to exclude the $65,000 settlement payment from petitioner's income.C. Section 104(a)(3) Generally, amounts received through accident or health insurance for personal injuries or sickness are excluded from gross income under section 104(a)(3). This exclusion does not apply, however, if the amounts are either (1) attributable to contributions by the employer that were not includible in the gross income of the employee or (2) paid by the employer.
Hayden v. Commissioner , T.C. Memo. 2003-184aff'd ,127 Fed. Appx. 975">127 Fed. Appx. 975 (9th Cir. 2005).In the instant case, petitioner received $65,000 in 2009 from Union Security in settlement of his claim that long-term disability benefits2014 Tax Ct. Summary LEXIS 87">*113 were due to him on the basis of an accident or health insurance plan sponsored by an employer, CCCD.
See Watts v. Commissioner , T.C. Memo. 2009-103, 2009 WL 1391414">2009 WL 1391414Conclusion If in 2006 Union Security had approved petitioner's claim for long-term disability benefits under the group insurance policy issued to CCCD, receipt of those benefits would have been taxable to petitioner. However, Union Security denied the claim and petitioner found it necessary to sue, alleging breach of contract and breach of the covenant of good faith and fair dealing. The $65,000 that petitioner received in settlement of his suit essentially represented a substitute for what he would have received had his claim been approved. Under these circumstances, no part of that payment is excludable under any subdivision of section 104(a). Respondent's determination is therefore sustained. To give effect to our disposition of the disputed issue,
Decision will be2014 Tax Ct. Summary LEXIS 87">*114 entered for respondent .Footnotes
1. Unless otherwise indicated, all subsequent section references are to the Internal Revenue Code in effect for 2009, the taxable year in issue. All Rule references are to the Tax Court Rules of Practice and Procedure.↩
2. Respondent reserved objections in the stipulation of facts, generally based on relevancy and hearsay, to many of petitioner's exhibits.
See Rule 91(d). The Court overrules respondent's objections given the more relaxed evidentiary standard applicable to small tax cases.See↩ Rule 174(b).3.
Brandt v. Superior Court , 693 P.2d 796">693 P.2d 796↩4. In 1996 Congress amended sec. 104(a)(2) by adding the requirement that any amount received must be on account of personal injuries that are physical or sickness that is physical. Small Business Job Protection Act of 1996, Pub. L. No. 104-188, sec. 1605, 110 Stat. at 1838.↩
5. The new regulations may be applied retroactively at the desire of the taxpayer.
Sec. 1.104-1(c)(3), Income Tax Regs.↩ The new regulations are favorable to petitioner; therefore, the Court applies the regulations retroactively for his benefit.6.
See Espinoza v. Commissioner , T.C. Memo. 2010-53aff'd ,636 F.3d 747">636 F.3d 747 (5th Cir. 2011);Save v. Commissioner , T.C. Memo. 2009-209, 2009 WL 2950838">2009 WL 29508387. The exclusion does not extend to amounts attributable to deductions allowed under sec. 213 (relating to medical expenses) for any prior taxable year.
See Watts v. Commissioner , T.C. Memo. 2009-103, 2009 WL 1391414">2009 WL 1391414
Document Info
Docket Number： Docket No. 21592-11S
Citation Numbers： 2014 Tax Ct. Summary LEXIS 87, 2014 T.C. Summary Opinion 85
Judges： ARMEN
Filed Date： 9/2/2014
Precedential Status： Non-Precedential
Modified Date： 4/18/2021