Dennis v. Comm'r , 2011 Tax Ct. Summary LEXIS 131 ( 2011 )

T.C. Summary Opinion 2011-134
UNITED STATES TAX COURT
DENISE DIANA DENNIS, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 22198-09S. Filed December 5, 2011.
Denise Diana Dennis, pro se.
Joline M. Wang, for respondent.
WELLS, 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 reviewable by any other court, and
1
Unless otherwise indicated, section references are to the
Internal Revenue Code of 1986 in effect for the year at issue,
and Rule references are to the Tax Court Rules of Practice and
Procedure.
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this opinion shall not be treated as precedent for any other
case. Respondent determined a deficiency of $11,396 in
petitioner’s 2007 Federal income tax and an accuracy-related
penalty of $2,279 pursuant to section 6662(a). The issues we
must decide are: (1) Whether proceeds from the settlement of a
racial discrimination lawsuit under the Missouri Human Rights
Act, alleging emotional distress, are excludable from gross
income; (2) whether petitioner failed to report wages of $3,510;
and (3) whether petitioner is liable for the accuracy-related
penalty pursuant to section 6662(a).
Background
Some of the facts and certain exhibits have been stipulated.
The parties’ stipulations of facts are incorporated in this
opinion by reference and are found accordingly. At the time she
filed her petition, petitioner was a resident of Missouri.
Petitioner was employed at Grandview Care Center, Inc.
(Grandview), from approximately August 2005 until she resigned in
December 2005. During that time, she suffered racial harassment
from Grandview’s residents, who spoke to her using racial
epithets. Although she complained to her supervisors, the
situation did not improve; and she eventually resigned because
her work environment was so unpleasant. After resigning,
petitioner filed a lawsuit against Grandview under the Missouri
Human Rights Act, claiming damages for “loss of self-esteem,
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humiliation, emotional distress and mental anguish and pain, and
related compensatory damages.” Petitioner suffered no physical
injuries as a result of the harassment. During June 2007,
Grandview entered into a confidential settlement agreement and
release (settlement) with petitioner. Pursuant to the
settlement, Grandview paid petitioner $82,500. Of that amount,
$3,674.24 constituted legal expenses, $35,471.59 was for
attorney’s fees, and petitioner received a check for $43,354.17.
On July 10, 2007, petitioner signed a document from her
attorneys titled “Settlement Distribution - Tax Consequences”,
which stated, among other things:
Counsel has informed client that there are complicated
issues surrounding the taxability of employment
discrimination awards and/or settlements. Counsel has
further informed Client [sic] that payment for non-physical
injuries are generally taxable * * *.
* * * * * * *
Counsel informed Client [sic] that the law is unsettled as
to whether emotional damages in non-physical injury cases
are taxable. Counsel informed client about the decision in
Murphy v. Internal Revenue Service 460 F.3d 79 (2006)
holding that such damages are not always taxable. Counsel
has urged client to obtain professional tax advice and
provide a copy of the attached case to the tax professional
to determine what, if any, impact it has on the resolution
of the issue of the tax consequences associated with this
settlement. Counsel has informed Client [sic] that there
has been an appeal of that case and the case may be
overturned and/or may not be followed by the Courts in
Missouri * * *.
The case mentioned in that document, Murphy v. IRS, 460 F.3d 79
(D.C. Cir. 2006), was later vacated by the Court of Appeals for
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the District of Columbia Circuit on December 22, 2006, Murphy v.
IRS, 99 AFTR 2d 2007-396, 2007-1 USTC par. 50,228 (D.C. Cir.
2006). The Court of Appeals subsequently heard additional
arguments before issuing another decision on July 3, 2007, in
which it held that the taxpayer’s compensatory award for
emotional distress was taxable. Murphy v. IRS, 493 F.3d 170
(D.C. Cir. 2007). However, petitioner was not aware of those
developments.
Petitioner received a Form 1099-MISC, Miscellaneous Income,
reporting her income from the settlement. Petitioner spoke with
several tax return preparers about her 2007 tax return. She
first spoke with someone at Jackson Hewitt, to whom she gave a
copy of her Form 1099. The tax return preparer at Jackson Hewitt
asked her about the lawsuit. Petitioner told her: “Well, I am
not supposed to disclose, but it is emotional distress.” The tax
return preparer at Jackson Hewitt was unsure about the tax
consequences of the settlement, so she called someone. However,
that person apparently did not know either, and Jackson Hewitt
never gave petitioner an answer about the tax consequences.
Petitioner then left Jackson Hewitt because she did not think the
people there knew what they were doing.
Petitioner called another tax return preparer and inquired
on the phone about whether the proceeds of a settlement from a
lawsuit seeking damages for emotional distress were taxable. She
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could not remember whom she had called, but she remembered that
the office was at 47th and Troost. The person with whom
petitioner spoke on the phone told her that the proceeds of the
settlement were not taxable.
Next, petitioner sought advice from Jarods Accounting
Services. However, petitioner did not give the tax return
preparer at that firm a copy of her Form 1099 because she could
not find it. She told the tax return preparer that she had
received a confidential settlement but did not ask the preparer
about the tax consequences of the settlement. The tax return
preparer did not ask petitioner for the Form 1099, and she
omitted from petitioner’s return the income from the settlement.
During 2007, petitioner received $3,510 in wages from a
woman named Barbara Biederman (Ms. Biederman) for whom petitioner
provided caretaking services. However, petitioner did not report
those wages on her return because she had not received a Form W-
2, Wage and Tax Statement. Petitioner called Ms. Biederman once
to inquire about the Form W-2 and was told it would be mailed to
her. Petitioner believed that Ms. Biederman was withholding
income tax from her wages, but Ms. Biederman actually withheld
only Social Security and Medicare taxes. Petitioner did not
report the wages she received from Ms. Biederman on her 2007 tax
return.
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Respondent mailed petitioner a notice of deficiency for her
2007 tax year on July 20, 2009. In the notice of deficiency,
respondent determined that petitioner’s income should be
increased to reflect wages of $3,510 received from Ms. Biederman
and other income of $82,500 from the settlement. Respondent
allowed petitioner a deduction of $39,146 for her attorney’s fees
and legal expenses. Petitioner timely filed her petition with
this Court.
Discussion
As a general rule, the Commissioner’s determinations set
forth in a notice of deficiency are presumed correct, and the
taxpayer bears the burden of proving otherwise. Rule 142(a);
Welch v. Helvering, 290 U.S. 111, 115 (1933).
Gross income generally includes all income from whatever
source derived. Sec. 61(a). The definition of gross income is
broad in scope, while exclusions from income are narrowly
construed. Commissioner v. Schleier, 515 U.S. 323, 328 (1995).
Damages (other than punitive) received on account of personal
physical injuries or physical sickness may generally be excluded
from gross income. Sec. 104(a)(2). For the damages to be
excluded under this provision, the underlying cause of action
must be based in tort or tort-type rights and the proceeds must
be damages received on account of personal physical injury or
sickness. Commissioner v. Schleier, supra at 337. Emotional
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distress is not treated as a personal physical injury or physical
sickness except for damages not in excess of the amount paid for
medical care attributable to emotional distress. Sec. 104(a)
(flush language).
Petitioner has cited Murphy v. IRS, 460 F.3d 79 (D.C. Cir.
2006), to argue that the proceeds of her settlement compensating
her for emotional distress should be exempt from income.
However, as noted above, the Murphy decision petitioner cites was
later vacated by the Court of Appeals. Accordingly, we reject
petitioner’s argument that her income from the settlement was
nontaxable.
We next consider whether petitioner owes income tax on the
wages of $3,510 she received from Ms. Biederman. Petitioner did
not dispute that she failed to report her wages from Ms.
Biederman on her tax return. However, she contended that Ms.
Biederman had told her that her Federal income tax was being
withheld from her wages. Respondent determined that petitioner’s
Federal income tax had not been withheld. Because petitioner
bears the burden of proof and offered no evidence to the
contrary, we conclude that no income tax had been withheld from
the wages petitioner received from Ms. Biederman and that
petitioner failed to pay income tax on those wages.
Finally, we consider whether petitioner is liable for the
accuracy-related penalty pursuant to section 6662(a). Generally,
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the Commissioner bears the burden of production with respect to
any penalty, including the accuracy-related penalty. Sec.
7491(c); Higbee v. Commissioner, 116 T.C. 438, 446 (2001). To
meet that burden, the Commissioner must come forward with
sufficient evidence indicating that it is appropriate to impose
the relevant penalty. Higbee v. Commissioner, supra at 446. The
Commissioner has the burden of production only; the ultimate
burden of proving that the penalty is not applicable remains on
the taxpayer. Id.
Subsection (a) of section 6662 imposes an accuracy-related
penalty of 20 percent of any underpayment that is attributable to
causes specified in subsection (b), including a “substantial
understatement” of income tax. Section 6664(c)(1) provides that
the accuracy-related penalty shall not apply to any portion of an
underpayment if it is shown that there was reasonable cause for
the taxpayer’s position with respect to that portion and that the
taxpayer acted in good faith with respect to that portion. The
determination of whether the taxpayer acted with reasonable cause
and in good faith is made on a case-by-case basis, taking into
account the relevant facts and circumstances. Sec.
1.6664-4(b)(1), Income Tax Regs. “Circumstances that may
indicate reasonable cause and good faith include an honest
misunderstanding of fact or law that is reasonable in light of
all of the facts and circumstances, including the experience,
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knowledge, and education of the taxpayer.” Id. Generally, the
most important factor is the extent of the taxpayer’s efforts to
assess the proper tax liability. Id. An honest misunderstanding
of fact or law that is reasonable in the light of the experience,
knowledge, and education of the taxpayer may indicate reasonable
cause and good faith. Remy v. Commissioner, T.C. Memo. 1997-72.
Petitioner is obviously unfamiliar with tax law. She was
advised by the attorneys who handled her lawsuit that she should
seek professional advice regarding the tax treatment of her
income from the settlement. By advising her of the Court of
Appeals’ holding in Murphy v. IRS, 460 F.3d 79 (D.C. Cir. 2006),
those attorneys also provided her with a reason to believe that
the income from the settlement might not be taxable.2 Petitioner
consulted three different tax preparation services, and none of
them advised her that the income from the settlement was taxable.
On the basis of petitioner’s background, education, and actions
seeking advice on a complex tax issue, we conclude that
petitioner had reasonable cause for her position and acted in
good faith on her belief, although mistaken, when she failed to
2
As noted above, by the time petitioner signed the
“Settlement Distribution - Tax Consequences” document prepared by
her attorneys on July 10, 2007, the decision in Murphy v. IRS,
460 F.3d 79 (D.C. Cir. 2006), had been vacated by Murphy v. IRS,
99 AFTR 2d 2007-396, 2007-1 USTC par. 50,228 (D.C. Cir. 2006)
(vacated Dec. 22, 2006), and the Court of Appeals had decided
Murphy v. IRS, 493 F.3d 170 (D.C. Cir. 2007) (decided July 3,
2007). Accordingly, the information provided to petitioner by
her attorneys was inaccurate even when she signed the document.
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report her income from the settlement. Consequently, we hold
that petitioner is not liable for the accuracy-related penalty on
the portion of her underpayment attributable to income from the
settlement.
Petitioner contends that she acted reasonably in not
reporting her income from Ms. Biederman because she did not
receive a Form W-2 and mistakenly believed that Ms. Biederman had
already withheld her Federal income tax. However, it was not
necessary that petitioner receive a Form W-2 in order for her to
know that she had received compensation for her services for Ms.
Biederman. See, e.g., Brunsman v. Commissioner, T.C. Memo.
2003-291. It was not reasonable for petitioner to simply omit
that compensation on her tax return. Accordingly, petitioner is
not excused from liability for the accuracy-related penalty on
the income she received from Ms. Biederman.
In reaching these holdings, we have considered all the
parties’ arguments, and, to the extent not addressed herein, we
conclude that they are moot, irrelevant, or without merit.
To reflect the foregoing,
Decision will be entered
under Rule 155.