Joshua Smith v. Commissioner

PURSUANT TO INTERNAL REVENUE CODE
SECTION 7463(b),THIS OPINION MAY NOT
BE TREATED AS PRECEDENT FOR ANY
OTHER CASE.
T.C. Summary Opinion 2014-93UNITED STATES TAX COURT
JOSHUA SMITH, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 24635-12S. Filed September 18, 2014.
Joshua Smith, for himself.
Erin K. Neugebauer, for respondent.
SUMMARY OPINION
GUSTAFSON, Judge: This case was heard pursuant to the provisions of
section 74631 in effect when the petition was filed. Pursuant to section 7463(b),
1
All section references are to the Internal Revenue Code (26 U.S.C.) in
effect for the year in issue, and all Rule references are to the Tax Court Rules of
Practice and Procedure, unless otherwise indicated.
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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.
The Internal Revenue Service (“IRS”) determined a deficiency of $7,705 in
and a section 6662(a) accuracy-related penalty of $1,541 on petitioner Joshua
Smith’s Federal income tax for 2010. This case arises from Mr. Smith’s timely
petition for redetermination of the tax and penalties in the statutory notice of
deficiency.
Respondent has conceded that the unreported income at issue is not subject
to self-employment tax. Additionally, respondent has conceded that Mr. Smith is
not liable for the corresponding section 6662(a) accuracy-related penalty of
$1,541. Thus, the only issue remaining for decision is whether the unreported
income at issue was a settlement payment for physical injuries or physical sickness
and therefore excludable from Mr. Smith’s gross income under section 104(a)(2).
We hold that it was not.
Background
The parties jointly moved to submit this case for consideration pursuant to
Rule 122, reflecting their agreement that the relevant facts could be presented
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without a trial, and we granted that motion.2 We incorporate by this reference the
parties’ stipulation of facts filed April 7, 2014, and the exhibits attached thereto.3
Mr. Smith resided in the State of Pennsylvania when he filed his petition.
Mr. Smith’s diagnosis
Mr. Smith was formerly employed as a server with MBFGMTW Limited
Partnership d.b.a. Monterey Bay Fish Grotto (“MBFG”) from approximately June
30, 2005, until MBFG terminated his employment on January 30, 2007. While he
was employed by MBFG, Mr. Smith was diagnosed with attention deficit
hyperactivity disorder (“ADHD”) and major depressive disorder (“MDD”). Both
ADHD and MDD are disabilities within the definition of “disability” in the
Americans with Disabilities Act of 1990 (“ADA”), Pub. L. No. 101-336, 104 Stat.
327.
As part of his treatment regimen he was prescribed a stimulant medication
called Desoxyn (methamphetamine hydrochloride). One of Desoxyn’s side effects
2
The burden of proof is generally on the taxpayer, see Rule 142(a), and the
submission of a case under Rule 122 does not alter that burden, see Borchers v.
Commissioner, 95 T.C. 82, 91 (1990), aff’d, 943 F.2d 22 (8th Cir. 1991); Rule
122(b).
3
The stipulated record consists of: the facts alleged in Mr. Smith’s petition
filed with this Court on October 5, 2012, to the extent they are admitted in
respondent’s answer filed on November 30, 2012; the stipulation of facts; and the
exhibits attached thereto.
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is appetite suppression. This was problematic for Mr. Smith, who is small in
stature. He is only five feet six inches tall, and his weight fluctuated between 120
and 140 pounds before he began taking the medication. Mr. Smith’s primary care
physician was concerned about the appetite suppressive effects of Desoxyn on his
general physical and mental health, particularly if he lost any weight. As a result,
the physician recommended that he consume as many calories as possible
whenever he was able to do so.
MBFG’s employee meal policy
This medical advice conflicted with MBFG’s longstanding policy
prohibiting servers from eating during a shift. The only exception that MBFG
allowed to the policy was that a food server could eat if less than 30 minutes
remained before the restaurant stopped seating guests, and if that server had no
guests remaining at his or her assigned tables. First and second violations of the
policy resulted in written warnings, while a third violation resulted in termination
of the server’s employment.
Mr. Smith recognized the tension between his physician’s recommended
eating regime and MBFG’s restrictive meal policy. He informed MBFG of his
disability and requested to be excepted from the policy. For a brief period, MBFG
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initially excepted Mr. Smith from the policy and he was permitted to eat without
restrictions as his appetite demanded.
However, management’s patience with Mr. Smith’s accommodation quickly
waned, and on January 30, 2006, Mr. Smith was informed that MBFG would no
longer accommodate his disability and that he was again subject to the meal
policy. At that meeting MBFG explained the terms of the meal policy to Mr.
Smith as follows: Mr. Smith was permitted to take up to two eight-minute breaks
per shift, but only after first receiving permission from the manager; Mr. Smith
was permitted to eat only pre-prepared food that was bought outside the
restaurant; and Mr. Smith was permitted to consume his food only while standing
in a particular location in the kitchen, in full view of all kitchen employees. Less
than two weeks later, Mr. Smith was called to a meeting with MBFG management
and disciplined for violating the meal policy. He was told that he would be
terminated if he violated the meal policy again.
Administrative complaint and District Court lawsuit
Mr. Smith submitted a questionnaire to the Pennsylvania Human Relations
Commission (“PHRC”) on February 16, 2006, alleging that MBFG had engaged in
discriminatory conduct. The following day Mr. Smith notified MBFG in writing
of his decision to pursue formal charges of discrimination as a result of its meal
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policy, retaliatory conduct, and refusal to accommodate his disability. On July 21,
2006, the PHRC dismissed Mr. Smith’s complaint because the complaint did not
establish probable cause to show discrimination.
MBFG terminated Mr. Smith on January 30, 2007. In response to his
termination, Mr. Smith filed on July 24, 2007, a civil lawsuit against MBFG in the
U.S. District Court for the Western District of Pennsylvania, Civil No. 07-01032,
pursuant to the ADA and the Pennsylvania Human Relations Act, 43 Pa. Cons.
Stat. secs. 951-963 (West 2009). In the lawsuit Mr. Smith alleged that MBFG
discriminated and retaliated against him because of his disability. Mr. Smith
alleged that he suffered emotional distress, anxiety, depression and other
consequential damages. Mr. Smith’s amended complaint filed November 19,
2007, stated: “As a direct and proximate result of defendant’s actions toward
Plaintiff, as described herein, Plaintiff has suffered, and will continue to suffer,
severe emotional distress, anxiety, depression and other consequential damages.”
Settlement of the discrimination claims
In March 2010 Mr. Smith and MBFG executed a “Confidential Settlement
Agreement and General Release”. The settlement agreement described
Mr. Smith’s claims as follows:
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[Mr. Smith] * * * does hereby fully and forever release, discharge and
hold harmless MBFG * * * from any and all liability upon claims,
causes of action or obligations of every nature whatsoever, whether
known or unknown, arising out of or relating to his employment and
termination from employment or to any other act, event, failure to act
or thing which has occurred or was created at any time before the date
on which this Agreement is signed. Without limiting the generality
hereof, this release covers claims or causes of action based upon torts
(such as, for example, negligence, fraud, defamation, wrongful
discharge); express and implied contracts; federal, state or local
statutes and ordinances, including those which regulate employment
practices (such as, for example, The Age Discrimination in
Employment Act of 1967, The American [sic] with Disabilities Act,
Title VII of the Civil Rights of 1964, the Pennsylvania Human
Relations Act); and every other source of legal rights and obligations
whatsoever.
This description includes no specific mention of physical injury or sickness. In
this settlement agreement, MBFG agreed to pay $35,000 in exchange for Mr.
Smith’s release and discharge of any claims or causes of action he had against
MBFG. Mr. Smith and MBFG’s agreement allocated the settlement payment as
follows:
Plaintiff has requested, and the parties have agreed, that Five
Thousand Dollars of the total payment be allocated to lost wages.
MBFG shall report this portion of the payment to the Internal
Revenue Service through an IRS Form W-2 and such payment shall
be subject to applicable employment tax withholdings. Plaintiff has
requested, and the parties have agreed, that the remainder of the sum
be allocated to pain and suffering, emotional distress and the expense
of suit. This portion shall be reported to the Internal Revenue Service
through an IRS Form 1099. [Emphasis added.]
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The settlement agreement also provided that Mr. Smith was “solely responsible for
the tax liabilities due from him, if any, which result from his receipt of money
under this Agreement”. MBFG issued Mr. Smith a Form 1099-MISC,
“Miscellaneous Income”, and reported the $30,000 of nonemployee compensation
paid to him during tax year 2010. Mr. Smith did not report the $30,000 of
nonemployee compensation on his 2010 Federal income tax return.
On July 2, 2012, the IRS mailed Mr. Smith the notice of deficiency, which
determined a deficiency in tax of $7,705, and on October 5, 2012, Mr. Smith filed
his petition in this Court. On April 7, 2014, the parties filed their stipulation of
facts and jointly moved to submit the case under Rule 122. By order dated April
7, 2014, the Court ordered the parties to submit simultaneous memoranda briefs by
July 7, 2014. Mr. Smith did not file a brief, but we construe his position to be that
the unreported income is excludable from his gross income pursuant to section
104(a)(2) because it was allocated to pain and suffering. Respondent’s brief
argues that the unreported income represents settlement proceeds that were not
received on account of personal physical injuries or physical sickness and
therefore are not excludable from gross income under section 104(a)(2).
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Discussion
As a general rule, the IRS’s determinations are presumed correct, and the
taxpayer has the burden of establishing that the determinations in the notice of
deficiency are erroneous. Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115
(1933). Mr. Smith has not contended that the burden of proof has shifted pursuant
to section 7491(a), and the record shows no basis for such a contention. The
record shows that Mr. Smith did receive the unreported income; thus, the
presumption of correctness attaches in this unreported income case. See, e.g.,
Harris v. Commissioner, T.C. Memo. 2012-333.
I. Taxability of settlement awards
Section 61(a) provides the following broad definition of the term “gross
income”: “Except as otherwise provided in this subtitle, gross income means all
income from whatever source derived”. Section 61(a) is thus broad in its scope,
and exclusions from gross income must be narrowly construed. Commissioner v.
Schleier, 515 U.S. 323, 328 (1995).
Section 104(a) provides that gross income does not include:
(2) the amount of any damages (other than punitive
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 * * *.
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* * * * * * *
For purposes of paragraph (2), emotional distress shall not be treated
as a physical injury or physical sickness. The preceding sentence
shall not apply to an amount of damages not in excess of the amount
paid for medical care (described in subparagraph (A) or (B) of section
213(d)(1)) attributable to emotional distress.
The legislative history shows that “[i]t is intended that the term emotional distress
includes symptoms (e.g., insomnia, headaches, stomach disorders) which may
result from such emotional distress”. H.R. Conf. Rept. No. 104-737, at 301 n.56
(1996), 1996-3 C.B. 741, 1041. Therefore, to be excludable from gross income
under section 104(a)(2), a settlement award must be paid to a taxpayer on account
of physical injuries or physical sickness, which does not include emotional distress
or symptoms thereof.
Where damages are received pursuant to a settlement agreement like
Mr. Smith’s, the nature of the claim that was the actual basis for settlement
controls whether those damages are excludable under section 104(a)(2). United
States v. Burke, 504 U.S. 229, 237 (1992). Whether the settlement payment is
excludable from gross income under section 104(a)(2) depends on the nature and
the character of the claims asserted in the lawsuit. See Bent v. Commissioner,
87 T.C. 236, 244 (1986), aff’d, 835 F.2d 67 (3d Cir. 1987); Church v.
Commissioner, 80 T.C. 1104, 1106-1107 (1983); Glynn v. Commissioner, 76 T.C.
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116, 119 (1981), aff’d without published opinion, 676 F.2d 682 (1st Cir. 1982).
The determination of the underlying nature of the claim is factual. 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); Seay v. Commissioner, 58
T.C. 32, 37 (1972).
Where there is a settlement agreement, the determination of the nature of the
claim is usually made by reference to the agreement. See 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 settlement agreement lacks an
express statement of the claims that payment was to settle, the intent of the payor
(here, MBFG) is critical to that determination. Knuckles v. Commissioner, 349
F.2d at 613; see also Agar v. Commissioner, 290 F.2d 283, 284 (2d Cir. 1961),
aff’g per curiam T.C. Memo. 1960-21.
II. The nature of Mr. Smith’s claim against MBFG
We surmise from Mr. Smith’s petition that his position is that the
unreported income is excludable from his income under section 104(a)(2) because
it was partially allocated as damages for pain and suffering under the settlement
agreement. (He makes no contention that the amounts were for medical care. Cf.
sec. 104(a) (flush language).) Because the unreported income arose from Mr.
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Smith’s settlement agreement with MBFG, we must first look to the settlement
agreement to determine the nature of the claims it was intended to settle. The
settlement payment is excludable from gross income only if it was paid on account
of physical injuries or physical sickness. Alternatively, if the settlement payment
was paid on account of general pain and suffering or emotional distress, then it
would not be excludable from gross income under section 104(a)(2).
As we have noted, the settlement agreement does not specifically mention
any claims for physical injuries or physical sickness. And by its terms (quoted
above), the settlement agreement does not provide that any portion of the payment
was allocable to claims for physical injuries or physical sickness. Rather, it
allocates the payment to “lost wages”, “pain and suffering, emotional distress and
the expense of suit.” This Court has noted, however, that “‘pain and suffering’ is a
broad term that includes emotional distress and its symptoms”. See Longoria v.
Commissioner, T.C. Memo. 2009-162. Settlement payments for non-physical
injuries such as emotional distress are not excludable from income under section
104(a)(2). See id.; Hawkins v. Commissioner, T.C. Memo. 2007-286, aff’d, 386
Fed. Appx. 697 (9th Cir. 2010); see also Blackwood v. Commissioner,
T.C. Memo. 2012-190 (holding that depression is a non-physical injury under
section 104(a)).
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When we look to Mr. Smith’s Federal court complaint to see whether it
states more particular claims (i.e., physical injuries or physical sickness) that
would justify exclusion, see Burke, 504 U.S. at 237; Church v. Commissioner, 80
T.C. at 1106-1107, we find it does not. The claims Mr. Smith asserted against
MBFG were for discrimination and retaliation; and the damages Mr. Smith
claimed were: “severe emotional distress, anxiety, depression and other
consequential damages”. These injuries are non-physical. As we have previously
held, section 104(a)(2) and the flush language of section 104(a) require that, to be
excluded from income, any damages must arise from personal injuries or personal
sickness other than emotional distress or the symptoms thereof. See Longoria v.
Commissioner, T.C. Memo. 2009-162. Thus, we cannot hold that Mr. Smith’s
claims for damages were for physical injuries that might give rise to a settlement
award that is excludable from income pursuant to section 104(a)(2).
The character of the settlement payment hinges ultimately on the dominant
reason of the payor in making the payment. See Agar v. Commissioner, 290 F.2d
at 284; Fono v. Commissioner, 79 T.C. 680, 696 (1982), aff’d without published
opinion, 749 F.2d 37 (9th Cir. 1984). Mr. Smith has not met his burden to
establish that he received the $35,000 settlement payment, or any identifiable part
thereof, from MBFG on account of personal physical injuries or physical sickness.
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For that reason we find that the $30,000 of unreported income is not excludable
from Mr. Smith’s gross income under section 104(a)(2) for his tax year 2010.
To reflect the foregoing,
Decision will be entered under
Rule 155.