Bryant D. Tillman-Kelly & Melanie Tillman-Kelly

United States Tax Court
T.C. Memo. 2022-111BRYANT D. TILLMAN-KELLY AND MELANIE TILLMAN-KELLY,
Petitioners
v.
COMMISSIONER OF INTERNAL REVENUE,
Respondent
—————
Docket No. 6127-20. Filed November 21, 2022.
—————
Bryant D. Tillman-Kelly and Melanie Tillman-Kelly, pro se.
Monica I. Cendejas, for respondent.
MEMORANDUM OPINION
URDA, Judge: Petitioners, Bryant and Melanie Tillman-Kelly,
challenge the Internal Revenue Service’s (IRS) determination of a
deficiency of $67,322 in their 2017 federal income tax. 1 Mr. Tillman-
Kelly received $230,671 to settle an Illinois state court action against
Chicago State University (CSU), its board of trustees, and Dr. Justin
Akujieze (Defendants) in 2017. Mr. Tillman-Kelly alleged that the
Defendants had retaliated against him for reporting the misuse of grant
funds, resulting in “emotional distress, humiliation, and lost income.”
The sole remaining question (in the wake of a stipulation of settled
issues) is whether the settlement proceeds should be excluded from the
Tillman-Kellys’ gross income under section 104(a)(2), which shields
damages received “on account of personal physical injuries or physical
1 Unless otherwise indicated, all statutory references are to the Internal
Revenue Code, Title 26 U.S.C. or I.R.C., in effect at all relevant times, all regulation
references are to the Code of Federal Regulations, Title 26 (Treas. Reg.), in effect at all
relevant times, and all Rule references are to the Tax Court Rules of Practice and
Procedure. All amounts are rounded to the nearest dollar.
Served 11/21/22
2
[*2] sickness” from inclusion in gross income. We conclude that the
settlement proceeds do not qualify for this exclusion and will sustain the
deficiency determination, subject to certain concessions made by the
Commissioner.
Background
The parties have moved to submit this case for decision without
trial under Rule 122. All facts relevant to this case have been stipulated
or otherwise included in the record. See Rule 122(a). The Tillman-
Kellys lived in California when they timely filed their petition.
I. Mr. Tillman-Kelly’s Lawsuit
In September 2009 CSU hired Mr. Tillman-Kelly as project
director of a federal grant that CSU had received. Mr. Tillman-Kelly
reported directly to Dr. Akujieze, a dean at CSU, and Robert Warner,
the dean’s executive assistant. A few months into his employment Mr.
Tillman-Kelly expressed concerns to the U.S. Department of Education
and CSU’s Ethics Office that certain grant funds were being
misappropriated. On June 17, 2010, CSU terminated Mr. Tillman-
Kelly’s employment.
Mr. Tillman-Kelly thereafter filed suit against the Defendants in
Illinois state court, alleging that they retaliated against him for his
complaints of misuse of funds. 2 He stated that he “was subjected to
humiliation, isolation, harsher discipline and different and
comparatively more negative terms and standards of employment,
[than] other university employees, denial of benefits, demotions, and
ultimately, termination.” Specifically, Mr. Tillman-Kelly asserted that
Dr. Akujieze threatened to “do what he had to do” in response to Mr.
Tillman-Kelly’s ethics complaints, which (again, according to the
complaint) consisted primarily of eliminating Mr. Tillman-Kelly’s job
responsibilities culminating with his termination.
Mr. Tillman-Kelly contended that these actions violated Illinois
state whistleblower protections and sought “damages included but not
limited to emotional distress and humiliation and lost income and
2 Mr. Tillman-Kelly originally had filed suit against CSU and its board of
trustees in the U.S. District Court for the Northern District of Illinois, but he moved
to dismiss that action a few months later.
3
[*3] benefits.” His complaint did not allege that he suffered any physical
injuries, nor did he seek compensation for physical injuries.
Mr. Tillman-Kelly and the Defendants settled the state court case
in 2017. Under the terms of the settlement agreement, Mr. Tillman-
Kelly received a payment of $230,671 in exchange for ending his suit.
The settlement agreement described this payment as being for “alleged
non-wage injuries, as non-economic emotional distress damages.”
II. IRS Examination and Notice of Deficiency
Although the Tillman-Kellys did not include the settlement
payment on their 2017 federal income tax return, CSU reported it to the
IRS on Form 1099-MISC, Miscellaneous Income. The IRS later issued
a notice of deficiency to the Tillman-Kellys, determining a deficiency of
$67,322 and an accuracy-related penalty of $13,423. 3 As most relevant
here, the notice adjusted the Tillman-Kellys’ gross income to reflect
receipt of the CSU settlement payment.
Discussion
I. Burden of Proof
The Commissioner’s determinations in a notice of deficiency are
generally presumed correct, and the taxpayer bears the burden of
proving those determinations erroneous. See Rule 142(a)(1); Welch v.
Helvering, 290 U.S. 111, 115 (1933); Merkel v. Commissioner, 192 F.3d
844, 852 (9th Cir. 1999), aff’g 109 T.C. 463 (1997). The U.S. Court of
Appeals for the Ninth Circuit, to which an appeal in this case would
ordinarily lie, see I.R.C. § 7482(b)(1)(A), has held that that the
Commissioner must establish “some evidentiary foundation” linking the
taxpayer to an alleged income-producing activity before the
presumption of correctness attaches to the deficiency determination,
Weimerskirch v. Commissioner, 596 F.2d 358, 361–62 (9th Cir. 1979),
rev’g 67 T.C. 672 (1977). Once the Commissioner has established such
a foundation, the burden of proof shifts to the taxpayer to prove by a
preponderance of the evidence that the Commissioner’s determinations
3 The deficiency determined in the notice reflected several other adjustments
to the Tillman-Kellys’ income, but those adjustments are not in dispute. We further
note that the Commissioner has conceded the accuracy-related penalty determined in
the notice.
4
[*4] are arbitrary or erroneous. See Hardy v. Commissioner, 181 F.3d
1002, 1004–05 (9th Cir. 1999), aff’g T.C. Memo. 1997-97.
The Tillman-Kellys have stipulated that they received the
settlement proceeds at issue, and the Commissioner has established an
evidentiary foundation linking them to the unreported income. The
Commissioner’s determination is accordingly presumed correct, and the
Tillman-Kellys have the burden of proving that the determination is
erroneous. See Rule 142(a)(1); Welch v. Helvering, 290 U.S. at 115. 4
II. Analysis
A. Legal Background
Gross income includes all income from whatever source derived.
See I.R.C. § 61(a); see also Commissioner v. Glenshaw Glass Co., 348
U.S. 426, 429 (1955); Helvering v. Clifford, 309 U.S. 331, 334 (1940).
Exclusions from gross income “must be narrowly construed.”
Commissioner v. Schleier, 515 U.S. 323, 328 (1995) (quoting United
States v. Burke, 504 U.S. 229, 248 (1992) (Souter, J., concurring in the
judgment)).
Settlement proceeds constitute gross income unless the taxpayer
proves that such proceeds fall within a specific statutory exception. See
id.; Save v. Commissioner, T.C. Memo. 2009-209, 2009 WL 2950838,
at *1. Section 104(a)(2) supplies one such exception, excluding from
gross income “any damages (other than punitive damages) received
(whether by suit or agreement . . . ) on account of personal physical
injuries or physical sickness.”
For the purposes of this exception, “emotional distress shall not
be treated as a physical injury or physical sickness.” I.R.C. § 104(a)
(flush text). 5 Treasury Regulation § 1.104-1(c)(1) further explains that
“[e]motional distress is not considered a physical injury or physical
sickness” unless it is “attributable to a physical injury or physical
sickness.” See Rivera v. Baker W., Inc., 430 F.3d 1253, 1256 (9th
4 We note that Mr. Tillman-Kelly did not seek a shift in the burden of proof
under section 7491(a) and that the submission of a case under Rule 122(a) does not
shift the burden of proof. See Rule 122(b).
5 The flush text of section 104(a) provides that the general rule against
exclusion of emotional-distress damages does not apply to “the amount paid for medical
care” attributable to emotional distress. The Tillman-Kellys neither raised this issue
nor introduced evidence regarding amounts for any medical care.
5
[*5] Cir. 2005) (“[O]nly damages for physical injuries or sickness, and
not damages for emotional distress, [are] excluded from . . . income.”);
see also Barbato v. Commissioner, T.C. Memo. 2016-23, at *7–9 (finding
that damages for emotional distress attributable to workplace
discrimination and not a physical injury or physical sickness do not fall
within the exclusion from income granted by section 104(a)(2)); Hawkins
v. Commissioner, T.C. Memo. 2007-286, 2007 WL 2736219, at *2 (“In
this context, the terms ‘physical injury’ and ‘physical sickness’ do not
include emotional distress . . . .”), aff’d, 386 F. App’x 697 (9th Cir. 2010).
“For a taxpayer to fall within [the section 104(a)(2)] exclusion, he
must show that there is ‘a direct causal link between the damages and
the personal injuries sustained.’” Doyle v. Commissioner, T.C.
Memo. 2019-8, at *11 (quoting Rivera, 430 F.3d at 1257); see also Blum
v. Commissioner, T.C. Memo. 2021-18, at *7, aff’d, No. 21-71113, 2022
WL 1797334 (9th Cir. June 2, 2022). When a taxpayer receives damages
pursuant to a settlement agreement, the nature of the claim that was
the actual basis for the settlement controls whether the damages are
excludable under section 104(a)(2). See Burke, 504 U.S. at 237; see also
Bagley v. Commissioner, 105 T.C. 396, 406 (1995) (“[T]he critical
question is, in lieu of what was the settlement amount paid[?]”), aff’d,
121 F.3d 393 (8th Cir. 1997); Blum, T.C. Memo. 2021-18, at *8; Smith v.
Commissioner, T.C. Memo. 2018-127, at *18, aff’d without published
opinion, No. 19-1050, 2020 WL 8368297 (D.C. Cir. 2020).
The nature of the claim is typically determined by looking to “the
underlying agreement to determine whether it expressly states that the
damages compensate for ‘personal physical injuries or physical sickness’
under § 104(a)(2).” Rivera, 430 F.3d at 1257; see also Ghadiri-Asli v.
Commissioner, T.C. Memo. 2019-142, at *38, aff’d sub nom. Najle-
Rahim v. Commissioner, No. 20-72031, 2022 WL 2869776 (9th Cir.
July 21, 2022). Should an agreement fail to answer the question, we
inquire as to “the intent of the payor.” Devine v. Commissioner, T.C.
Memo. 2017-111, at *11 (quoting Longoria v. Commissioner, T.C. Memo.
2009-162, 2009 WL 1905040, at *7); see also Rivera, 430 F.3d at 1257;
Knuckles v. Commissioner, 349 F.2d 610, 613 (10th Cir. 1965), aff’g T.C.
Memo. 1964-33; Ahmed v. Commissioner, T.C. Memo. 2011-295, 2011
WL 6440130, at *3, aff’d, 498 F. App’x 919 (11th Cir. 2012).
The payor’s intent may be discerned by taking into account “all
the facts and circumstances of the case,” including the amount paid, the
allegations in the injured party’s complaint, and the factual
circumstances that led to the agreement. Rivera, 430 F.3d at 1257
6
[*6] (quoting Allum v. Commissioner, T.C. Memo. 2005-177, 2005 WL
1692488, at *4, aff’d, 231 F. App’x 550 (9th Cir. 2007)); see Green v.
Commissioner, 507 F.3d 857, 868 (5th Cir. 2007), aff’g T.C. Memo. 2005-
250; see also Bent v. Commissioner, 87 T.C. 236, 245 (1986), aff’d, 835
F.2d 67 (3d Cir. 1987). “Ultimately, the character of the payment hinges
on the payor’s dominant reason for making the payment.” Green, 507
F.3d at 868. “[T]he nature of underlying claims cannot be determined
from a general release [of claims] that is broad and inclusive.” Ahmed
v. Commissioner, 2011 WL 6440130, at *3.
B. Mr. Tillman-Kelly’s Settlement Payment
The settlement agreement establishes that the payment is not
excludable under section 104(a)(2). The parties expressly agreed that
the $230,671 payment to Mr. Tillman-Kelly was for “non-wage injuries,
as non-economic emotional distress damages.” The parties do not
reference physical injuries or sickness in the agreement, much less tie
the settlement payment to any such physical injuries or sickness.
The Tillman-Kellys respond that the retaliation claim was
actually rooted in a heated altercation between Mr. Tillman-Kelly and
Mr. Warner, which resulted in physical injury from the slamming of a
door, and that the settlement proceeds were meant to compensate Mr.
Tillman-Kelly for that injury. The Tillman-Kellys assert that their
treatment of the proceeds was thus consistent with IRS
Publication 4345, which states in relevant part that “proceeds you
receive for emotional distress or mental anguish attributable to a
personal physical injury or physical sickness are treated the same as
proceeds received for Personal physical injuries or physical sickness.”
I.R.S. Publication 4345 (Revised Nov. 2022), Settlements—Taxability,
at 1.
The settlement agreement belies the Tillman-Kellys’ position. In
that agreement, the parties characterized the payment as one for
“emotional distress damages” and did not reference any physical injury
whatsoever.
Even if we were to expand our focus beyond the settlement
agreement, the Tillman-Kellys would fare no better. As an initial
matter, Mr. Tillman-Kelly’s claim against the Defendants does not
relate to compensation for physical injuries. The state court claim
alleges violation of an Illinois whistleblower statute, describing a
retaliatory campaign involving improper removal of job responsibilities
7
[*7] and ultimately termination, not physical injury. Nor did Mr.
Tillman-Kelly’s complaint seek damages for physical injury, instead
pursuing damages for “emotional distress and humiliation and lost
income and benefits.”
The only clear reference in the record to any physical injury comes
in Mr. Tillman-Kelly’s responses to interrogatories in the state court
action. 6 In the context of a lengthy description of the events at issue and
his complaints, Mr. Tillman-Kelly stated he reported to CSU ethics
officials an incident in which Mr. Warner “slammed a door on [him]
injuring [him].” Mr. Tillman-Kelly, however, did not identify this
purported injury in response to an interrogatory asking for “the basis
for any damages you claim to be entitled to, including the compensatory
and punitive damages articulated in your Prayer for Relief.” Nor does
the record explain the precise nature or extent of Mr. Tillman-Kelly’s
purported physical injury from the door.
In short, we return to the plain text of the settlement agreement
that the payment was made for “alleged non-wage injuries, as non-
economic emotional distress damages.” This text is clear on its face, but
even if there were some doubt, the nature of the state court litigation
supports the conclusion that the dominant reason for the payment was
to compensate for emotional distress and was altogether unrelated to
physical injury.
III. Conclusion
In sum, we hold that the settlement payment is not excludable
from Mr. Tillman-Kelly’s gross income under section 104(a)(2) for tax
year 2017. We accordingly sustain the IRS’s deficiency determination,
subject to the Commissioner’s concessions.
To reflect the foregoing,
Decision will be entered for respondent as to the deficiency and
for petitioners as to the accuracy-related penalty under section 6662(a).
6 We note that during his deposition in the state court litigation, Mr. Tillman-
Kelly referenced a hospital visit in August 2010 in response to panic attacks.
According to Mr. Tillman-Kelly’s own testimony, however, the hospital sent him home
because “physically nothing was wrong with [him].”