Connolly v. Commissioner
| Decision Date | 24 April 2007 |
| Docket Number | Dkt. No. 8224-05. |
| Citation | 93 T.C.M. 1138 |
| Parties | Christina Connolly v. Commissioner. |
| Court | U.S. Tax Court |
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 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.
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 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 disorder and "panic attack". Petitioner was still receiving treatment for anxiety disorder at the time of trial.
OPINIONThe 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 [3 USTC ¶ 1164], 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. [55-1 USTC ¶ 9308], 348 U.S. 426, 430 (1955) (). Exclusions from gross income must be narrowly construed. Commissioner v. Schleier [95-1 USTC ¶ 50,309], 515 U.S. 323, 328 (1995) (citing United States v. Burke [92-1 USTC ¶ 50,254], 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 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 [Dec. 55,556(M)], T.C. Memo. 2004-47, affd. [2005-2 USTC ¶ 50,487] 139 Fed. Appx. 319 (2d Cir. 2005).
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 [Dec. 49,648], 102 T.C. 116, 126 (1994) , affd. in part, revd. in part on another ground and remanded [95-2 USTC ¶ 50,644] 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.
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 [Dec. 55,188(M)], 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 [Dec. 56,454(M)], 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 "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 [94-1 USTC ¶ 50,085], 835 F. Supp. 744, 746 (S.D.N.Y. 1993), affd. [94-2 USTC ¶ 50,470] 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...
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