Fono v. Comm'r of Internal Revenue , Docket No. 1008-77.

CourtUnited States Tax Court
Writing for the CourtFEATHERSTON
Citation79 T.C. 680
PartiesLASZLO FONO and PAULETTE FONO, PETITIONERS v. COMMISSIONER of INTERNAL REVENUE, RESPONDENT
Docket NumberDocket No. 1008-77.
Decision Date27 October 1982

79 T.C. 680

LASZLO FONO and PAULETTE FONO, PETITIONERS
v.
COMMISSIONER of INTERNAL REVENUE, RESPONDENT

Docket No. 1008-77.

United States Tax Court

Filed October 27, 1982.


Petitioners, developers of the Magic Pan restaurant concept and owners of equipment and recipes, sold their restaurant business to Quaker in 1969 in consideration of approximately $277,000 in cash and employment and royalty agreements. Dissatisfied with the operation of the 1969 agreements, petitioners in 1972 negotiated a settlement under which the employment and bonus agreements were terminated, and petitioners received $425,000, none of which was allocated to claimed mental distress or other personal injuries. Again dissatisfied, petitioners in 1975 sued Quaker and in 1980 settled the suit in consideration of a $175,000 payment for personal injuries and an agreement to reform the 1972 agreement to allocate retroactively $258,334 of the 1972 payment to damages for physical and emotional distress. Held, in computing their 1972 income tax, petitioners are not entitled to exclude from gross income any part of the 1972 payment as damages for personal injuries within the meaning of sec. 104(a)(2), I.R.C. 1954.

[79 T.C. 681]

Norman I. Book, Jr., for the petitioners.

Rebecca T. Hill, for the respondent.

FEATHERSTON , Judge:

Respondent determined a deficiency in petitioners' Federal income tax for 1972 in the amount of $167,576. Other issues having been resolved by agreement between the parties,1 the only issue remaining for decision is what part, if any, of a payment received by petitioners in 1972 in settlement of a dispute with the Quaker Oats Co. should be allocated to personal injuries within the meaning of section 104(a)(2).2

FINDINGS OF FACT
1. General

Petitioners Laszlo Fono and Paulette Fono are husband and wife. They filed a joint Federal income tax return for 1972 with the Internal Revenue Service Center, Fresno, Calif. At the time the petition in this case was filed, petitioners resided in San Francisco, Calif.

Petitioners are native Hungarians. They left Hungary in 1956, following the Hungarian revolution, and arrived in the United States as refugees in 1957. Petitioners first settled in Colorado, where they remained for about 8 years. During this time, Mr. Fono first worked in a taxidermy shop, then as a groundkeeper at a country club. Later, for most of the last 4 years that petitioners lived in Colorado, he worked in a bank processing checks and doing bookkeeping.

Mr. Fono had acquired some minimal bookkeeping experience working in his father's china and hardware business in Hungary. He had also taken basic accounting classes in secondary school in Hungary and took accounting classes,

[79 T.C. 682]

including a basic tax course, at night school while he was working for the bank in Colorado. Mr. Fono was not a professional accountant, however. In particular, he had no professional experience in income tax matters, and he never prepared his own or anyone else's U.S. tax return. Mrs. Fono also worked in a bank in Colorado for 71;2 years, but the record does not reveal what her duties were.

2. The Magic Pan

While petitioners were living in Colorado, Mrs. Fono also did some catering from her house, often serving crepes prepared according to a recipe that she had learned from her mother. The crepes were a great success with Mrs. Fono's customers, many of whom encouraged her to open a restaurant. Petitioners decided to act on this suggestion; they moved to San Francisco in 1964 and in the next year there opened a restaurant named The Magic Pan. The restaurant featured crepes cooked in a special pan that petitioners had patented. The restaurant was small, seating only about 20 guests, but it won an enthusiastic response from its customers, and petitioners received several inquiries about purchasing or franchising the business.

Petitioners opened a second, larger3 Magic Pan in San Francisco's Ghirardelli Square shopping center in 1967. Petitioners continued to receive inquiries from outsiders, including large national concerns, who expressed interest in getting in “on the ground floor” of their business. Petitioners commenced negotiations with several large companies, including Stouffer Foods Corp. and Holiday Inns, for the purchase by these companies of The Magic Pan. None of these negotiations produced a final agreement, however, until Quaker Oats Co. (hereinafter Quaker) became interested.

3. The 1969 Agreements

Petitioners commenced negotiations with Quaker no later than October 1968. These negotiations culminated in four agreements which were formally concluded in January 1969

[79 T.C. 683]

(hereinafter referred to as the 1969 agreements), the provisions of which are described as follows:

(a) Purchase agreement.—-Petitioners agreed to sell, and Quaker agreed to buy “the restaurant business * * * known as The Magic Pan” for a total price, exclusive of inventory,4 of $56,015.94, allocated as follows:

+----------------------------------+
                ¦Leasehold improvements ¦$22,570.56¦
                +-----------------------+----------¦
                ¦Restaurant equipment ¦21,026.72 ¦
                +-----------------------+----------¦
                ¦Furniture and fixtures ¦8,816.51 ¦
                +-----------------------+----------¦
                ¦Office equipment ¦1,256.15 ¦
                +-----------------------+----------¦
                ¦Automotive equipment ¦1,346.00 ¦
                +-----------------------+----------¦
                ¦Trademarks and goodwill¦1,000.00 ¦
                +-----------------------+----------¦
                ¦Total ¦56,015.94 ¦
                +----------------------------------+
                

The purchase agreement also provided for the execution of the remaining three agreements concurrently with the closing of the purchase agreement.

(b) Assignment agreement.—-Petitioners assigned to Quaker the patent for their special pan for making crepes, related trade secret technology, and various formulas and recipes for and in consideration of $221,584.06. In addition, Quaker agreed—-

As additional purchase price installments for the Patent * * * to pay to ASSIGNORS 30/100's of 1 percent of ASSIGNEE's net sales, if any, of frozen crepe products * * * during each fiscal year ending June 30, commencing July 1, 1969, and continuing through June 30, 1979, payable within 90 days of the end of each such year, but in no event shall such additional purchase price installments in any year exceed the sum of $60,000.00.* * *

(c) and (d) Employment agreements.—-Separate employment agreements were entered into with petitioners providing that they would both be employed for a period of not less than 5 years by Magic Pan, Inc., a subsidiary of Quaker newly formed to operate the restaurant business. The agreements were substantially identical except that the annual base salary provided for was $30,000 for Mr. Fono and $20,000 for Mrs. Fono. Each employment contract contained the following bonus provision:

4. In addition to your base salary, you will receive an annual bonus of five

[79 T.C. 684]

percent of the profits, if any, of our restaurant subsidiary for each fiscal year ending June 30, commencing July 1, 1969 and continuing through June 30, 1979, payable within 90 days of the end of each such year, determined by deducting from the gross income of our restaurant subsidiary

(a) all costs and expenses associated with the business (except Federal taxes on income, interest on loans and this bonus) determined in accordance with generally accepted accounting principles and procedures as reported in audited financial statements of our restaurant subsidiary, and,

(b) fifteen percent of the total assets of our restaurant subsidiary as reported in audited financial statements as of the end of the particular fiscal year, and

(c) fifteen percent of the value of leases of our restaurant subsidiary, which value shall be determined by multiplying the annual rent by the number of years the lease has to run.

Mr. Fono became president of Magic Pan, Inc., and Mrs. Fono became vice president and assistant secretary. Both of them were on the board of directors.

Petitioners' association with Quaker did not prove to be as successful as they had hoped when they entered into the 1969 agreements. On the contrary, the relationship soon soured and eventually became a source of great distress to petitioners. Much of petitioners' ill feelings was caused by their personal incompatibility with their immediate superior, Frederick Montgomery (Montgomery), the Quaker executive whom the company appointed to oversee Magic Pan, Inc.5

The troubled personal relationship between petitioners and Montgomery only increased the difficulty of resolving their disagreements about the management of the business. When openings of new Magic Pans failed to proceed smoothly and Magic Pan, Inc., suffered losses in the years after the acquisition by Quaker, much acrimony accompanied the process of fixing the blame. Montgomery wrote memoranda to his superiors which criticized petitioners' contribution to the business and impugned their personal integrity. Although petitioners did not learn of these memoranda at the time, Montgomery was also sharply critical of them in their dealings with him.

In addition to their difficulties in dealing with Montgomery, petitioners believed that Quaker had failed to live up to its representations as to its expertise, experience, and resources

[79 T.C. 685]

for managing and franchising restaurants at the time of the 1969 agreements. Petitioners were also upset that they were forced to play an employment role (work on practical restaurant management) rather than the one (consulting and public relations work) that they had anticipated in the development of new Magic Pan restaurants. Petitioners were also disappointed that they never received any payments under the bonus clauses contained in their 1969 employment agreements and set forth above. Petitioners came to believe that the clauses were unfair, both because of the manner in which “profits” were computed,6 and because the management of the company, and, consequently, the power decisively to...

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61 practice notes
  • Koithan v. Comm'r of Internal Revenue (In re Estate of La Meres), Docket No. 6909-88.
    • United States
    • United States Tax Court
    • March 23, 1992
    ...327, 329-330 (8th Cir. 1957), affg. 24 T.C. 69 (1955); Estate of Nicholson v. Commissioner, 94 T.C. 666, 673 (1990); Fono v. Commissioner, 79 T.C. 680, 695 (1982), affd. without published opinion 749 F.2d 37 (9th Cir. 1984); American Nurseryman [98 T.C. 312] Publishing Co. v. Commissioner, ......
  • Downey v. Comm'r of Internal Revenue, Docket No. 11120-89.
    • United States
    • United States Tax Court
    • July 31, 1991
    ...Metzger v. Commissioner, 88 T.C. 834, 847848 (1987), affd. without published opinion 845 F.2d 1013 (3d Cir. 1988); Fono v. Commissioner, 79 T.C. 680, 694 (1982), affd. without published opinion 749 F.2d 37 (9th Cir. 1984). In Rickel v. Commissioner, 92 T.C. 510 (1989), affd. in part and rev......
  • Delaney v. C.I.R., No. 95-2066
    • United States
    • U.S. Court of Appeals — First Circuit
    • February 8, 1996
    ...(1996); Threlkeld v. Commissioner, 87 T.C. 1294, 1306-1307, 1986 WL 22061 (1986), aff'd, 848 F.2d 81 (6th Cir.1988); Fono v. Commissioner, 79 T.C. 680, 694, 1982 WL 11175 (1982), aff'd, 749 F.2d 37 (Table) (9th Cir.1984); see also Mitchell v. Commissioner, 60 T.C.M. (CCH) 1368 (1990) (alloc......
  • Byrne v. Comm'r of Internal Revenue, Dkt. No. 38959-84
    • United States
    • United States Tax Court
    • May 16, 1988
    ...to the purpose in making the payment‘ must nevertheless be determined. Metzger v. Commissioner, 88 T.C. at 847-848; Fono v. Commissioner, 79 T.C. 680, 694 (1982), affd. 749 F.2d 37 (9th Cir. 1984). The settlement does not expressly provide whether the purpose of the payment was to compensat......
  • Request a trial to view additional results
61 cases
  • Koithan v. Comm'r of Internal Revenue (In re Estate of La Meres), Docket No. 6909-88.
    • United States
    • United States Tax Court
    • March 23, 1992
    ...327, 329-330 (8th Cir. 1957), affg. 24 T.C. 69 (1955); Estate of Nicholson v. Commissioner, 94 T.C. 666, 673 (1990); Fono v. Commissioner, 79 T.C. 680, 695 (1982), affd. without published opinion 749 F.2d 37 (9th Cir. 1984); American Nurseryman [98 T.C. 312] Publishing Co. v. Commissioner, ......
  • Downey v. Comm'r of Internal Revenue, Docket No. 11120-89.
    • United States
    • United States Tax Court
    • July 31, 1991
    ...Metzger v. Commissioner, 88 T.C. 834, 847848 (1987), affd. without published opinion 845 F.2d 1013 (3d Cir. 1988); Fono v. Commissioner, 79 T.C. 680, 694 (1982), affd. without published opinion 749 F.2d 37 (9th Cir. 1984). In Rickel v. Commissioner, 92 T.C. 510 (1989), affd. in part and rev......
  • Delaney v. C.I.R., No. 95-2066
    • United States
    • U.S. Court of Appeals — First Circuit
    • February 8, 1996
    ...(1996); Threlkeld v. Commissioner, 87 T.C. 1294, 1306-1307, 1986 WL 22061 (1986), aff'd, 848 F.2d 81 (6th Cir.1988); Fono v. Commissioner, 79 T.C. 680, 694, 1982 WL 11175 (1982), aff'd, 749 F.2d 37 (Table) (9th Cir.1984); see also Mitchell v. Commissioner, 60 T.C.M. (CCH) 1368 (1990) (alloc......
  • Byrne v. Comm'r of Internal Revenue, Dkt. No. 38959-84
    • United States
    • United States Tax Court
    • May 16, 1988
    ...to the purpose in making the payment‘ must nevertheless be determined. Metzger v. Commissioner, 88 T.C. at 847-848; Fono v. Commissioner, 79 T.C. 680, 694 (1982), affd. 749 F.2d 37 (9th Cir. 1984). The settlement does not expressly provide whether the purpose of the payment was to compensat......
  • Request a trial to view additional results

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