Gross v. Commissioner
| Decision Date | 07 November 2000 |
| Docket Number | Docket No. 3440-98. |
| Citation | 80 T.C.M. 648 |
| Court | U.S. Tax Court |
| Parties | Ronald N. and Karen M. Gross v. Commissioner. |
Respondent determined deficiencies in petitioners' Federal income taxes for taxable years 1993 and 1994 of $120,226 and $39,914, respectively. The sole issue for decision1 is whether petitioners may exclude from gross income under section 104(a)(2)2 three sets of payments received during the years at issue pursuant to a settlement agreement.
Some of the facts have been stipulated and are so found. The stipulation of facts is incorporated herein by this reference. Petitioners are married and resided in Brooklyn Park, Minnesota, at the time the petition was filed. References to petitioner are to Ronald N. Gross.
Petitioner's Employment at Okabena Co.
Petitioner is a certified public accountant. In October 1977, petitioner accepted a position as staff accountant at Okabena Co. (Okabena). In 1980, petitioner was promoted to vice president of administration, and in 1990, petitioner was promoted to executive vice president of administration. At no time during petitioner's employment did Okabena have more than 15 employees.
On April 6, 1993, a female employee at Okabena made a sexual harassment claim against petitioner to the president of Okabena, Bruce Lueck. That same day, Mr. Lueck informed petitioner of the allegations, and, upon advice of counsel, Okabena began an investigation. On April 7 and 8, 1993, Okabena's outside legal counsel interviewed each female employee of Okabena regarding these allegations. Petitioner was instructed not to discuss the investigation with anyone and to continue normal business operations. At the conclusion of its investigation, Okabena determined that sufficient evidence existed to conclude that petitioner had conducted himself improperly, that he no longer could manage the employees effectively, and that he was subject to termination.
On the morning of April 9, 1993, petitioner retained the legal services of James Roth to represent petitioner in connection with the investigation of the alleged sexual harassment. At a conference that morning, petitioner and Mr. Roth discussed the allegations against petitioner and a possible resolution of them. After this meeting, petitioner submitted a handwritten letter of resignation to Mr. Lueck.
Over the weekend of April 10 and 11, 1993, petitioner worked at Okabena to review tax files and clean up his desk. On April 10, 1993, petitioner and Mr. Lueck discussed petitioner's situation in petitioner's office at Okabena. During the discussion, Mr. Lueck informed petitioner that petitioner's resignation was unnecessary and that he should reconsider it.
On April 12, 1993, petitioner met with Mr. Lueck and withdrew his resignation. At the same time, petitioner requested an employment contract with Okabena and submitted a proposed handwritten employment contract for consideration. At this meeting, Mr. Lueck asked petitioner to leave the Okabena offices and not to return until further notice. Petitioner departed and never returned to Okabena.
From April 15 to June 21, 1993, petitioner, Mr. Roth, Okabena officials, and Okabena's attorneys engaged in negotiations to resolve the matter and to formulate a severance package for petitioner. Several meetings were held regarding the terms and conditions of petitioner's termination from Okabena. The negotiations between Okabena and petitioner were adversarial.
At the first meeting, on or about April 15, 1993, petitioner and Mr. Roth met with Mr. Lueck, Robert Dayton, chairman of the board of Okabena, and Okabena's outside counsel. Okabena presented petitioner with the option either of being terminated or of submitting a voluntary resignation and accepting 12 months of severance pay. Petitioner rejected the offer and made a counteroffer proposing, among other things, that a portion of any funds paid be allocated to personal injuries in order to enable him to exclude such proceeds under section 104. Okabena asked petitioner to turn over his keys and not to return to Okabena's offices.
Additional negotiating sessions and conferences regarding the proposed settlement were held on April 16, 19, 20, and 21, 1993. On April 21, 1993, Mr. Lueck sent petitioner a termination letter confirming that Okabena had terminated petitioner's employment effective April 20, 1993.
Throughout the negotiations, petitioner threatened litigation against Okabena and specifically mentioned a potential claim for age discrimination, referring to a pattern of alleged age discrimination at Okabena. During these meetings, petitioner also mentioned claims of wrongful termination and defamation of character. Petitioner never filed a complaint against Okabena in any court.
On May 12, 1993, Okabena's counsel sent petitioner a draft settlement proposal. After extended negotiations over the terms of the proposed settlement agreement, a final settlement agreement (settlement agreement) and two releases were signed on June 21 and 22, 1993.
Pursuant to the settlement agreement, both petitioner and Okabena agreed to release all claims that either party had or might have against the other. The settlement agreement acknowledged the following facts, among others:
WHEREAS, Gross has alleged that certain matters relating to his employment with * * * [Okabena] and his separation from * * * [Okabena] give rise to legal claims against * * * [Okabena] for age discrimination; and
WHEREAS, Gross claims that he is entitled to receive damages from * * * [Okabena] for loss of future income and for personal injuries, and to be reimbursed by * * * [Okabena] for his attorneys' fees and costs; and
WHEREAS, * * * [Okabena] expressly denies that it may be liable to Gross on any basis or that it has engaged in any improper or unlawful conduct or wrongdoing against him * * *
The settlement agreement required Okabena to make several distinct categories of payments to or on behalf of petitioner. Three of those categories, severance payments, lump-sum payments, and liquidation payments, are at issue here.3
Under paragraph 3(a) of the settlement agreement, Okabena agreed to make 18 monthly payments of $10,417, less all applicable withholding, beginning on May 1, 1993, and concluding on October 31, 1994 (severance payments). Petitioners included these severance payments in gross income and paid the applicable Federal income taxes on these amounts in 1993 and 1994. The severance payments form the basis of petitioners' claim that they overpaid their Federal income taxes in 1993 and 1994 and are entitled to a refund.
Under paragraph 3(b) of the settlement agreement, Okabena agreed to make two lump-sum payments to petitioner — one of $112,500 shortly after the settlement agreement was executed and a second payment of $100,000 on May 15, 1994 (lump-sum payments). Petitioner excluded the lump-sum payments from gross income as damages received on account of personal injuries.
Under paragraph 5(a) of the settlement agreement, Okabena agreed to pay petitioner $516,907 for his interests in several Okabena investment entities (liquidation payment). Okabena made the required payment in 1993. Petitioner excluded the liquidation payment from gross income as damages received on account of personal injuries.
The settlement agreement also contained the following provision with respect to the tax treatment of the payments made to petitioner pursuant to the settlement agreement:
7. Payment of Taxes. The parties expressly acknowledge that the payments to be made to Gross under subparagraph 3(b) of this Agreement [the lump-sum payments] are intended solely as compensation for claimed damages on account of alleged personal injuries arising from an occurrence within the meaning of Section 104(a)(2) of the Internal Revenue Code, the administrative regulations promulgated thereunder, and applicable case law. No part of the payments to be made to Gross under subparagraphs 3(b) or 5(a) [the liquidation payment] is allocable to punitive damages, compensation for other claimed damages, or interest thereon. The Company makes no representation or warranty to Gross or his attorneys regarding the tax treatment or consequences of any payment made to Gross under this Agreement by the Internal Revenue Service or any other tax authority. Gross will be solely responsible for the payment of any and all taxes of whatever kind that may be due or payable from him in connection with any payment made to him under this Agreement. Gross agrees to indemnify and hold harmless the Company from any and all liens, actions, or claims on the part of the Internal Revenue Service or any other tax authority in connection with any payment made to Gross under subparagraphs 3(b) or 5(a) of this Agreement. This indemnity and hold harmless agreement will apply as to the full amount of any such liens, actions, or claims, and as to the amount of any expenses incurred in connection therewith.
The release signed by petitioner defined the universe of claims released by petitioner in the settlement agreement as follows:
"My Claims" means all of my existing rights to any relief of any kind from * * * [Okabena] or the Investments,4 whether or not I now know about those rights including, but not limited to:
1. all claims that arise out of or that relate to my employment or the termination of my employment with * * * [Okabena];
2. all claims that arise out of or that relate to the statements or actions of * * * [Okabena] or the Investments;
3. all claims for any alleged unlawful discrimination or any other alleged unlawful practices that arise out of or that relate to the statements or...
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