Knuckles v. Commissioner, Docket No. 4139-62.

• Decision Date: 12 February 1964
• Docket Number: Docket No. 4139-62.
• Citation: 23 TCM (CCH) 182,1964 TC Memo 33
• Parties: Mason K. Knuckles and Bernice A. Knuckles v. Commissioner.
• Court: U.S. Tax Court

23 T.C.M. (CCH) 182 (1964)

T.C. Memo. 1964-33.

Mason K. Knuckles and Bernice A. Knuckles v. Commissioner.

Docket No. 4139-62.

United States Tax Court.

Filed February 12, 1964.

Joseph L. Arnold, for the petitioners. S. Clay Freed, for the respondent.

Memorandum Findings of Fact and Opinion

WITHEY, Judge:

The Commissioner has determined a deficiency in the income tax of petitioners for the calendar year 1959 in the amount of $9,081. The sole issue to be decided is whether amounts paid petitioner Mason K. Knuckles (hereinafter referred to as petitioner) in settlement of his claims against his former employer were received by him as compensation for injury to his health and his personal reputation or as compensation due him under the terms of a written employment contract.

Findings of Fact

For the calendar year 1959, Mason K. Knuckles and Bernice A. Knuckles filed a joint Federal income tax return with the district director of internal revenue for the district of Colorado. During the year 1959 and at all times material hereto, they were husband and wife residing in Denver, Colorado. They used the cash receipts and disbursements method of accounting in computing their taxable income for the year 1959.

Petitioner, commencing November 1, 1956, was employed as Executive Vice President of Perpetual Life Insurance Company. In his capacity as executive vice president, petitioner was charged with the responsibility of overall development and management of Perpetual.

On December 1, 1958, petitioner's employment with Perpetual was terminated by resolution of its board of directors on the stated grounds of petitioner's incompetency to manage the affairs of the company. At the board's meeting petitioner denied the incompetency, refused to resign, and insisted upon the company's compliance with its employment contract.

Perpetual was organized under the laws of Colorado in 1956. Petitioner was its first executive vice president, having been employed in that capacity because of his reputation in the insurance field. He was an excellent salesman, but had no previous experience in the management of a life insurance company.

At the date of termination of petitioner's employment the board of directors of Perpetual believed that he had so mismanaged the company's affairs that its continued existence was imperiled. Certain of its directors adopted a policy of attempting through threats to bring about petitioner's voluntary resignation. These threats, as above indicated, were unsuccessful and the board's action to terminate petitioner's employment resulted.

Petitioner engaged counsel for the purpose of bringing suit upon his employment contract against Perpetual. Suit was commenced in the District Court for the City and County of Denver, Colorado, by the issuance of a summons on March 4, 1959. No complaint had theretofore been filed nor was one served upon Perpetual. The body of the summons however designated the nature of the action as follows:

This is an action for judgment against Defendant:

1. In the amount of $73,282.00 for Defendant's breach of its March 25, 1957 employment contract with Plaintiff;

2. Requiring Defendant to maintain in force its $50,000 insurance policy on Plaintiff's life;

2. For interest, costs, and such other and further relief as Plaintiff may be entitled.

By agreement between counsel for petitioner and counsel for Perpetual the filing of a complaint was delayed pending proceedings in the nature of discovery under rules of the court. These proceedings consisted of the taking of the preliminary depositions of several members of Perpetual's board of directors. During this period negotiations were carried on between counsel for petitioner and Perpetual looking toward settlement of petitioner's claims. Not until May of 1959 was any other theory of recovery advanced by petitioner's counsel than that indicated upon the mentioned summons. At that time the dollar amount of settlement had for some time been agreed upon. On the last-mentioned date petitioner's counsel for the first time proposed that settlement be made upon the basis of a tort claim for personal injury allegedly suffered by petitioner. At this time petitioner's counsel gave as one reason for this change in theory of recovery the tax advantage which would result to petitioner. Perpetual has refused throughout the settlement negotiations to acknowledge any tort liability to petitioner. In the settlement agreement it has in fact denied tort or other liability.

Petitioner's primary purpose in instituting suit against Perpetual was to collect amounts due him under his employment contract. He became increasingly concerned with his inability to obtain employment in the insurance field and with the fact that he no longer enjoyed his former good general reputation in his community. He became emotionally "upset" and "unstable." He instructed his attorneys that he refused to make any settlement except upon such basis that he would be vindicated "in the eyes of the public and the insurance world." He felt that his health had been impaired because of the action of Perpetual and the members of its board who had made depositions on discovery. He thereupon insisted that settlement be made only upon the basis of compensation for "personal injury."

Due to what Perpetual's board of directors believed to be its extremely precarious position, the board felt settlement with petitioner had to be effectuated because the publicity incident to a trial of petitioner's claims would, in the board's opinion, endanger the continued existence of Perpetual. Perpetual's counsel was thereupon instructed to settle with petitioner on the following basis as stated in the resolution of its board adopted May 20, 1959:

RESOLVED, That the offer of Mr. Knuckles to settle all claims which Mr. Knuckles contends to have against Perpetual Life Insurance Co. be accepted on the basis as offered as follows:

                  Cash on settlement .................. $20,000.00
                  Perpetual Life to pay, as due, the
                    8 remaining annual premiums
                    of $4,402.50 each year on Policy
                    No. 1 of the Company. (In case
                    such premiums are not due, due
                    to Mr. Knuckles' death during
                    said 8-year period, then in that
                    case the balance of such annual
                    premium yet due is payable, as
                    if due on said premium, to Mrs
                    Knuckles) .........................  35,220.00
                                                        __________
                                                        $55,220.00
                

BE IT FURTHER RESOLVED, That the offer of such settlement include complete release of the Corporation, its Officers and Directors of any asserted liability to Knuckles; that Mr. John Tippit be authorized to draw the legal instrument to embody the offer of settlement, including the proper releases; and that a committee consisting of Ernest

...