Lefleur v. Commissioner, Docket No. 720-96.

• Court: U.S. Tax Court
• Writing for the Court: Korner
• Citation: Lefleur v. Commissioner, 74 T.C.M. 37 (T.C. 1997)
• Decision Date: 07 July 1997
• Docket Number: Docket No. 720-96.
• Parties: Lance R. and Elaine C. LeFleur v. Commissioner.

74 T.C.M. 37

T.C. Memo. 1997-312

Lance R. and Elaine C. LeFleur v. Commissioner.

Docket No. 720-96.

United States Tax Court.

Filed July 7, 1997.

Alan E. Rothfeder, Jo Karen Parr, Montgomery, Ala., and Carla R. Cole, for the petitioners. John F. Driscoll and Shuford A. Tucker, Jr., for the respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

KORNER, Judge:

Respondent determined a deficiency in the Federal income tax of petitioners (Lance R. and Elaine C. LeFleur) for the tax year ended December 31, 1991, in the amount of $283,078. (Petitioner Elaine C. LeFleur is a party to this proceeding solely because she filed a joint return with her husband, and the term "petitioner" will be used henceforth to refer to Lance R. LeFleur).

Unless otherwise indicated, all section references are to the Internal Revenue Code in effect for the year at issue. All Rule references are to the Tax Court Rules of Practice and Procedure.

After concessions, the issues remaining for decision are as follows:

(1) Whether $800,000 of the $1 million lump sum paid to petitioner in 1991 in settlement of a suit against his former employer is excludable from petitioners' gross income under section 104(a)(2) as damages received on account of personal injuries. We hold that it is not.

(2) Whether petitioners may deduct legal fees and costs incurred in bringing the suit as Schedule C expenses to the extent that such fees are allocable to taxable income. We hold that they may not.

Some of the facts are stipulated and are found accordingly. The stipulation of facts and the attached exhibits are incorporated herein by this reference. Petitioners resided in Montgomery, Alabama, at the time they filed their petition in this case.

FINDINGS OF FACT

In 1984, petitioner was hired as vice president for Blount Energy Resource Corp. (BERC), a wholly owned subsidiary of Blount, Inc. (Blount). In late 1988, Blount decided to develop an information package for the purpose of exploring the potential sale of BERC.

In March 1989, the management of Blount and BERC decided to reduce operating expenses at BERC in anticipation of the possible sale of the subsidiary. As part of the expense reduction plan, BERC's Montgomery-based staff was cut by approximately 50 percent. Approximately 20 employees of BERC's Montgomery office were either discharged or reassigned to other business entities owned by Blount.

As an incentive to many of BERC's remaining employees, including petitioner, and in order to induce them to continue their employment with BERC pending the sale, Blount offered certain bonuses and severance benefits. In so doing, Blount sought to preserve BERC's value as a functioning business while looking for a buyer. Blount's use of incentive packages in such a manner is a common business practice.

The benefits were outlined in a letter from R. William Van Sant (Van Sant), then president and chief operating officer of Blount, to petitioner dated April 6, 1989 (the April 6 letter). The April 6 letter provided a lump-sum bonus equal to 12 months' salary, among other things, in the event that BERC was sold.

Due to petitioner's request, Blount, by letter dated April 27, 1989 (the April 27 letter), offered petitioner an additional arrangement whereby, among other things, petitioner would receive a cash payment that was tied to the sales price obtained for BERC. On May 2, 1989, petitioner accepted the offer.

On October 23, 1989, a meeting was held between Van Sant and petitioner in which they discussed the possible separation and sale of BERC's domestic and foreign assets (the October 23 meeting). After the October 23 meeting, petitioner grew doubtful of Blount's intent to abide by the arrangement set forth in the April 27 letter. Petitioner's concern led him to contact an attorney, John Bolton (Bolton). On November 3, 1989, a meeting was held to discuss the terms of the April 27 letter (the November 3 meeting). At the conclusion of the November 3 meeting, Van Sant fired petitioner.

Blount ultimately sold all of the assets of BERC in three separate sales, all of which had closed prior to the end of 1991. Blount sold BERC for $38-39 million net of transaction costs. Blount failed to make any payments to petitioner under either the April 6 or April 27 letters.

Petitioner's Action Against Blount, BERC, and Van Sant

On January 22, 1991, petitioner instituted suit against Blount, BERC, and Van Sant (referred to collectively herein as the defendants) in the Circuit Court of Montgomery County, Alabama. The complaint set forth five causes of action. The first and second counts alleged that Blount and BERC had breached their contract with petitioner arising out of the April 6 and April 27 letters. The third and fourth counts alleged that the defendants fraudulently induced petitioner to enter into the agreement set forth in the April 27 letter (fraud in the inducement) and fraudulently represented to petitioner that they would pay him an incentive commission based upon the sales price of BERC, among other benefits (promissory fraud). The fifth count alleged that the defendants intended to inflict emotional distress upon petitioner (the tort of outrageous conduct). Petitioner sought compensatory damages, interest, and costs for the breach of contract counts. Petitioner sought compensatory and punitive damages for the fraud counts, as well as for the tort claim of outrageous conduct.

Bolton agreed to represent petitioner in the suit. After evaluation of petitioner's various claims against the defendants, Bolton determined that petitioner's best cause of action was for breach of contract arising out of the April 27 letter.

On March 1, 1991, the defendants filed a Notice of Removal to the United States District Court for the Middle District of Alabama, Northern Division, based upon the premise that all of the claims asserted by petitioner were preempted and controlled by the Employee Retirement Income Security Act of 1974, Pub. L. 93-406, sec. 502(a), 88 Stat. 829, 891.

On October 14, 1991, Blount publicly disclosed the unexpected resignation of Van Sant as its president. Upon Van Sant's resignation, Oscar J. Reak (Reak), a former president of Blount, returned from retirement to serve as interim president of the company.

The Settlement Negotiations and Agreement

On November 25, 1991, Reak met with petitioner to discuss the possibility of a settlement (the November 25 meeting). Reak had no interest in partially settling the litigation with petitioner and was interested only in a settlement that resolved all outstanding issues. After the November 25 meeting, Reak tendered a written settlement offer to petitioner dated November 27, 1991 (the November 27 offer). Petitioner did not accept the November 27 offer.

Jim Alexander (Alexander), defendant's counsel, was first advised of petitioner's response to the November 27 offer by a telephone call from Bolton the next day, November 28, 1991 (Thanksgiving Day). On Thanksgiving Day, extensive discussions took place between Bolton and Alexander. By the end of the day, Alexander and Bolton reached an agreement in principle for a basis of settlement of the lawsuit (the agreement in principle), and Alexander reported to his clients that the matter had been resolved. On Saturday, November 30, 1991, Alexander faxed a draft settlement agreement to Bolton.

On December 2, 1991, Alexander met with L. Daniel Morris (Morris), Blount's vice president of legal services, and communicated with Bolton in an effort to finalize a written settlement agreement. Morris and Alexander considered the adversarial nature of the relationship between petitioner and the defendants reduced prior to the execution of this document since an agreement in principle had already been attained.

At this time, petitioner expressed concerns about the tax implications that any settlement of the case would have on him. Alan Rothfeder, another of petitioner's attorneys, advised petitioner with regard to the allocation of the settlement proceeds, and petitioner and his attorneys discussed the settlement allocation issues with defendants. Blount's sole tax concern regarding the settlement of the case was that nothing be done to compromise Blount's ability to deduct any settlement payment. In that regard, Morris, Alexander, and Reak received assurances from Blount's comptroller that the proposed settlement would be deductible by Blount. Alexander, Bolton, and Morris all actively participated in negotiating the final wording of a formal settlement agreement letter.

Petitioner accepted Blount's settlement offer on December 2, 1991 (the settlement agreement). The settlement agreement states in pertinent part as follows:

Dear Lance,

This letter will document the agreement which we have reached, through our attorneys, on November 28, 1991. [Emphasis added.] We agree as follows:

1. * * * In exchange for the dismissal of * * * [the] lawsuit, * * * Blount will pay to LeFleur the sum of One Million Dollars ($1,000,000) * * *. This $1,000,000 sum will be payable within five days after the dismissal of that lawsuit. Blount agrees to pay LeFleur such sum for the following claims asserted by the plaintiff:

A. the sum of $0.00 for the amounts claimed by LeFleur under the April 6, 1989 letter;

B. the sum of $200,000 for the commissions due LeFleur under the April 27, 1989, letter plus any future payments due LeFleur under said April 27, 1989, letter * * *;

C. the sum of $800,000 for LeFleur's tort claims on account of personal injuries and compensatory damages, including mental pain and suffering;

D. the sum of $0.00 for punitive damages.

Petitioners filed their 1991 Form 1040, U.S. Individual Income Tax Return, on October 14, 1992. Petitioners excluded from gross income $800,000 of the $1 million lump-sum settlement and reported on Form 8275, Disclosure Statement, attached to their return that this amount was exempt income under section 104(a)(2). Petitioners included in...