                                                 KATHLEEN S. SIMPSON AND GEORGE T. SIMPSON,
                                                  PETITIONERS v. COMMISSIONER OF INTERNAL
                                                           REVENUE, RESPONDENT
                                                    Docket No. 26619–11.                     Filed October 28, 2013.

                                                 P–W sued E, her employer, for employment discrimination
                                              under California’s Fair Employment and Housing Act (FEHA),
                                              claiming, among other things, that she was entitled to
                                              compensatory damages for, among other things, physical
                                              injuries. After the State court dismissed all but one claim
                                              alleged in the suit, P–W’s attorney concluded that P–W would
                                              not be able to extract a settlement from E on the basis of the
                                              one remaining FEHA claim. P–W’s attorney learned, however,
                                              that P–W was eligible for workers’ compensation benefits
                                              under California’s workers’ compensation laws. On that basis
                                              alone, P–W and E engaged in settlement discussions and
                                              eventually entered into a settlement agreement by which
                                              P–W released E from ‘‘each and every claim’’ she might have
                                              against E, ‘‘including, but not limited to, claims asserted in’’
                                              the FEHA lawsuit; the settlement agreement did not specifi-
                                              cally mention P–W’s possible workers’ compensation claims.
                                              Neither P–W nor E submitted the settlement agreement to
                                              the California Workers’ Compensation Appeals Board (WCAB)
                                              for the approval required under California’s workers’ com-
                                              pensation laws. Ten percent of the settlement award was
                                              attributable to P–W’s personal physical injuries and physical
                                              sickness. Held: None of the settlement payment P–W received
                                              is excludable from Ps’ gross income under I.R.C. sec. 104(a)(1)
                                              because P–W did not obtain the requisite approval from the

                                                                                                                                 331




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                                     332                 141 UNITED STATES TAX COURT REPORTS                                    (331)

                                              WCAB required by the State’s workers’ compensation laws.
                                              Held, further, 10% of P–W’s settlement award is excludable
                                              from Ps’ gross income under I.R.C. sec. 104(a)(2) and the
                                              newly amended regulations under that section, which exclude
                                              damages from income as long as recovery is for personal phys-
                                              ical injuries or physical sickness even if recovery is under a
                                              statute that does not provide for a broad range of remedies
                                              and even if the injury is not defined as a tort under State or
                                              common law. Held, further, the portion of the settlement
                                              award allocated to attorney’s fees and court costs is deductible
                                              under I.R.C. sec. 62(a)(20).

                                           Elizabeth L. Riles and David C. Anton, for petitioners.
                                           Matthew D. Carlson, for respondent.
                                        LARO, Judge: Respondent determined a Federal income tax
                                     deficiency of $73,407 for 2009 and an accuracy-related pen-
                                     alty under section 6662(a) of $14,681. 1 Petitioners, while
                                     residing in California, timely petitioned this Court to redeter-
                                     mine respondent’s determination. Following respondent’s
                                     concession that petitioners are not liable for the accuracy-
                                     related penalty, we decide: (1) whether any portion of
                                     $250,000 2 petitioners received in 2009 in settlement of a dis-
                                     pute with Sears, Roebuck & Co. (Sears) is excludable from
                                     their gross income under section 104(a)(1) or (2). We hold it
                                     is not excludable under section 104(a)(1) but excludable
                                     under section 104(a)(2) to the extent set out in this Opinion;
                                     and (2) whether section 62(a)(20) allows petitioners to deduct
                                     $152,000 of attorney’s fees and court costs as an above-the-
                                     line deduction. We hold it does.

                                                                         FINDINGS OF FACT

                                       The parties filed with the Court a stipulation of facts and
                                     related exhibits. Those facts and exhibits are incorporated in
                                     this Opinion by this reference. We find the facts accordingly.
                                       Ms. Simpson started working for Sears in 1972 and per-
                                     formed various jobs such as data retrieval, project manage-
                                     ment, compensation management, and human resources. In
                                       1 Unless otherwise indicated, section references are to the Internal Rev-

                                     enue Code (Code) in effect for the year in issue, and Rule references are
                                     to the Tax Court Rules of Practice and Procedure.
                                       2 The actual settlement amount was $262,500, which included $12,500

                                     for lost wages and benefits. Petitioners included the $12,500 in their gross
                                     income for 2009, and the $12,500 is not at issue.




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                                     (331)                         SIMPSON v. COMMISSIONER                                       333


                                     the latter part of the 1990s Ms. Simpson began taking on
                                     more responsibilities and was promoted to manager of a
                                     small store in Prescott, Arizona, a position she held for about
                                     18 months. Subsequently, she was promoted to a district-
                                     level position as a merchandise manager assisting the stores
                                     to purchase and assort hardware and lawn and garden mer-
                                     chandise. Two years after that, in October 2000 Ms. Simpson
                                     was transferred to manage another Sears store in Fairfield,
                                     California.
                                        The Fairfield store was much larger than the Prescott
                                     store, e.g., the Fairfield store had three times the sales
                                     volume and a fuller assortment of merchandise than the
                                     Prescott store. In addition, Ms. Simpson knew that the Fair-
                                     field store was a problem store in that the prior store man-
                                     ager and prior numerous management and staff were termi-
                                     nated and almost the entire staff had less than one year of
                                     management experience.
                                        Because of the problems at the store and the need to pro-
                                     vide relief to the staff, Ms. Simpson had to work long hours,
                                     sometimes 50 to 60 hours a week in addition to her three-
                                     hour daily commute. In addition, Ms. Simpson had to fill in
                                     for some of her sales managers and engage in strenuous
                                     physical activities such as receiving, unpacking, and stocking
                                     merchandise, moving garments from racks, and ripping
                                     plastic. The physical exertion resulted in injuries to her
                                     shoulders, to her left knee, and to her neck. Ms. Simpson
                                     became exhausted, lost 25 pounds, and considered commit-
                                     ting suicide. She sought counselors and physicians for treat-
                                     ment and was ultimately diagnosed with clinical depression,
                                     irritable bowel syndrome, and fibromyalgia.
                                        In March 2002 Ms. Simpson approached Sears’ district
                                     human resources manager, Nancy Mallory, and informed her
                                     of the diagnoses and the physical problems Ms. Simpson was
                                     experiencing. Ms. Simpson also told Ms. Mallory that her
                                     sickness was work related and that on the advice of her
                                     doctor, she wanted to transfer to another position. Ms.
                                     Simpson fully expected Ms. Mallory to refer the issue to
                                     management and to provide a reasonable solution.
                                        Ms. Mallory never informed anyone within Sears of the
                                     information Ms. Simpson provided in the March 2002
                                     meeting. Nor did Ms. Mallory tell anyone that Ms. Simpson




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                                     334                 141 UNITED STATES TAX COURT REPORTS                                    (331)


                                     had requested a transfer because of her work-related clinical
                                     depression and physical illness.
                                       After not hearing back from Ms. Mallory about her com-
                                     plaints, Ms. Simpson spoke to Sears’ district manager in
                                     June of the same year and advised him of the diagnoses. Ms.
                                     Simpson also explained to the district manager that her clin-
                                     ical depression and physical sickness were work related and
                                     requested that she be transferred to another position. Sears
                                     never transferred Ms. Simpson to another position. In
                                     August 2002, Sears terminated Ms. Simpson’s employment.
                                     No one at Sears ever provided Ms. Simpson with a California
                                     Workers’ Compensation Claim Form or with information
                                     about filing such a claim.
                                       Ms. Simpson continued to suffer from depression and
                                     work-related physical injuries after her termination, and she
                                     remained unemployed for one year. She was then able to
                                     secure a retail position with a home improvement retail
                                     chain where she had to quit after a month because of the
                                     limitations imposed by her mental and physical problems.
                                     She eventually secured employment with the State of Cali-
                                     fornia in a human resources position and remains employed
                                     there today.
                                       After termination of her employment with Sears, Ms.
                                     Simpson retained David Anton to file a lawsuit against Sears
                                     under California’s Fair Employment and Housing Act
                                     (FEHA). The first amended complaint alleged in the first
                                     cause of action a claim for employment discrimination on the
                                     basis of gender, age, and harassment in violation of Cal.
                                     Gov’t Code sec. 12940(a), (j), and (k) (West 2011). The first
                                     cause of action claimed that Ms. Simpson experienced lost
                                     wages, lost employment benefits, emotional distress, and
                                     mental pain and suffering. The second cause of action alleged
                                     retaliation in employment in violation of Cal. Gov’t Code sec.
                                     12940(h) and claimed Ms. Simpson experienced lost wages,
                                     lost employment benefits, emotional distress, and mental
                                     pain and suffering resulting in physical injury.
                                       The third cause of action alleged two claims. One claim
                                     under Cal. Gov’t Code sec. 12940(m) alleged that Sears failed
                                     to provide a reasonable accommodation of a job transfer for
                                     Ms. Simpson after learning of her work-related mental dis-
                                     ability. The other claim under Cal. Gov’t Code sec. 12940(n)
                                     alleged that Sears failed to engage in an interactive process




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                                     (331)                         SIMPSON v. COMMISSIONER                                       335


                                     with Ms. Simpson when it learned that Ms. Simpson had a
                                     work-related mental disability, was receiving treatment, and
                                     had asked to be transferred to another position because of
                                     the disability. The third cause of action alleged that Ms.
                                     Simpson suffered lost wages and employment benefits, emo-
                                     tional distress, mental pain and suffering, and physical
                                     injury. Ms. Simpson sought economic damages (e.g., back and
                                     future pay), noneconomic damages (e.g., compensatory dam-
                                     ages for emotional distress), punitive damages, interest,
                                     attorney’s fees and costs, and appropriate injunctive relief.
                                        Sears filed a summary judgment and adjudication motion
                                     that was heard in May 2009. The State court granted Sears’
                                     motion on the first and second causes of action. As to the
                                     third cause of action, the State court granted Sears’ motion
                                     on the claim under Cal. Gov’t Code sec. 12940(m) but allowed
                                     the claim under Cal. Gov’t Code sec. 12940(n) to go forward.
                                     In reaching its decisions, the State court found Ms. Simpson
                                     could not prove that Sears had fired her for reasons other
                                     than poor job performance or that her transfer to another
                                     position within Sears would have been a reasonable
                                     accommodation.
                                        Ms. Simpson and Sears later engaged in settlement discus-
                                     sions. Mr. Anton concluded that as a result of the State
                                     court’s findings, Ms. Simpson would not be able to claim
                                     damages for lost wages or emotional distress on the basis of
                                     Sears’ failure to engage in an interactive process required
                                     under Cal. Gov’t Code sec. 12940(n). 3 However, Mr. Anton’s
                                     research led him to conclude that Sears’ failure to give Ms.
                                     Simpson a California Workers’ Compensation Claim Form
                                     and a notice of potential eligibility for benefits that were
                                     required under California’s workers’ compensation laws, see
                                     Cal. Lab. Code secs. 5400–5413 (West 2011), violated Sears’
                                     legal obligations under those laws.
                                        Mr. Anton relayed his conclusion to Sears’ counsel and
                                     asserted that Ms. Simpson would have been entitled to cer-
                                     tain workers’ compensation benefits, including benefits for
                                     temporary disabilities and permanent disabilities resulting
                                       3 We do not express any opinion as to whether Mr. Anton’s assessment

                                     was supported by the facts and the law underlying Ms. Simpson’s FEHA
                                     claims.




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                                     336                  141 UNITED STATES TAX COURT REPORTS                                    (331)


                                     from work-related injuries, if she had filed such a claim. 4
                                     Mr. Anton believed these workers’ compensation benefits
                                     were the only damages available to Ms. Simpson, and he
                                     formulated a settlement proposal on that basis alone. He
                                     hypothesized the weekly temporary disability benefits that
                                     Ms. Simpson would be entitled to receive under California’s
                                     workers’ compensation laws (approximately $500) as well as
                                     an additional 25% penalty that could be imposed on Sears for
                                     failing to advise Ms. Simpson of potential workers’ compensa-
                                     tion eligibility and benefits, as the amount of temporary dis-
                                     ability benefits owing to Ms. Simpson. Mr. Anton referenced
                                     the Schedule for Rating Permanent Disabilities issued under
                                     California workers’ compensation laws as the amount of
                                     permanent disability award Ms. Simpson would be entitled
                                     to receive. These two amounts formed the sole basis of a
                                     settlement agreement that Ms. Simpson and Sears later
                                     entered into in June 2009 as to Ms. Simpson’s lawsuit
                                     against Sears.
                                        In exchange for the release, Sears agreed to pay under the
                                     settlement agreement $12,500 to Ms. Simpson as to her
                                     claim for lost wages and employment benefits; $98,000 to Ms.
                                     Simpson as to her claims for ‘‘emotional distress, physical
                                     and mental disability’’; and $152,000 to Mr. Anton for attor-
                                     ney’s fees and court costs. Mr. Anton understood that the
                                     $98,000 was intended to compromise Ms. Simpson’s claim for
                                     workers’ compensation benefits for ‘‘emotional distress and
                                     physical and mental disabilities’’ that she suffered from
                                     work-related injuries, i.e., clinical depression, irritable bowel
                                     syndrome, and fibromyalgia, while working for Sears, and he
                                     attributed 10% to 20% of the $98,000 to the work-related
                                     physical illness and disabilities Ms. Simpson suffered. The
                                     settlement agreement provides that California laws govern
                                     the contract and states that
                                           SIMPSON expressly waives, releases and forever discharges the Com-
                                           pany from each and every claim, whether known or unknown that
                                           SIMPSON has, had, or might have, arising out of, or related to, any
                                           events occurring up to the date this Agreement is fully executed,
                                           including, but not limited to, claims asserted in * * * [the FEHA law-
                                           suit]. SIMPSON also promises that she will not seek any further com-

                                       4 Mr. Anton had initially argued for vocational retraining benefits in ad-

                                     dition to temporary disability and permanent disability benefits but did
                                     not include these benefits in the final settlement value.




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                                     (331)                          SIMPSON v. COMMISSIONER                                               337


                                           pensation for any other claimed damages, costs or attorneys’ fees in
                                           connection with the matters encompassed in this Agreement. [Emphasis
                                           added.]
                                        Ms. Simpson never filed a workers’ compensation claim,
                                     and Sears and Ms. Simpson never submitted the settlement
                                     agreement to the California Workers’ Compensation Appeals
                                     Board (WCAB) for the approval required under Cal. Lab.
                                     Code sec. 5001 (West 2011). Mr. Anton was not aware of the
                                     approval requirement.
                                        Petitioners timely filed their 2009 Federal income tax
                                     return with the assistance of H&R Block. The 2009 return
                                     reported as income the $12,500 payment that Sears made to
                                     Ms. Simpson for lost wages and employment benefits. The
                                     2009 return did not report anything else from the settlement.
                                     Petitioners attached to the 2009 return a letter dated March
                                     18, 2010, from Mr. Anton, explaining the nature of the
                                     $250,000 proceeds reported in petitioners’ Form 1099–MISC,
                                     Miscellaneous Income, received from Sears and why peti-
                                     tioners were not reporting any portion of it. The letter stated
                                     the following:
                                           The listed amount includes amounts that were paid to my office for
                                           attorney’s fees and costs, which my office is reporting as income, in the
                                           amount of $113,985.60, for a net to Ms. Simpson from the $250,000.00
                                           of $136,014.40. Due to the nature of the claim that was settled, although
                                           I am not Ms. Simpson’s tax adviser, I understand that the settlement
                                           proceeds should not be considered taxable.

                                                                       *    *      *       *      *        *      *
                                           * * * [On the summary judgment and adjudication motion, the] Judge
                                           found that there was evidence that the Human Resources Manager
                                           failed to take any action or interact with anyone at the company as a
                                           result of the information that Ms. Simpson was sick and disabled as a
                                           result, and failed to advise the direct managers over Ms. Simpson of the
                                           illness and resulting disability. The Human Resources Manager should
                                           have considered placing Ms. Simpson on Workers’ Compensation dis-
                                           ability leave, or on Short Term Disability leave, but did not do so.
                                             The settlement was entirely based upon the claim that Ms. Simpson
                                           became ill due to work, became disabled due to the severity of that ill-
                                           ness, and Ms. Simpson should have been accommodated by being pro-
                                           vided Workers’ Compensation or Short Term Disability Leave, but was
                                           not. It is our understanding that a lawsuit settlement based on illness
                                           and disability from work are non-taxable settlement proceeds to the
                                           injured taxpayer.




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                                     338                 141 UNITED STATES TAX COURT REPORTS                                    (331)


                                       On April 25, 2011, respondent issued to petitioners a notice
                                     of deficiency in which he determined that petitioners failed
                                     to report the $250,000 settlement proceeds as income. In
                                     response, petitioners filed the instant petition.

                                                                                 OPINION

                                        Gross income includes all income from whatever source
                                     derived, sec. 61(a); Commissioner v. Glenshaw Glass Co., 348
                                     U.S. 426, 429 (1955), unless specifically excluded. Under sec-
                                     tion 104(a)(1), ‘‘amounts received under workmen’s com-
                                     pensation acts’’ to compensate for personal injuries or sick-
                                     ness are excluded from income. Section 104(a)(2) excludes
                                     from income the amount of any damages (other than punitive
                                     damages) received (by suit or agreement) on account of per-
                                     sonal physical injuries or physical sickness.
                                        Adjusted gross income means gross income less certain
                                     enumerated deductions. Sec. 62(a). One of these deductions
                                     is a deduction for attorney’s fees and court costs paid by, or
                                     on behalf of, a taxpayer in connection with any action
                                     involving a claim of unlawful discrimination. Sec. 62(a)(20).
                                        Petitioners argue primarily that the entire settlement
                                     amount in issue, $250,000, is excludable from gross income
                                     under section 104(a)(1) as an amount received under Califor-
                                     nia’s workers’ compensation laws. Petitioners argue alter-
                                     natively that (1) up to 20% of the $98,000 settlement figure
                                     allocated to ‘‘emotional distress and physical and mental
                                     disabilities’’ is excludable from gross income under section
                                     104(a)(2) as an amount received on account of personal phys-
                                     ical injuries and physical sickness and that (2) petitioners
                                     are entitled to deduct under section 62(a)(20) $152,000 allo-
                                     cated to attorney’s fees and court costs in connection with
                                     Ms. Simpson’s FEHA action involving unlawful discrimina-
                                     tion claims.
                                     I. Burden of proof
                                       The Commissioner’s determinations in a notice of defi-
                                     ciency are generally presumed correct, and a taxpayer bears
                                     the burden of proving those determinations are erroneous.
                                     Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933). It
                                     is well established that statutory exclusions, such as those
                                     provided in section 104, are to be narrowly construed, see




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                                     (331)                         SIMPSON v. COMMISSIONER                                       339


                                     Commissioner v. Schleier, 515 U.S. 323, 328 (1995), and that
                                     taxpayers generally bear the burden of proving that they fall
                                     squarely within the requirements for any exclusion from
                                     gross income, Forste v. Commissioner, T.C. Memo. 2003–103,
                                     85 T.C.M. (CCH) 1146, 1151 (2003).
                                        At trial, petitioners conceded that the burden of proof falls
                                     on them. In their posttrial brief, however, petitioners for the
                                     first time request the Court to shift the burden of proof to
                                     respondent under section 7491(a). 5 We find that petitioners
                                     conceded this issue at trial and that their request made in
                                     the posttrial brief to shift the burden of proof to respondent
                                     prejudices respondent and is untimely. See Dunne v.
                                     Commissioner, T.C. Memo. 2008–63, 95 T.C.M. (CCH) 1236,
                                     1240 (2008); Smith v. Commissioner, T.C. Memo. 2007–368,
                                     94 T.C.M. (CCH) 574, 581 (2007), aff ’d, 364 Fed. Appx. 317
                                     (9th Cir. 2009); Deihl v. Commissioner, T.C. Memo. 2005–
                                     287, 90 T.C.M. (CCH) 579, 584 (2005). At a minimum,
                                     respondent has not been afforded an opportunity to test peti-
                                     tioners’ allegations, either by cross-examination or by pro-
                                     ducing evidence, that petitioners have complied with the
                                     substantiation and recordkeeping requirements under section
                                     7491(a)(2).
                                     II. Exclusion from income
                                        Gross income does not include ‘‘amounts received under
                                     workmen’s compensation acts as compensation for personal
                                     injuries or sickness’’ as well as ‘‘the amount of any damages
                                     (other than punitive damages) received (whether by suit or
                                     agreement and whether as lump sums or as periodic pay-
                                     ments) on account of personal physical injuries or physical
                                     sickness’’. Sec. 104(a)(1) and (2). When a taxpayer receives a
                                     payment under a settlement agreement, as is the case here,
                                     the nature of the claim that was the actual basis for settle-
                                     ment guides our determination of whether such payments
                                     are excludable from income. See United States v. Burke, 504
                                     U.S. 229, 237 (1992). Whether a settlement is achieved
                                     through a judgment or by a compromise agreement, the ques-
                                     tion to be asked is: ‘‘In lieu of what were the damages
                                       5 Neither the petition nor petitioners’ pretrial brief asked the Court to

                                     shift the burden of proof to respondent under sec. 7491(a).




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                                     340                  141 UNITED STATES TAX COURT REPORTS                                    (331)


                                     awarded?’’ Fono v. Commissioner, 79 T.C. 680, 692 (1982),
                                     aff ’d without published opinion, 749 F.2d 37 (9th Cir. 1984). 6
                                           A. Sears’ intent
                                        What Ms. Simpson and Sears intended to compromise
                                     through the settlement agreement is a question of fact, see
                                     Bagley v. Commissioner, 105 T.C. 396, 406 (1995), aff ’d, 121
                                     F.3d 393 (8th Cir. 1997), determined by reference to the
                                     express language of the agreement, Knuckles v. Commis-
                                     sioner, 349 F.2d 610, 613 (10th Cir. 1965), aff ’g T.C. Memo.
                                     1964–33. If we cannot find evidence of the parties’ express
                                     intent in the settlement agreement specifying the purpose of
                                     the compensation, we look to the payor’s intent. Rivera v.
                                     Baker West, Inc., 430 F.3d 1253, 1257 (9th Cir. 2005);
                                     Knuckles v. Commissioner, 349 F.2d at 613; see also Fono v.
                                     Commissioner, 79 T.C. at 696 (stating that payee’s belief as
                                     to reasons for payment is relevant evidence although ulti-
                                     mate inquiry is into payor’s reasons for payment); cf.
                                     Commissioner v. Duberstein, 363 U.S. 278, 285–286 (1960)
                                     (stating that transferor’s intention is most crucial consider-
                                     ation in determining whether payment is gift). Under Cali-
                                     fornia law, which governs the interpretation of Ms. Simpson’s
                                     settlement agreement with Sears, we must consider all cred-
                                     ible evidence to determine whether the language of the
                                     agreement is fairly susceptible of more than one interpreta-
                                     tion, and if it is, we must consider extrinsic evidence relevant
                                     to prove which one of these meanings reflects the intent of
                                     the contracting parties. Pac. Gas & Elec. Co. v. G.W. Thomas
                                     Drayage & Rigging Co., 69 Cal. 2d 33, 39–40 (1968).
                                        The settlement agreement is ambiguous as to whether it
                                     was made to settle Ms. Simpson’s FEHA claims, her workers’
                                     compensation claims, or both. The preamble of the agreement
                                     broadly states that Sears and Ms. Simpson desired to resolve
                                     all claims Ms. Simpson raised or could have raised in the
                                           6 United
                                                 States v. Burke, 504 U.S. 229 (1992), and Fono v. Commissioner,
                                     79 T.C. 680 (1982), aff ’d without published opinion, 749 F.2d 37 (9th Cir.
                                     1984), deal with agreements to settle personal injuries claims in the con-
                                     text of sec. 104(a)(2). While sec. 104(a)(1) does not explicitly mention settle-
                                     ment, we find it helpful here to look to cases like Burke and Fono to deter-
                                     mine whether a settlement for a workers’ compensation claim sanctioned
                                     by a State’s workers’ compensation laws can be excludable under section
                                     104(a)(1).




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                                     (331)                         SIMPSON v. COMMISSIONER                                       341


                                     FEHA lawsuit as well as ‘‘any other matters involving SIMP-
                                     SON’s former employment relationship with * * * [Sears]’’,
                                     but it falls short of expressly including Ms. Simpson’s
                                     workers’ compensation claim. Indeed, the settlement agree-
                                     ment includes multiple references to the FEHA lawsuit but
                                     does not mention Ms. Simpson’s potential workers’ com-
                                     pensation claims at all. But we also accept Mr. Anton’s cred-
                                     ible testimony that he had advised Sears’ counsel that his
                                     client was eligible to make such claims. In the light of this
                                     fact, the broad and inclusive general release in the settle-
                                     ment agreement ought to place Ms. Simpson’s workers’ com-
                                     pensation claims under the settlement agreement although
                                     the agreement itself does not state so expressly.
                                        Ambiguity also arises where California’s workers’ com-
                                     pensation laws specifically require that any compromise
                                     agreement to settle such workers’ compensation claims be
                                     submitted to the WCAB for approval, and the parties did not
                                     do so here. From this fact one may infer that the parties,
                                     who were represented by presumably competent counsel, did
                                     not contemplate any potential workers’ compensation claim.
                                     See Steller v. Sears, Roebuck & Co., 189 Cal. App. 4th 175,
                                     182 (Ct. App. 2010). Because extrinsic evidence before us
                                     exposes a latent ambiguity in Ms. Simpson’s settlement
                                     agreement with Sears, we must consider extrinsic evidence to
                                     determine the parties’ intent. See id. at 183 (finding ambi-
                                     guity in settlement agreement and concluding on extrinsic
                                     evidence that settlement encompassed workers’ compensation
                                     claim and disability discrimination claim).
                                        We find Ms. Simpson and Mr. Anton to be generally cred-
                                     ible. Ms. Simpson testified that she believed the settlement
                                     agreement was made to settle her one remaining FEHA
                                     claim (i.e., Sears’ failure to engage in an interactive process
                                     under Cal. Gov’t Code sec. 12940(n)) and her workers’ com-
                                     pensation claims. Mr. Anton testified that he saw no damage
                                     potential on the basis of the one remaining claim in the
                                     FEHA lawsuit and concluded that he could extract a settle-
                                     ment from Sears only on the basis of Ms. Simpson’s entitle-
                                     ment to workers’ compensation benefits. Mr. Anton also testi-
                                     fied credibly that the $98,000 amount was determined by ref-
                                     erence to the disability benefits provided under California’s
                                     workers’ compensation laws for the ‘‘emotional distress, phys-
                                     ical and mental disability’’ that Ms. Simpson suffered while




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                                     342                 141 UNITED STATES TAX COURT REPORTS                                    (331)


                                     employed at Sears. He further testified credibly that 10% to
                                     20% of the $98,000 portion of the settlement amount was
                                     attributable to personal physical injuries (other than emo-
                                     tional distress). Viewing the entire record before us, we find
                                     that Sears and Ms. Simpson intended to settle her workers’
                                     compensation claims and that a portion of the settlement
                                     was made to compensate her for her work-related personal
                                     physical injuries and sickness.
                                           B. Section 104(a)(1)
                                        The intent of the parties to a settlement of a workers’ com-
                                     pensation claim does not necessarily mean that the payment
                                     is excludable under section 104(a)(1), however. 7 Section
                                     104(a)(1) excludes from gross income amounts received by an
                                     employee under a workers’ compensation act or under a
                                     statute in the nature of a workers’ compensation act that
                                     provides compensation to employees for occupational per-
                                     sonal injuries or sickness. Sec. 1.104–1(b), Income Tax Regs.
                                     To qualify for the exclusion, a taxpayer must show that she
                                     received her benefits under a statute or a regulation. Rutter
                                     v. Commissioner, 760 F.2d 466, 468 (2d Cir. 1985), aff ’g T.C.
                                     Memo. 1984–525. In other words, unless payments are made
                                     pursuant to ‘‘ ‘a rule of general applicability promulgated by
                                     a public agency to govern conduct within the agency’s juris-
                                     diction’ ’’, a taxpayer cannot exclude the payments from gross
                                     income under section 104(a)(1). Wallace v. United States, 139
                                     F.3d 1165, 1167 (7th Cir. 1998) (quoting Rutter v. Commis-
                                     sioner, 760 F.2d at 468). Thus, for Ms. Simpson’s settlement
                                     payment to be an amount ‘‘received under workmen’s com-
                                     pensation acts’’, the settlement agreement must comply with
                                     the statutory requirements to be valid under California’s
                                     workers’ compensation laws and not go beyond the scope of
                                     such laws. 8
                                        California’s workers’ compensation laws set up a strict
                                     regime for parties to validly settle a workers’ compensation
                                        7 It is conceivable that under certain statutory regimes, parties may pri-

                                     vately settle a workers’ compensation claim pursuant to a statute without
                                     State action. These are not the facts of this case, and we need not discuss
                                     hypotheticals.
                                        8 For example, compensation received for an occupational injury or sick-

                                     ness in excess of the amount provided in the applicable workers’ compensa-
                                     tion act is not excludable. Sec. 1.104–1(b), Income Tax Regs.




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                                     (331)                         SIMPSON v. COMMISSIONER                                       343


                                     claim under those laws. The laws provide a rule of general
                                     applicability requiring that the WCAB approve any release of
                                     or agreement to compromise an employer’s liability for
                                     workers’ compensation benefits before the agreement or
                                     release could become valid. Cal. Lab. Code sec. 5001. The
                                     same laws also require that the parties file the signed
                                     release or compromise agreement with the WCAB for the
                                     board to enter the award based on the release or compromise
                                     agreement. Id. sec. 5002. Petitioners have acknowledged that
                                     they never submitted the settlement agreement in issue to
                                     WCAB for approval, nor did they obtain the required
                                     approval from the board. Mr. Anton apparently was not
                                     aware of these requirements under Cal. Lab. Code secs. 5001
                                     and 5002.
                                        Because the settlement agreement fails to meet the
                                     express requirement of California’s workers’ compensation
                                     laws to obtain approval from the WCAB, any payments
                                     received under the agreement cannot be payments received
                                     under or pursuant to the State’s workers’ compensation act.
                                     The aggregate payments of $250,000 petitioners received
                                     under the settlement agreement are merely payments made
                                     under a private contract, cf. Rutter v. Commissioner, 760
                                     F.2d at 468, that has no force or effect under California’s
                                     workers’ compensation laws, see Steller, 189 Cal. App. 4th at
                                     181–182; Raischell & Cottrell, Inc. v. Workmen’s Comp.
                                     Appeals Bd., 249 Cal. App. 2d 991, 997 (Ct. App. 1967).
                                        A recent California State court decision informs our conclu-
                                     sion. The State court in Steller was confronted with facts
                                     very similar to those here. There, an employee sued her
                                     employer for disability discrimination and was simulta-
                                     neously pursuing a workers’ compensation claim against her
                                     employer. Steller, 189 Cal. App. 4th at 178. The parties
                                     entered into an agreement to settle all of the employee’s
                                     claims that arose from the lawsuit and related to her employ-
                                     ment; the settlement agreement did not expressly mention
                                     the pending workers’ compensation action. Id. at 179. The
                                     trial court entered a judgment in the disability discrimina-
                                     tion action according to the terms of the compromise agree-
                                     ment. Id. The record did not show that the parties were
                                     aware of the approval requirement or contemplated obtaining
                                     the WCAB’s approval. Id. at 181.




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                                     344                 141 UNITED STATES TAX COURT REPORTS                                    (331)


                                       On appeal, the California Court of Appeal construed the
                                     judgment as encompassing both the disability discrimination
                                     and workers’ compensation claims. Id. at 180. But citing Cal.
                                     Lab. Code sec. 5001, the court stated that ‘‘ ‘the effect of the
                                     section, by its clear wording, is to make every compromise
                                     invalid until it is approved by [the WCAB].’ ’’ Id. (alteration
                                     in original) (quoting Chavez v. Indus. Accident Comm’n, 49
                                     Cal. 2d 701, 702 (1958)). The Court of Appeal thus held that
                                     a compromise agreement seeking to settle both a civil action
                                     and a related workers’ compensation claim must be deemed
                                     to have been conditioned on the WCAB’s approval. Id. at 181.
                                     Until parties to a settlement obtain such approval, any com-
                                     promise and release of workers’ compensation liability is
                                     invalid. Id.; see also Raischell & Cottrell, Inc., 249 Cal. App.
                                     2d at 997.
                                       Thus, the settlement agreement between Sears and Ms.
                                     Simpson is not a valid agreement to settle her workers’ com-
                                     pensation claims because the parties failed to obtain the req-
                                     uisite approval from the WCAB. Because neither Sears nor
                                     Ms. Simpson has taken the crucial step to submit the settle-
                                     ment agreement for the WCAB’s approval, any payments
                                     received under the settlement are not ‘‘amounts received
                                     under workers’ compensation acts’’. See Forste v. Commis-
                                     sioner, 85 T.C.M. (CCH) at 1152 n.15.
                                           C. Section 104(a)(2)
                                        We now turn to petitioners’ alternative claim that 10% to
                                     20% of the $98,000 received under the settlement agreement
                                     is excludable under section 104(a)(2) as an amount received
                                     ‘‘on account of personal physical injuries or physical sick-
                                     ness.’’
                                           1. Section 104(a)(2) regulations
                                       The Supreme Court has held that for a recovery to be
                                     excludable under section 104(a)(2), a taxpayer must ‘‘dem-
                                     onstrate that the underlying cause of action giving rise to the
                                     recovery is ‘based upon tort or tort type rights’; * * * [in
                                     addition], the taxpayer must show that the damages were
                                     received ‘on account of personal injuries or sickness.’ ’’ 9
                                       9 In 1996 Congress amended sec. 104(a)(2) by adding the requirement

                                     that any amount received must be on account of personal injuries that are
                                     physical or sickness that is physical. Small Business Job Protection Act of




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                                     (331)                          SIMPSON v. COMMISSIONER                                       345


                                     Commissioner v. Schleier, 515 U.S. at 337. The requirement
                                     that recovery be based on a tortlike action was rooted in the
                                     former regulations, see sec. 1.104–1(c), Income Tax Regs.,
                                     before amendment by T.D. 9573, 2012–12 I.R.B. 498 (former
                                     regulations), which for the first time ‘‘formally * * * linked
                                     identification of a personal injury for purposes of §104(a)(2)
                                     to traditional tort principles’’. 10 Burke, 504 U.S. at 234; see
                                     also T.D. 6500, 25 Fed. Reg. 11402, 11490 (Nov. 26, 1960).
                                        Fifteen years after Congress amended section 104(a)(2) in
                                     1996 to state that the section applies to personal injuries and
                                     sickness that are physical, the Secretary amended the regu-
                                     lations and abandoned the ‘‘based upon tort or tort type
                                     rights’’ requirement so long as recovery is for personal phys-
                                     ical injuries or physical sickness even if recovery is under a
                                     statute that does not provide for a broad range of tort rem-
                                     edies. See sec. 1.104-(c), Income Tax Regs. 11
                                     1996, Pub. L. No. 104–188, sec. 1605, 110 Stat. at 1838.
                                       10 The former regulations read as follows:

                                           Section 104(a)(2) excludes from gross income the amount of any damages
                                           received (whether by suit or agreement) on account of personal injuries
                                           or sickness. The term ‘damages received (whether by suit or agreement)’
                                           means an amount received (other than workmen’s compensation)
                                           through prosecution of a legal suit or action based upon tort or tort type
                                           rights, or through a settlement agreement entered into in lieu of such
                                           prosecution.
                                       Current sec. 1.104–1(c)(3), Income Tax Regs., ‘‘applies to damages paid
                                     pursuant to a written binding agreement, court decree, or mediation award
                                     entered into or issued after September 13, 1995, and received after Janu-
                                     ary 23, 2012. Taxpayers also may apply these final regulations to damages
                                     paid pursuant to a written binding agreement, court decree, or mediation
                                     award entered into or issued after September 13, 1995, and received after
                                     August 20, 1996.’’
                                       11 The preamble of the amended regulations, T.D. 9573, 2012–12 I.R.B.

                                     498, states:
                                           Before the 1996 amendment, the section 104(a)(2) exclusion was not lim-
                                           ited to damages for physical injuries or sickness. The tort-type rights
                                           test was intended to distinguish damages for personal injuries from, for
                                           example, damages for breach of contract. Since that time, however, Com-
                                           missioner v. Schleier, 515 U.S. 323 (1995), has interpreted the statutory
                                           ‘‘on account of’’ test to exclude only damages directly linked to ‘‘personal’’
                                           injuries or sickness. Furthermore, under the 1996 Act, only damages for
                                           personal physical injuries or physical sickness are excludable. These leg-
                                           islative and judicial developments have eliminated the need to base the
                                                                                                       Continued




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                                     346                 141 UNITED STATES TAX COURT REPORTS                                    (331)


                                        We have said that ‘‘[s]ettlement amounts which are paid to
                                     settle workers’ compensation claims are not excludable from
                                     gross income under section 104(a)(2) * * * [because] claims
                                     for workers’ compensation do not necessarily involve tort or
                                     tort type rights.’’ Forste v. Commissioner, 85 T.C.M. (CCH) at
                                     1155 (‘‘A worker’s compensation claim is not itself a tort or
                                     tort type cause of action since its elements involve fixed
                                     awards and since it is based on no-fault principles.’’). Hence,
                                     absent a change in the law that applied in this case, the
                                     result here would seem to flow from our statement in
                                     Forste. 12 Such a change in law, however, appears in the new
                                     regulations which have dispensed with the ‘‘based upon tort
                                     or tort type rights’’ requirement outlined in Burke and its
                                     progeny.
                                        The parties do not dispute the validity of the new regula-
                                     tions, and in the setting at hand we apply them as written. 13
                                     In other words, under the applicable regulations, even if pay-
                                     ments under a settlement of a workers’ compensation claim
                                     are not excludable under section 104(a)(1) because they fail
                                     to be ‘‘amounts received under workmen’s compensation
                                     acts’’, some or all of the payments may nonetheless be
                                        section 104(a)(2) exclusion on tort cause of action and remedy concepts.
                                        12 As Mr. Anton’s testimony shows, the workers’ compensation claim that

                                     formed the basis of Ms. Simpson’s eventual settlement with Sears provided
                                     only the types of fixed and limited benefits that were incongruous with tra-
                                     ditional tort or tort type damages. Permanent disability benefits under
                                     California laws, which underlaid a portion of the settlement amount, are
                                     intended to compensate an injured worker for her diminished earning ca-
                                     pacity resulting from her work-related injuries. Gamble v. Workers’ Comp.
                                     Appeals Bd., 143 Cal. App. 4th 71, 80 (Ct. App. 2006). Similarly, tem-
                                     porary disability benefits under California laws, which formed the remain-
                                     ing portion of Ms. Simpson’s settlement, seek to provide an injured em-
                                     ployee interim wage replacement assistance during the period she is heal-
                                     ing. Id. at 79–80. Thus, the remedial scheme under the California laws
                                     does not appear to compensate an injured employee for tortlike personal
                                     injuries that are broad in scope. But it instead appears to address nar-
                                     rowly and exclusively ‘‘ ‘legal injuries of an economic character’ ’’, Commis-
                                     sioner v. Schleier, 515 U.S. at 335 (quoting Burke, 504 U.S. at 238–239),
                                     because it aims only to restore the injured employee to the economic posi-
                                     tion that the State has deemed she would have occupied absent the dis-
                                     ability or disabilities the occupational injuries have caused.
                                        13 The new regulations may be applied retroactively at the desire of the

                                     taxpayer. Sec. 1.104–1(c)(3), Income Tax Regs. The new regulations are fa-
                                     vorable to petitioners, and we thus apply the regulations retroactively to
                                     their benefit.




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                                     (331)                         SIMPSON v. COMMISSIONER                                       347


                                     excluded from gross income under section 104(a)(2) if the tax-
                                     payer can show the portion of the workers’ compensation
                                     claim that is predicated on the taxpayer’s personal physical
                                     injuries or physical sickness. As we elaborate below, we find
                                     that a portion of the settlement amount was to compensate
                                     Ms. Simpson for her personal physical injuries and physical
                                     sickness.
                                           2. Amount attributable to personal physical injuries or
                                              physical sickness

                                         On the basis of admissible and credible extrinsic evidence,
                                     we have found that Sears and Ms. Simpson intended to settle
                                     her potential workers’ compensation claims. The record has
                                     also established that she suffered physical personal injuries
                                     and sickness forming part of the basis of her workers’ com-
                                     pensation claims. Viewing the entire record, we conclude that
                                     the settlement of Ms. Simpson’s workers’ compensation
                                     claims had elements intended to compensate those physical
                                     personal injuries and sickness. Because the record before us
                                     ‘‘is not susceptible of any precisely accurate determination’’ of
                                     the extent to which the settlement was attributable to Ms.
                                     Simpson’s personal physical injuries and sickness, we use our
                                     best judgment and find that 10% of the settlement payment
                                     of $98,000 was made on account of those physical injuries
                                     and physical sickness (other than emotional distress). See
                                     generally Eisler v. Commissioner, 59 T.C. 634, 641 (1973). As
                                     we stated before, when a precise determination cannot be
                                     made, ‘‘the most that can be expected of us is the exercise of
                                     our best judgment based upon the entire record.’’ Id. This we
                                     have endeavored to do. Accordingly, we conclude 10% of Ms.
                                     Simpson’s settlement payment of $98,000 is excludable from
                                     gross income under section 104(a)(2).
                                     III. Deduction for attorney’s fees and court costs
                                       Because we have concluded that the settlement amount
                                     was not received under a workers’ compensation act, we now
                                     have to decide whether $152,000 of the settlement amount
                                     allocated to attorney’s fees and court costs is deductible
                                     under section 62(a)(20).
                                       Section 62(a)(20) allows an above-the-line deduction for
                                     attorney’s fees and court costs paid by, or on behalf of, a tax-




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                                     348                  141 UNITED STATES TAX COURT REPORTS                                    (331)


                                     payer in connection with any action involving an unlawful
                                     discrimination claim. See also sec. 62(e) (defining ‘‘unlaw-
                                     ful discrimination’’). The amount of a deduction under this
                                     section cannot exceed the amount includible in the taxpayer’s
                                     gross income for the taxable year on account of a judgment
                                     or settlement resulting from such claim. Sec. 62(a)(20) (last
                                     sentence).
                                       At trial respondent conceded that petitioners were entitled
                                     to deduct under section 62(a)(20) a portion of the settlement
                                     amount allocated to attorney’s fees and court costs. 14 On
                                     brief, respondent argues that petitioners can deduct only
                                     $113,985.60 because Mr. Anton represented to respondent
                                     that this was what he received. Petitioners maintain the
                                     entire $152,000 is deductible because Mr. Anton used
                                     $38,014.40 of the $152,000 to reimburse petitioners for the
                                     court costs that they paid over the years of the litigation.
                                       Deductions are a matter of legislative grace, and a tax-
                                     payer bears the burden of producing sufficient evidence to
                                     substantiate any allowable deduction under the Code. Sec.
                                     6001; Rule 142(a); INDOPCO, Inc. v. Commissioner, 503 U.S.
                                     79, 84 (1992); sec. 1.6001–1(a), Income Tax Regs. Under the
                                     familiar Cohan rule, where a taxpayer is able to demonstrate
                                     that she has paid or incurred a deductible expense but
                                     cannot substantiate the precise amount, the Court may esti-
                                     mate the amount of the expense if the taxpayer produces
                                     credible evidence providing a reasonable basis for the Court
                                     to do so. Cohan v. Commissioner, 39 F.2d 540, 544 (2d Cir.
                                     1930); Vanicek v. Commissioner, 85 T.C. 731, 743 (1985).
                                       Mr. Anton testified credibly at trial that $38,014.40 was
                                     paid to reimburse petitioners for the court costs relating to
                                     Ms. Simpson’s unlawful discrimination suit. In other words,
                                           14 It
                                            appears to be factually inconsistent for petitioners to maintain, on
                                     the one hand, that the $250,000 was includible in their gross income ‘‘on
                                     account of a judgment or settlement * * * resulting from * * * [an unlaw-
                                     ful discrimination claim]’’ and on the other hand, that Ms. Simpson and
                                     Sears intended to allocate the entire settlement value to Ms. Simpson’s
                                     workers’ compensation claims and nothing to the employment discrimina-
                                     tion suit. If none of the $250,000 was allocable to the unlawful discrimina-
                                     tion suit and if Sears would not have entered into the settlement agree-
                                     ment but for Ms. Simpson’s workers’ compensation claims, it would appear
                                     that none of the attorney’s fees and court costs are deductible under sec.
                                     62(a)(20) by virtue of the last sentence of that section. But because re-
                                     spondent has conceded this issue, we need not address it.




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                                     (331)                         SIMPSON v. COMMISSIONER                                       349


                                     Mr. Anton’s testimony shows that petitioners paid $38,014.40
                                     in court costs and $113,985.60 in attorney’s fees. The settle-
                                     ment agreement that Ms. Simpson and Sears negotiated at
                                     arm’s length corroborates Mr. Anton’s testimony. In sum, the
                                     credible evidence on this issue provides a reasonable basis
                                     for us to conclude that petitioners paid $152,000 in attorney’s
                                     fees and court costs. Accordingly, they are entitled to deduct
                                     this amount under section 62(a)(20).
                                       Any arguments not discussed in this Opinion are irrele-
                                     vant, moot, or lacking in merit.
                                       To reflect the foregoing,
                                                                         Decision will be entered under Rule 155.

                                                                               f




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