                  T.C. Summary Opinion 2003-15



                     UNITED STATES TAX COURT


                  TONIA V. CATES, Petitioner v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent


     Docket No. 2312-01S.             Filed February 28, 2003.


     Timothy J. Condon, Sr., for petitioner.

     Sean R. Gannon, for respondent.



     POWELL, Special Trial Judge:    This case was heard pursuant

to the provisions of section 74631 of the Internal Revenue Code

in effect at the time the petition was filed.    The decision to be

entered is not reviewable by any other court, and this opinion

should not be cited as authority.

     Respondent determined a deficiency of $8,634 in petitioner’s

1998 Federal income tax.    The issue is whether petitioner may


     1
        Unless otherwise indicated, subsequent section references
are to the Internal Revenue Code in effect for the year in issue.
                                - 2 -

exclude from gross income under section 104(a)(2) payments

received by her from her former employer pursuant to a settlement

agreement.   Petitioner resided in Machesney Park, Illinois, at

the time the petition was filed.

                              Background

     Rockford Memorial Health Services Corp. (Rockford) hired

petitioner in December of 1992 and promoted her to head secretary

in the Human Resources Department after 1 year.    In March of

1995, however, petitioner received an unfavorable performance

evaluation and was placed on a 90-day performance improvement

plan.   Petitioner believed that she was exposed to racially

offensive jokes and racial slurs at work and that Rockford

refused to act on her complaints of discrimination and attempted

to discourage any complaints of discrimination.    Petitioner asked

to be transferred to an assignment under a different supervisor.

That request was refused.   Instead, Rockford terminated

petitioner’s employment on April 25, 1995, after 53 days of her

90-day probationary period.    During the time of the alleged

harassment petitioner suffered from headaches, stomach problems,

insomnia, and hypertension.

     On April 9, 1997, petitioner filed a complaint in the United

States District Court for the Northern District of Illinois,

Western Division, as a member of a class action suit filed

against Rockford.   In the complaint, petitioner alleged that
                                 - 3 -

Rockford violated Title VII of the Civil Rights Act of 1964, as

amended, and the Civil Rights Act of 1991.    Petitioner sought

relief in the amount of back pay and prejudgment interest, and

“compensation for past and future non-pecuniary losses resulting

from the unlawful employment practices * * * including

humiliation”.

     On January 22, 1998, petitioner and Rockford entered into a

settlement agreement.   The agreement stated in pertinent part:

     [Rockford] shall pay to * * * [petitioner] the gross sum of
     Forty-Five Thousand Dollars ($45,000) in the form of two
     checks made payable to * * * [petitioner]. One check, in
     settlement of * * * [petitioner’s] claim for back pay
     damages, shall be in the gross amount of Ten Thousand
     Dollars ($10,000), less all applicable withholdings,
     including FICA. The second check, in settlement of * * *
     [petitioner’s] claim for compensatory damages for emotional
     injuries, shall be in the gross amount of Thirty-Five
     Thousand Dollars ($35,000). [Emphasis added.]

     In preparing her 1998 Federal income tax return, petitioner

excluded the $35,000 damage award on the grounds that it was

received in compensation of her “emotional distress due to

physical sickness” and was excludable under section 104(a)(2).

The taxability of the $10,000 petitioner received as back pay is

not in dispute.

                            Discussion

     Section 61 provides that “gross income means all income from

whatever source derived”.   Gross income is an inclusive term with

broad scope, designed by Congress to “exert * * * ‘the full

measure of its taxing power.’”     Commissioner v. Glenshaw Glass
                                 - 4 -

Co., 348 U.S. 426, 429 (1955) (quoting Helvering v. Clifford, 309

U.S. 331, 334 (1940)).   Statutory exceptions from income are

narrowly construed.   Commissioner v. Schleier, 515 U.S. 323, 328

(1995).

     Section 104(a)(2) excludes from gross income “the amount of

any damages (other than punitive damages) received (whether by

suit or agreement and whether as lump sums or as periodic

payments) on account of personal physical injuries or physical

sickness”.   Section 1.104-1(c), Income Tax Regs., defines

“damages received” as “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.”    Amounts are

excludable from gross income only when (1) the underlying cause

of action giving rise to the recovery is based on tort or tort

type rights, and (2) the damages were received on account of

personal injuries or sickness.     Commissioner v. Schleier, supra

at 337.

     Where amounts are received pursuant to a settlement

agreement, the nature of the claim that was the actual basis for

settlement controls whether such amounts are excludable under

section 104(a)(2).    United States v. Burke, 504 U.S. 229, 237

(1992).   Determination of the nature of the claim is a factual
                                  - 5 -

inquiry,2 and is generally made by reference to the settlement

agreement.     Robinson v. Commissioner, 102 T.C. 116, 126 (1994),

affd. in part and revd. in part 70 F.3d 34 (5th Cir. 1995).     An

important factor in determining the validity of the agreement is

the “intent of the payor” in making the payment.      Knuckles v.

Commissioner, 349 F.2d 610, 613 (10th Cir. 1965), affg. T.C.

Memo. 1964-33.

     In examining the nature of the claim, we find that

petitioner filed a complaint under Title VII of the Civil Rights

Act of 1964, as amended, and the Civil Rights Act of 1991.     In

United States v. Burke, supra at 237, the Supreme Court held that

recoveries received for the settlement of claims based on Title

VII of the Civil Rights Act of 1964, Pub. L. 88-352, 78 Stat.

253, are not excludable from gross income under section

104(a)(2).     The Supreme Court concluded that because the remedies

under the Act did not create remedies for personal injuries, the

causes of action involving the Act were not based on tort or tort

type rights.     Id. at 241.   In 1991, Congress amended the Civil

Rights Act of 1964, effective November 21, 1991, to permit

recovery of compensatory and punitive damages for certain

violations.     Civil Rights Act of 1991, Pub. L. 102-166, sec. 102,

105 Stat. 1072.



     2
        Sec. 7491(a), concerning burden of proof, has no bearing
on the underlying substantive issue.
                               - 6 -

     The settlement agreement does not reference whether the

damage award was based on the Civil Rights Act of 1964 or 1991.

However, Rockford clearly intended to pay petitioner a settlement

in compensation of her emotional distress.    The settlement

agreement clearly stated that the $35,000 was to compensate her

for “emotional injuries”.

     Section 104(a) provides that “emotional distress shall not

be treated as a physical injury or sickness.”    The Committee

Report provides “that the term emotional distress includes

physical symptoms (e.g., insomnia, headaches, stomach disorders)

which may result from such emotional distress.”    H. Rept. 104-586

(1996), 1996-3 C.B. 331, 482 n.24.     Thus, petitioner’s headaches,

insomnia, and stomach problems were intended by Congress to be

treated as emotional distress, and therefore the compensation for

those symptoms is not excluded from gross income under section

104(a)(2).

     Moreover, assuming that hypertension is a physical injury (a

point that we specifically do not decide) we cannot find that

Rockford intended to compensate petitioner for her hypertension.

Petitioner’s medical records submitted to this Court establish

that petitioner was first diagnosed with borderline hypertension

in May of 1993.   Petitioner was later hospitalized in June of

1993 for hypertension, weakness, and hyponatremia.    Petitioner

alleged that she suffered racial discrimination in 1995, perhaps
                               - 7 -

as early as 1994.   It is, therefore, highly unlikely that

Rockford could have intended to compensate petitioner for her

hypertension because those symptoms appeared before petitioner

suffered any alleged racial discrimination at work.

     We hold that the $35,000 award for “emotional injuries” is

not excludable from gross income under section 104(a)(2).

     Reviewed and adopted as the report of the Small Tax Case

Division.

                                       Decision will be entered

                               for respondent.
