                  T.C. Memo. 2003-339



                UNITED STATES TAX COURT



              GAVIN POLONE, Petitioner v.
     COMMISSIONER OF INTERNAL REVENUE, Respondent



Docket No. 12665-00.           Filed December 16, 2003.


     P was a high-profile, successful Hollywood talent
agent. P represented numerous Hollywood stars. Until
1996, P worked for a major Hollywood talent agency (U).

     On Apr. 21, 1996, U fired P. U leaked P’s
termination to the media. The press coverage of P’s
termination was extensive and defamatory to P.

     P immediately hired attorneys to represent him
against U. P’s attorneys prepared a complaint
alleging, among other things, defamation and breach of
contract. P and U engaged in settlement negotiations
that were extremely hostile, adversarial, and
acrimonious. P and U quickly settled P’s claims. U
agreed to pay $4 million to settle the defamation claim
and $2 million plus “back-end” payments to settle the
breach of contract claim. P was paid the $4 million in
four installments of $1 million in May 1996, November
1996, May 1997, and November 1998.
                              - 2 -

          Even though there was a quick settlement and a
     public apology by U, P’s career as a talent agent was
     ended by his termination and the negative publicity.
     Subsequently, P became a talent manager and producer.

          P, after consultation with tax professionals, did
     not include the May 1996, May 1997, or November 1998
     payments in income on his tax returns for 1996, 1997,
     and 1998. P initially included the November 1996
     payment in income but later filed an amended return
     seeking a refund of taxes associated with this payment.
     P’s returns contained detailed statements disclosing
     P’s reasons for excluding the payments from income.

          R audited P’s 1996, 1997, and 1998 returns.
     During the audit, P’s attorney delayed several times in
     responding to R. P did not provide certain documents
     requested by R. P refused to be interviewed by R. R
     denied P’s claim for refund and determined that none of
     the $4 million paid to settle the defamation claim was
     excludable from income, and P was liable for a penalty
     pursuant to sec. 6662, I.R.C., for all years.

          Held: P did not cooperate with R. Accordingly, P
     bears the burden of proof. Sec. 7491(a), I.R.C.; Rule
     142(a).

          Held, further, pursuant to sec. 104(a)(2), I.R.C.,
     before its amendment by the Small Business Job
     Protection Act of 1996 (SBJPA), Pub. L. 104-188, sec.
     1605, 110 Stat. 1838, the May 1996 payment is
     excludable from income for 1996.

          Held, further, pursuant to sec. 104(a)(2), I.R.C.,
     as amended by the SBJPA, P is not entitled to an
     overpayment for 1996, and the May 1997 payment and the
     November 1998 payment are not excludable from income.

           Held, further, P is not liable for the penalty
     pursuant to sec. 6662, I.R.C., for 1996, 1997, and
     1998.



     Edwin L. Norris, Jonathan M. Brenner, and Ethan D. Millar,

for petitioner.
                                   - 3 -



     Steven M. Roth, Mark A. Weiner, and Leslie B. Van Der Wal,

for respondent.


             MEMORANDUM FINDINGS OF FACT AND OPINION


     VASQUEZ, Judge:     Respondent determined the following

deficiencies in and penalties on petitioner’s Federal income tax:

                                                  Penalty
     Year           Deficiency                   Sec. 6662

     1996               $407,880                  $81,567
     1997                407,880                   81,567
     1998                407,880                   81,567

Unless otherwise indicated, all section references are to the

Internal Revenue Code in effect for the years in issue, and all

Rule references are to the Tax Court Rules of Practice and

Procedure.

     The issues for decision are:      (1) Which party bears the

burden of proof; (2) whether four $1 million payments petitioner

received from United Talent Agency, Inc. (UTA), in May 1996,

November 1996, May 1997, and November 1998 are excludable from

petitioner’s gross income pursuant to section 104(a)(2); and (3)

whether petitioner is liable for the accuracy-related penalty for

1996, 1997, and 1998.
                                - 4 -

                          FINDINGS OF FACT1

     Some of the facts have been stipulated and are so found.

The stipulation of facts and the attached exhibits are

incorporated herein by this reference.    At the time he filed the

petition, petitioner resided in Beverly Hills, California.

Talent Agencies and Talent Agents

     Talent agencies are regulated businesses in the State of

California.   They procure employment and negotiate deals for

their clients.    For these services, talent agencies receive a

maximum commission of 10 percent.    This industry is a very

competitive business--every day someone tries to steal someone

else’s clients.    To be a successful talent agent requires an

aggressive personality.

Petitioner’s Career as a Talent Agent

     After graduating from the University of California at

Berkeley with a bachelor’s degree in film, petitioner became a

talent agent.    Petitioner signed and represented many young

writers for television shows that became “hits”.    Petitioner

primarily represented clients who were in the television

industry; however, he also represented clients in the feature



     1
        We make our findings of fact on the basis of the credible
evidence. We note that some of the witnesses were credible with
regard to only certain portions of their testimony. The
animosity between petitioner and UTA rendered some testimony not
credible. Additionally some testimony was conclusory and/or
questionable in certain material respects.
                                   - 5 -

film industry.       His clients were directors, writers, producers,

and actors.       Some of petitioner’s clients, who numbered over 75,

included:       Maria Conchita Alonso, Larry David (creator of

“Seinfeld”), David Foley, Gregory Hines, David Koepp (whose

credits include “Jurassic Park”, “Carlito’s Way”, and “Mission

Impossible”), Norm MacDonald, Conan O’Brien, Bronson Pinchot,

John Singleton, and several writers from “The Simpsons” and

“Seinfeld”.

       Martin Bauer and Peter Benedek owned the Bauer Benedek

Agency (BBA).2      BBA was a talent agency.   In the summer of 1989,

after working at International Creative Management (ICM), one of

the three largest Hollywood talent agencies,3 for 4 years,

petitioner left ICM and began working at BBA.

       Petitioner had offers to work for other agencies but chose

BBA.       BBA primarily had feature film clients.   Petitioner went to

BBA to build its television business.       Petitioner’s initial

salary at BBA was $90,000.       In 1990, BBA increased his salary to

$150,000.

       In 1991, Leading Artists Agency (LAA), primarily a

television talent agency, merged with BBA to become UTA.         James



       2
            Messrs. Bauer and Benedek were also attorneys.
       3
        During the years in issue, the three largest talent
agencies in Hollywood, in alphabetical order, were the Creative
Artists Agency (CAA), International Creative Management (ICM),
and the William Morris Agency (William Morris).
                                - 6 -

Berkus, a founding partner in LAA, is a talent agent at UTA and

the chairman of UTA.   Mr. Berkus, an attorney, has been in the

entertainment industry for over 25 years.

     From 1991 through 1998, with the exception of a short period

in 1996, Mr. Bauer was the president of UTA.   From sometime in

1996 through 1998, he was a cochairman of UTA.   During April

1996, however, Mr. Bauer was not on good terms with the other

people involved in the management of UTA.4

     From its inception until April 21, 1996, petitioner worked

as a talent agent for UTA.   Petitioner’s initial salary at

UTA was $150,000.

     Since its inception, UTA has grown in the number of its

employees and the amount of revenue it has generated.   In 1996,

UTA was the fourth “most prestigious” talent agency in Hollywood.

During 1995 and/or 1996, UTA “packaged” seven shows including

“Cybil”, “Married...With Children”, “The Drew Carey Show”, and

“Mad About You”.    During 1996, UTA represented high-profile stars

including Sandra Bullock, Jim Carey, Lawrence Kasdan, Martin

Lawrence, John Singleton, Jean-Claude Van Damme, and the Coen

brothers.

     During his employment at UTA, petitioner became “the de

facto leader” of the television department--the largest earning


     4
        Mr. Bauer is no longer associated, and has an adversarial
relationship, with UTA. As of the time of trial, he was a talent
manager.
                                - 7 -

department at UTA.    By 1996, petitioner was the number one or

number two revenue generator at UTA.

     Petitioner worked extremely hard.     He worked long hours 7

days a week.   During the first 6 years of his career, he took a

total of only 4 weeks’ vacation.    Petitioner fought aggressively

for his clients.   Petitioner was extremely successful in

representing his clients.

     On January 27, 1992, petitioner and UTA entered into an

employment contract (employment agreement).     The employment

agreement provided petitioner with base compensation of $350,000

per year with a 10-percent annual increase and a discretionary

bonus.   The employment agreement had a term of 5 years.

     The employment agreement provided that UTA could terminate

petitioner at any time for “cause”.     The employment agreement

defined “cause” as:    (1) A conviction for any felony that was

materially injurious to UTA; (2) any breach by petitioner of any

of the material terms or covenants of the employment agreement;

or (3) any fraudulent, illegal, or immoral activity by petitioner

that materially and adversely affected UTA or UTA’s reputation.

Pursuant to the employment agreement, if UTA terminated

petitioner for cause, UTA had no further liability to petitioner

except for compensation accrued to the date of termination.

     The employment agreement also provided that UTA was not

required to use petitioner’s services and had the unilateral
                               - 8 -

right to terminate his employment without cause.    In that event,

UTA would be required to pay petitioner his base salary,

petitioner would not be required to mitigate damages, and

petitioner’s income from other employment would not reduce the

amount owed to him by UTA.   In order to terminate petitioner

without cause, the elected directors of UTA would have to approve

the termination unanimously.

     After its execution, the employment agreement was amended

several times for various reasons, including to increase

petitioner’s base salary.

Wendy Casselith’s Accusation of Sexual Harassment

     Wendy Casselith was employed by UTA as petitioner’s

assistant.   Around April 1994, Ms. Casselith accused petitioner

of verbally abusing and sexually harassing her.    She hired an

attorney to pursue claims against UTA.   UTA resolved Ms.

Casselith’s claims by paying Ms. Casselith.

Petitioner Remains at UTA

     As of January 1995, petitioner’s base salary at UTA was $1

million per year.

     On May 1, 1995, UTA and petitioner amended the employment

agreement (May 1995 amendment) to extend its term until March 30,

1998, and to increase petitioner’s base salary to $2 million per

year.   The May 1995 amendment also provided that petitioner

exchanged his interest in the UTA termination of employment plan
                                - 9 -

for (1) 25 percent of the commissions received by UTA from

package fees or profits (or advances on profits) from

petitioner’s clients’ projects which were booked or being

negotiated by UTA while petitioner was at UTA or were payable

under the terms of agency agreements signed by petitioner’s

clients while he was at UTA, and (2) all revenue, not just

package fees and profits, on Conan O’Brien’s deal for “Late Night

With Conan O’Brien” (altogether, the back-end payments).5

Additionally, petitioner agreed that his bonus would be at UTA’s

discretion and would be based upon his performance, his attitude,

and the performance of UTA.    Except as expressly modified

therein, the terms of the employment agreement remained in

effect.

Petitioner’s Relationship With UTA

     Petitioner’s interaction with UTA’s management committee,

partners,6 agents, assistants, and employees often was

confrontational.   Petitioner was tough on, and demanding of,

other agents and assistants.     During his employment at UTA,

petitioner prided himself in being brash, outspoken, and


     5
        The May 1995 amendment provides examples including “25%
of * * * the commissions received from Larry David’s ‘Seinfeld’
profits”.
     6
        The witnesses used the words “principals” and “partners”
with regard to UTA interchangeably. For convenience, we do so as
well. The title “partner” at a talent agency does not
necessarily mean that this person has an ownership interest in
the agency.
                                - 10 -

aggressive.   Petitioner’s persona was eccentric, physically

demonstrative, and intense.

     During his employment at UTA, petitioner grew dissatisfied

with some of UTA’s practices.     He felt the television department

employees were undercompensated, compensation was not based on

merit, money was being wasted, and UTA was not run efficiently.

Petitioner believed that personal expenses of the partners were

inappropriately being claimed as business expenses (such as

country club memberships), that improper personal loans were

being made to the partners, and that there were problems with

drug use.

     Petitioner repeatedly disagreed with and challenged the

partners and management committee of UTA with respect to the way

they ran the agency and regarding compensation.    On at least two

occasions, petitioner proposed that he either withdraw or be

removed as a partner.

Events Leading Up To Petitioner’s Termination

     In March 1996, when he had 2 years left on his employment

contract, petitioner met with UTA’s principals to discuss

problems petitioner had with how UTA conducted its business.      In

March 1996, the principals of UTA were Mr. Bauer, Mr. Berkus, Mr.

Benedek, Gary Cosay, J.J. Harris, David Schiff, Nick Stevens,

Jeremy Zimmer, and petitioner.7    At that time, UTA’s board of



     7
         Petitioner was not a partner when LAA and BBA merged.
                               - 11 -

directors and owners were Mr. Bauer, Mr. Berkus, Mr. Benedek, and

Mr. Cosay.   Although Mr. Harris and Mr. Schiff were partners,

they did not have a say in the operation of UTA.    During this

period, there was infighting between Mr. Bauer and Mr. Berkus

that created an acrimonious atmosphere at UTA.

     At the March 1996 meeting, UTA offered to raise petitioner’s

salary to $2.5 million per year; however, UTA wanted petitioner

to commit to 5 years with UTA.    At this time, UTA was having

problems making deals and re-signing junior agents.    Petitioner

felt that no one at UTA wanted to address the problems petitioner

had with UTA.   Petitioner stated that he would not agree to the

offer, he would finish his contract, and then he would leave UTA.

Petitioner believed that the other partners were frightened that

petitioner’s clients would leave with him.

Nancy Jones’s Accusation of Sexual Harassment

     During early 1996, Nancy Jones was a talent agent at UTA.

Petitioner helped hire Ms. Jones.    She worked with petitioner in

the television department for many years.    Although petitioner

did not describe his relationship with Ms. Jones as a “romantic

relationship”, at one point he and Ms. Jones had a “personal and

sexual relationship”.    They went on vacation together to Mexico

and traveled together outside the office.

     In early 1996, petitioner talked with Ms. Jones about her

performance.    He felt that she was not working hard, she was

embarrassing clients, and she had claimed to be sick when she
                                - 12 -

actually took a vacation to New York City.     Ms. Jones suggested

that she should be let out of her contract even though she had

several years left on it.     At this time, Ms. Jones was seeking to

leave UTA and join CAA.

       In or about April 1996, Ms. Jones made accusations to Mr.

Benedek that petitioner was sexually harassing and abusing her.

Although she did not demand monetary compensation, she demanded

to be released from her written employment agreement or she would

make her claims public.

       UTA, over Mr. Bauer’s objection, released Ms. Jones from her

contract in exchange for her releasing UTA from her sexual

harassment claims.    Ms. Jones left UTA and joined CAA.   Ms. Jones

later stated that she never intended to file a complaint against

UTA.

Petitioner’s Termination

       On or about Sunday, April 21, 1996, a meeting was held at

Mr. Zimmer’s home to discuss terminating petitioner’s employment

(April 21 meeting).     Mr. Benedek, Mr. Berkus, Mr. Cosay, Mr.

Stevens, and Mr. Zimmer attended the April 21 meeting.     Mr. Bauer

was not invited.     Everyone attending the April 21 meeting

participated in the discussion about what to do to petitioner.

The April 21 meeting lasted approximately 1 hour, and at the end

of the April 21 meeting, all present agreed to terminate

petitioner’s employment.
                              - 13 -

     Although it was not UTA’s practice to terminate an employee

on a Sunday or without notice, on Sunday, April 21, 1996, UTA

terminated petitioner’s employment.    Mr. Bauer was the only board

member not informed of the meeting, and he did not give his

consent to terminate petitioner without cause.    Mr. Bauer felt

betrayed and treated with a lack of respect by the actions of the

other partners present at the April 21 meeting.    Mr. Zimmer later

told Mr. Bauer to look at the bright side of the firing:     they

could go after petitioner’s clients together.    In the end,

however, most of petitioner’s clients left UTA.

Events Following UTA’s Decision To Terminate Petitioner

     Immediately after deciding to terminate petitioner, UTA

contacted the media so that they would hear from UTA about

petitioner’s termination and not from petitioner or someone else.

It was not UTA’s general practice to contact the media to

announce the termination of an agent.

     That same day, Mr. Stevens called petitioner at home and

informed him that he was fired for cause on account of his

inappropriate behavior towards Ms. Jones.   It is unclear,

however, whether Mr. Stevens called petitioner before or after

calling the news media.   Petitioner was shaken, upset, and

fearful about his future after learning he had been fired.

     Since petitioner knew he needed an attorney, he called an

old friend from high school, Brad Berenson, who was an attorney

at Sidley Austin Brown & Wood (Sidley Austin) in Washington, D.C.
                               - 14 -

Petitioner explained to Mr. Berenson what had happened, and Mr.

Berenson told petitioner that he would call Sidley Austin’s Los

Angeles office and get back to petitioner.

     Mr. Berenson called petitioner back and gave him the name of

Peter I. Ostroff, who was the head of the litigation group at

Sidley Austin in Los Angeles, California.    On April 21, 1996,

petitioner engaged Sidley Austin to represent him.

     Among the other individuals petitioner called on April 21,

1996, after being informed of his termination, was Bill Block,

president of ICM.   Mr. Block had previously expressed an interest

in retaining petitioner’s services.     Mr. Block said he was going

to have to call petitioner back after discussing matters with his

other partners at a company retreat that was being held on

Monday, April 22, 1996, at the Four Seasons in Santa Barbara,

California (ICM retreat).

     Late in the day on April 21, 1996, petitioner went to UTA’s

offices to collect his personal effects.    A guard was posted at

UTA’s offices.   Usually, there was no guard.   Petitioner’s

electronic key no longer worked.   The guard asked petitioner for

petitioner’s driver’s license.   Petitioner showed the guard his

license, and the guard informed petitioner he was not allowed in.

Petitioner called Mr. Berkus in the hope that he would be allowed

to enter the office and retrieve his belongings, but Mr. Berkus

would not come to the phone.
                                     - 15 -

     On April 22 and 23, 1996, Daily Variety, the Hollywood

Reporter, and the Los Angeles Times published articles regarding

petitioner’s termination.8      UTA’s termination of petitioner was

also reported on KTLA Channel 5 and KNX News Radio.

     The front page of the Monday, April 22, 1996, edition of

Daily Variety had the banner headline “UTA ZAPS POLONE”.      Beneath

the banner headline was the phrase “Agency cites behavior; agent

denies charge”.       The article included the following statements:

          United Talent Agency’s Gavin Polone * * * was
     abruptly fired from UTA Sunday over what agency
     partners referred to as “inappropriate” behavior toward
     fellow TV agent Nancy Jones, who resigned Wednesday.

                  *       *      *       *    *    *    *

          “We have terminated his employment,” UTA partner
     Jim Berkus told Daily Variety on Sunday. “The decision
     was ours. We called today (Sunday) and told him. We
     felt the way he accorded himself with colleagues and


     employees was inappropriate. His behavior toward
     (fellow TV agent) Nancy Jones was of significant
     concern to us.”

                  *       *      *       *    *    *    *

          Polone was ordered to attend a counseling session
     with an attorney who specialized in behavioral
     problems.



     8
        Daily Variety and the Hollywood Reporter are widely read
each business day by people in the entertainment industry. The
Los Angeles Times is a newspaper of general circulation in
Southern California. In April 1996, the daily paid circulation
of these papers was as follows: (1) Daily Variety, over 25,000
people, (2) the Hollywood Reporter, over 20,000 people, and (3)
the Los Angeles Times, over 1 million people.
                                   - 16 -

     UTA however had not hired an attorney who specialized in

behavioral problems to counsel petitioner.       Furthermore,

petitioner had not been ordered to seek counseling from such an

attorney or other professional.

     The Monday, April 22, 1996, edition of the Hollywood

Reporter also contained an article about petitioner’s

termination.   The article included the following statements:

          Reached Sunday, a spokesman for the agency would
     only comment “We have terminated Gavin Polone’s
     employment at United Talent Agency for reasons that his
     philosophy on inter-personal relationships and ours are
     antithetical * * * .”

                *     *        *       *     *     *    *

     * * * sources inside the agency said the move was
     triggered late in the week after another employee, TV
     agent Nancy Jones, approached management and asked to
     be released from her contract because of Polone’s
     allegedly inappropriate behavior toward her.

     The Tuesday, April 23, 1996, edition of the Los Angeles

Times reported that “One allegation from UTA is that Polone was

abusive toward Nancy Jones, an agent there who worked under him.”

     The Tuesday, April 23, 1996, edition of Daily Variety again

reported:   “Agency partners said the cause for the firing was

Polone’s ‘inappropriate’ behavior toward fellow TV agent Nancy

Jones, who resigned Wednesday” and “partner Jim Berkus said on

Sunday:   ‘We felt the way he accorded himself with colleagues and

employees was inappropriate.       His behavior toward Nancy Jones was

of significant concern to us.’”
                               - 17 -

     Petitioner started receiving calls from journalists asking

for comments.    Petitioner believed that the statements in the

articles attributed to UTA were false and that UTA had no cause

to fire him.    Petitioner told the journalists that none of the

statements were true.

Petitioner’s Prospects With ICM

     On Monday, April 22, 1996, the ICM retreat was attended by

the executives of ICM and approximately 80 agents (including

personnel from ICM’s London office).     Jeff Berg, the chairman or

CEO of ICM, was at the ICM retreat.     The articles about

petitioner that appeared in the trade publications that morning

were brought to the ICM retreat.    At the ICM retreat, Mr. Berg

spoke to those in attendance and, referring to petitioner,

stated:   “This is the poster boy for bad behavior” and “This kind

of behavior will not be tolerated at ICM”.     Mr. Berg had the

articles about petitioner in his hand when he made these

statements.

     Toni Howard, a senior vice president in the motion picture

department of ICM, attended the ICM retreat.     When Ms. Howard

learned that ICM was in discussions to hire petitioner, she

opposed hiring petitioner.    She spoke to six executives at ICM

and questioned how ICM could hire petitioner after noting the

articles in the trade publications.

     Eventually, petitioner met with ICM.     ICM would not hire

him, in part because of the articles in the trade publications.
                              - 18 -

Petitioner’s 1996 Litigation Against UTA

     On Monday, April 22, 1996, petitioner met with Mr. Ostroff

to discuss his legal claims against UTA.   Mr. Ostroff prepared a

draft complaint that alleged the following claims against UTA:

Defamation, intentional infliction of emotional distress,

intentional interference with prospective economic advantage,

invasion of privacy, wrongful termination, and breach of contract

(the complaint).   Petitioner’s primary concern was to “clear his

name”.   He wanted UTA to retract what UTA had said and to

apologize.   Petitioner and Mr. Ostroff wanted to resolve

petitioner’s claims against UTA as quickly as possible in order

to mitigate the damages to petitioner’s reputation.   Petitioner

was also concerned that UTA had the resources to make litigation

of these claims very expensive, that litigation would tie up his

life and ruin any chance he had of starting a new career, and

that UTA might fabricate more (and worse) stories about him.

     That same day, Mr. Ostroff sent a letter to UTA that, among

other things, asserted legal claims against UTA based on UTA’s

alleged unlawful and tortious actions and demanded that (1) UTA

cease and desist from making further defamatory statements

regarding petitioner, (2) UTA allow petitioner access to his

personal files, and (3) UTA pay petitioner all of his earned but

unpaid wages.   Mr. Ostroff also proposed a meeting by the

afternoon of Tuesday, April 23, 1996.   Petitioner hoped that UTA

would admit that UTA had made a “massive mistake” and apologize.
                                - 19 -

Settlement Negotiations

     On Tuesday, April 23, 1996, a meeting was held at the office

of UTA’s attorneys, O’Melveny & Myers, in Los Angeles, California

(April 23 meeting).    Petitioner, Mr. Ostroff, Lori Dillman

(another attorney for petitioner from Sidley Austin), Mr. Berkus,

Mr. Benedek, and Scott Dunham of O’Melveny & Myers attended the

April 23 meeting.   Mr. Dunham, Healy Condon, and David Wyle

represented UTA in the April 1996 dispute with petitioner.9    The

atmosphere and the negotiations at the April 23 meeting were

hostile, adversarial, and acrimonious.

     At the April 23 meeting, Mr. Ostroff summarized the elements

of the complaint.     The complaint included the following

allegations:10

          15. Over the course of his employment with UTA
     and his service on the Management Committee, and
     especially in the last six months of his employment
     with UTA, Plaintiff became aware of and concerned by a
     number of improper and/or illegal acts and practices


     9
        Although the record is somewhat unclear, it appears that
the dispute in April 1996 was not the only dispute, or
threatened/actual litigation, between petitioner and UTA.
Apparently, sometime after the settlement of the defamation and
breach of contract claims was reached, petitioner allegedly
violated the confidentiality provisions of the settlement
agreements. When Mr. Bauer was informed that petitioner was
allegedly violating the confidentiality provisions of the
settlement agreements and speaking to the Internal Revenue
Service regarding UTA’s principals, he instructed UTA’s attorneys
to initiate a lawsuit against petitioner for, among other things,
breach of the settlement agreements and misappropriation of trade
secrets.
     10
        The redactions noted are contained in the copy of the
complaint submitted to the Court.
                           - 20 -

occurring within UTA, which were undertaken by or with
the authorization and ratification of, defendants
BENEDEK, BERKUS, STEVENS, ZIMMER, and COSAY. Over a
period of several months, Plaintiff made known to
defendants BENEDEK, BERKUS, STEVENS, ZIMMER, and COSAY
Plaintiff’s concerns that these acts and practices were
wrongful and/or illegal and could expose UTA to
liability, condemnation within the industry, loss of
clients, and general damage and harm. * * * The acts
and practices about which Plaintiff complained
included, but were not limited to, the following:

          A. The defrauding of UTA clients through
misrepresentation that commission rates were in most
instances non-negotiable at 10% and uniform for all
clients, while in truth, UTA agreed to special reduced
commission deals with selected and favored clients;

           *     *     *       *     *    *    *

          D. Illegally recording, as phony “loans”
that were interest-free and never intended to be paid
back to UTA, payments made by UTA to [names redacted]
to cover country club fees, among other things, so as
to disguise income to said persons for tax purposes;
and

          E. Condoning and tolerating illegal use of
controlled substances by UTA employees * * * and by one
member of the [redacted] who participated in the
illegal use of drugs with other employees of UTA at a
company retreat.

     16. In response to Plaintiff’s complaints about
their improper and illegal conduct, defendants BENEDEK,
BERKUS, STEVENS, ZIMMER, and COSAY failed to put a stop
to the conduct and, in fact, gave every indication that
the conduct would continue.

          *     *     *       *     *    *    *

     21. * * * the conduct [of Mr. Polone] alleged [by
UTA] was not at variance with and in no instances worse
than the standards of conduct tolerated at UTA by
defendants in view of the fact that defendants had
themselves routinely committed sexual, for example,
misconduct in connection with their employment,
including sexual liaisons between [name redacted] and
various subordinate employees of UTA, and unwelcome
                               - 21 -

     sexual pursuit of a client of the firm by [name
     redacted].

Some of the redacted portions of the complaint contained

accusations that Mr. Benedek had sexually harassed UTA clients.

     Mr. Ostroff also advised UTA that petitioner would file the

complaint unless a settlement could be reached quickly.    Mr.

Ostroff informed UTA that he thought petitioner’s claims against

UTA totaled approximately $20 million.    Mr. Ostroff estimated the

contract damages to be worth approximately $8 million and the

tort damages, because of the egregious nature of and publicity

surrounding petitioner’s termination, to be worth approximately

$12 million.   Petitioner was serious about prosecuting the

complaint in the event a settlement was not reached with UTA.

     Mr. Berkus felt that petitioner’s attorneys were being

aggressive and that petitioner’s monetary demand was absurd.     Mr.

Berkus scoffed at, and was derisive of, petitioner’s settlement

offer.   He felt that petitioner was attempting to extort money

from UTA.

     Mr. Dunham spoke for UTA at the April 23 meeting.    He

indicated that UTA had the right to fire petitioner without cause

and would owe petitioner only $4 million if he was fired without

cause.   UTA’s initial offer was between $2 million and $3

million.    UTA adamantly defended its actions.

     No agreement was reached between petitioner and UTA at the

April 23 meeting.    At the time, Ms. Dillman thought that the
                               - 22 -

complaint was going to be filed, and no agreement would be

reached.

     That evening, petitioner spoke to Mr. Bauer.   After speaking

to Mr. Bauer, petitioner felt he had a stronger case against UTA.

Mr. Bauer told petitioner that he was never consulted about

firing petitioner, nothing about the situation was handled

appropriately, UTA had defamed petitioner, he was considering

suing UTA as well, and he believed that petitioner had not

harassed Ms. Jones.

     Negotiations continued after the April 23 meeting.    Mr.

Dunham indicated that UTA wanted to resolve the matter and gave

Mr. Ostroff and Sidley Austin permission to speak directly to Mr.

Berkus.    Mr. Dunham felt comfortable with Mr. Berkus’s ability to

negotiate a deal with petitioner’s attorneys.   Mr. Berkus’s

business was the negotiation of deals, and the issue to be

negotiated was financial (i.e., how much to pay petitioner for

each cause of action).

     Mr. Berkus negotiated directly with Mr. Ostroff and Ms.

Dillman.   Petitioner made a counterproposal of $9.25 million, and

UTA countered with $4 million.   These monetary demands were

accompanied by additional terms.   Petitioner wanted Jay Sures (an

agent at UTA) released from his contract, an apology and

retraction, the ability to compete with UTA, vacation pay, and

his personal effects that were still in UTA’s offices.    UTA

wanted a noncompete agreement, a nonsolicitation agreement, and a
                                - 23 -

release from the defamation claim.       Each side demanded terms that

the other rejected.

Settlement Reached

     On Wednesday, April 24, 1996, only days after petitioner’s

discharge, petitioner and UTA reached an agreement.      UTA agreed

to pay petitioner $4 million to settle the defamation claim and

$2 million plus the back-end payments to settle the breach of

contract claim.11    Petitioner wanted payment up front; however,

UTA would not agree to an up-front payment.

     At the time of the settlement, the back-end payments were

estimated to be worth approximately $2 million.      As of the time

of trial, petitioner had received significantly more than $2

million in back-end payments, and the back-end payments were

continuing to be made to petitioner.

     That same day, Ms. Dillman faxed a letter to UTA regarding

the settlement reached between petitioner and UTA (April 24,

1996, letter).   Also on that day, Mr. Berkus made handwritten




     11
        The agreement also consisted of many other monetary and
nonmonetary aspects. These included a confidentiality provision,
petitioner’s right to audit UTA, UTA’s reimbursement of unpaid
expenses petitioner incurred for UTA, UTA’s provision of health
insurance to petitioner, UTA’s payment of petitioner’s accrued
vacation days, UTA’s payment of all petitioner’s legal fees
incurred in connection with “this dispute”, petitioner’s
refraining from interfering with collection of accounts
receivable from petitioner’s clients, petitioner’s refraining
from disclosing UTA trade secrets, petitioner’s ability to
compete against UTA, and the exchange of mutual and general
releases.
                                - 24 -

notations on the April 24, 1996, letter, signed it, and faxed it

back to petitioner’s counsel.    The terms contained in the

April 24, 1996, letter included a provision whereby UTA would pay

petitioner a total of $6 million in several installments, and

petitioner would also be entitled to the back-end payments.

        Before he signed the April 24, 1996, letter, Mr. Berkus

spoke with Mr. Bauer, Mr. Benedek, Mr. Cosay, Mr. Stevens, and

Mr. Zimmer.    The decision to settle was a group decision by UTA’s

management--all knew about the agreement and agreed with the

obligation UTA was assuming.    Mr. Berkus sensed that petitioner

was extremely close to filing the complaint when he signed the

April 24 letter.    Mr. Berkus took very seriously petitioner’s

threats to file the complaint.

     On Wednesday, April 24, 1996, UTA issued the following press

release, as was required by the agreement reached on April 24,

1996:

     Upon further investigation, we have determined that
     there were insufficient grounds to terminate Gavin
     Polone’s employment for cause. We regret any
     misconception created as a result of the reporting of
     these events in the media. We have reached an amicable
     settlement with Gavin Polone and wish him well in his
     future endeavors.

The entire press release was reported in the Hollywood

Reporter in its Thursday, April 25, 1996, edition under the

headline “UTA apologizes, pays off Polone”.    The first two
                                 - 25 -

sentences of the press release were reported by Daily Variety in

its April 25, 1996, edition.12

Documenting the Settlement

     After UTA and petitioner reached the settlement on

Wednesday, April 24, 1996, Mr. Dunham was involved in the

drafting of the final documents.     On Friday, April 26, 1996, Mr.

Dunham delivered to Mr. Ostroff a draft of a comprehensive

settlement and general release agreement with respect to

petitioner’s claims against UTA.

     Mr. Ostroff and Ms. Dillman asked Gary Cohen, a tax attorney

at Sidley Austin, to document the settlement reached between

petitioner and UTA.   Mr. Cohen proposed the use of two settlement

agreements to Mr. Dunham.    Mr. Cohen believed that two documents,

rather than one, were advisable from a tax perspective.    He felt

that the employment claim and defamation claim should be kept

separate.   On April 29, 1996, Mr. Cohen sent Mr. Dunham drafts of

two settlement agreements with respect to petitioner’s claims

against UTA (two settlement agreements).

     On May 1, 1996, Mr. Cohen sent Mr. Dunham revised pages of

the two settlement agreements that were blacklined to show

corrections made by Mr. Dunham to the versions sent to him on

April 29, 1996.




     12
        The article immediately to the right of the article on
UTA and petitioner’s settlement (on the front page) reported that
Ms. Jones had joined CAA.
                               - 26 -

     That same day Ms. Dillman also sent a separate letter to Mr.

Berkus and Mr. Dunham.   The letter was sent at Mr. Berkus’s and

Mr. Dunham’s request to confirm that the April 24, 1996, letter,

as countersigned and slightly amended by Mr. Berkus, represented

a binding settlement agreement.

     On May 2, 1996, Mr. Dunham delivered to Mr. Ostroff revised

drafts of the two settlement agreements, both in unmarked and

redlined versions, with changes from the versions sent to Mr.

Dunham on May 1, 1996.   Mr. Dunham made changes to eliminate

language he thought was unnecessary, not part of the agreement

reached between UTA and petitioner (i.e., inconsistent with the

agreement that was detailed in the April 24, 1996, letter),

overbroad, and/or redundant.

     On May 3, 1996, Mr. Dunham faxed Mr. Cohen and Mr. Ostroff

further revised drafts of the two settlement agreements.    That

same day, petitioner and UTA executed two agreements--the

Employment Termination Agreement and Mutual General Release

(employment termination agreement) and the Defamation Agreement

and Mutual General Release (defamation agreement).

     The employment termination agreement provided UTA would pay

petitioner $2 million in five installments ($475,000 by June 30,

1996, and December 31, 1996, and $350,000 by June 30, 1997,

December 31, 1997, and January 1, 1998) and the back-end payments

received after March 31, 1998.
                              - 27 -

     The defamation agreement provided UTA would pay petitioner

$4 million in four $1 million installments.   The first payment

was to be made on May 1, 1996.13   The last three payments were to

be made by November 1, 1996, May 1, 1997, and November 1, 1997.

The defamation agreement specifically provided that these

payments would be paid to petitioner as compensation to him for

the alleged personal injuries he suffered on account of the

defamation.   UTA entered into the defamation agreement, and

agreed to pay petitioner $4 million pursuant to the defamation

agreement, in order to settle petitioner’s defamation claim.    UTA

would not have agreed to settle with petitioner if petitioner had

not agreed to release UTA from his defamation and other legal

claims.

Petitioner’s Career After His Termination By UTA

     Before his termination by UTA, petitioner was a top-earning

talent agent at UTA, had numerous well-known and prestigious

clients, was considered a “partner” at UTA, and was considered

very successful within the entertainment industry.    After being

fired by UTA, petitioner did not receive any calls from CAA or

William Morris.   ICM specifically would not hire petitioner

because of the concern expressed by some of ICM’s partners

regarding the adverse publicity surrounding petitioner’s

dismissal from UTA.



     13
        We note that this payment was due 2 days before the
execution of the defamation agreement.
                               - 28 -

     After his termination and the conclusion of the settlement

negotiations, petitioner felt he had no viable career as a talent

agent.    He also did not believe he could start his own talent

agency.   Petitioner thus decided to pursue a career as a talent

manager and as a film and television producer.     Talent managers

are not allowed to procure employment on behalf of clients and do

not benefit from the fixed commission rates that talent agents

are entitled to receive under their agreements with the talent

guilds.

     Around May 1996, he started Hofflund Polone with Judy

Hofflund (a former partner at UTA).     During 2001 or 2002,

petitioner formed a production company named Pariah Productions.

     As of the time of trial, petitioner had at least two

television shows on the air--Family Affair and Hack.     Several

pilots he produced had not yet been picked up as series, and he

had not produced any feature films.

Payments Made to Petitioner Pursuant to the Settlement Agreements

     Pursuant to the employment termination agreement, UTA paid

petitioner $950,000 in 1996 and $1,050,000 in 1998.     Petitioner

included these amounts on his respective Federal income tax

returns for 1996 and 1998.

     Pursuant to the defamation agreement, UTA paid petitioner $1

million on or about:    (1) May 1, 1996 (May 1996 payment), (2)

November 11, 1996 (November 1996 payment), (3) May 5, 1997 (May
                                - 29 -

1997 payment), and (4) November 11, 1998 (November 1998

payment).14

     UTA did not withhold any taxes from the $4 million it paid

petitioner pursuant to the defamation agreement (i.e., with

respect to petitioner’s defamation claim).     Petitioner never

attempted to sell his anticipated stream of income from the

settlement.

Petitioner’s Tax Returns

     In April and May 1996, petitioner consulted with tax

accountants and tax attorneys to discuss the state of the tax law

as it related to the settlement with UTA.    Petitioner was told

that the $4 million allocated to the defamation claim would be

nontaxable.

     Petitioner advised his business manager, from the firm of

Kessler Schneider, to disclose the settlement with UTA on his tax

returns in the most clear and proper way possible.     Petitioner’s

business manager prepared petitioner’s tax returns in

consultation with petitioner’s tax attorneys.

     On his Federal income tax returns for 1992 through 1996,

petitioner reported the following total salary and bonus received

from UTA:     $450,000 in 1992, $954,000 in 1993, $1,190,229 in

1994, $1,956,408 in 1995, and $1,768,681 in 1996.




     14
        Sometime after the settlement was executed, UTA ceased
making payments provided for in the settlement agreement. A
lawsuit ensued, and payments eventually resumed.
                               - 30 -

      Hofflund Polone, a partnership, allocated to petitioner or

petitioner’s wholly owned corporation the following taxable

income:   $84,416 in 1996, $1,300,423 in 1997, $1,624,867 in 1998,

$1,684,024 in 1999, $2,395,145 in 2000, and $2,377,146 in 2001.

      On or about October 10, 1997, petitioner filed his 1996

Federal income tax return.    Petitioner did not include the May

1996 payment in income on his 1996 return.    Petitioner reported,

under other income on his 1996 return, a $1 million payment from

UTA on his 1996 return.    This amount, which represented the

November 1996 payment, was in addition to the wages he reported

from UTA in 1996.   Statement 1 of petitioner’s 1996 return

stated:   “Taxpayer received $1 million from United Talent Agency

(UTA), representing settlement of claims by taxpayer for personal

injury against UTA, pursuant to an agreement as of May 1, 1996.

The lump-sum payment received does not constitute income subject

to self-employment tax.”

      On his 1997 return, petitioner reported, under other income,

$2,000.   Petitioner did not include the May 1997 payment in

income.   On the line for other income “See Statement 1" was typed

in.   Statement 1 of petitioner’s 1997 return listed $2,000 from

Conde Nast Publications and $1 million from UTA as “miscellaneous

income” and subtracted out $1 million as UTA settlement proceeds

to arrive at a total of $2,000.    Below the subtraction were the

words “see footnote”.   The footnote, contained in statement 2,

stated:
                               - 31 -

     Taxpayer settled a lawsuit with his prior employer for
     defamation on May 1, 1996, by entering into a
     settlement agreement. In the settlement agreement, the
     taxpayer released his former employer from any
     liability related to his claims for defamation and, in
     exchange, received $4 million. This $4 million was
     comprised of the former employer’s promise to pay $1
     million at the time the settlement agreement was
     executed, $1 million in November 1996, $1 million in
     May 1997 and $1 million in November 1997.

     During the tax year 1997, the taxpayer received the
     lawsuit settlement installment in May 1997. The former
     employer failed to make payment in November 1997.

     Under “Warren Jones v. Commissioner,” 524 F. 2nd 788
     (9th Cir. 1975), rev’g 60 T.C. 663 (1973), and “Heller
     Trust v. Commissioner,” 382 F.2nd 675 (9th Cir. 1967),
     the taxpayer is required to treat his receipt of his
     former employer’s promise to pay $4 million as an
     amount realized in the 1996 taxable year at the time of
     his receipt of the promise to pay, in May 1996. Under
     IRC section 104, amounts received in May 1996 on
     account of claims for defamation and other tort type
     rights were excludable from gross income. (Reg. sec.
     1.104-1(c)).

     Accordingly, the taxpayer’s receipt of his former
     employer’s promise to pay was excludable from gross
     income.

Petitioner’s 1997 return also included a Form 8275, Disclosure

Statement.   The disclosure statement cross-referenced the above

footnote.

     On his 1998 return, petitioner reported his other income in

substantially the same manner as it was reported on his 1997

return--i.e., petitioner did not include the November 1998

payment in income and included a statement and a footnote similar

to those on his 1997 return.   The footnote on the 1998 return

also noted that petitioner received the payment he was supposed

to receive in November 1997 in November 1998.   Petitioner’s 1998
                               - 32 -

return also included a Form 8275.    The disclosure statement

cross-referenced the footnote in Statement 2.

     On or about April 16, 1998, petitioner filed an amended 1996

Federal income tax return.    On the amended return, among other

things, petitioner decreased his adjusted gross income by $1

million.   Essentially, petitioner sought to exclude the November

1996 payment from income and sought a refund of Federal income

taxes paid with respect to the November 1996 payment.

Petitioner’s amended return also included a Form 8275.    The

disclosure statement referred to an attached explanation.      The

explanation was substantially similar to paragraphs 1 and 3 of

the footnote contained in his 1997 return.    The explanation also

stated:    “The taxpayer’s original 1996 Form 1040, however,

erroneously reported $1 million of the amounts received under the

settlement agreement as income.    As a result, taxpayer is now

filing this amended return to correct the error in his original

return.”

Examination of Petitioner’s 1996, 1997, and 1998 Tax Returns

     Revenue Agent Marcelle Colline (RA Colline) conducted the

examination of petitioner’s 1996, 1997, and 1998 returns.      RA

Colline has worked at the Internal Revenue Service (IRS) for

approximately 20 years.    During most of that time, she has been a

revenue agent.    In 2001, she was promoted to manager.
                                - 33 -

     John Alan Harbin represented petitioner during the

examination of petitioner’s 1996, 1997, and 1998 returns.      Mr.

Harbin is an attorney and a certified public accountant.

     RA Colline met with Mr. Harbin several times during the

examination.    RA Colline issued several Information Document

Requests (IDR) to petitioner.    Mr. Harbin was professional, but

he delayed several times in responding to the IRS.

     RA Colline requested that petitioner sign a Form 12180,

Third Party Authorization.    RA Colline requested permission to

interview a third party--Mr. Berkus.     Mr. Harbin stated that he

would sign the Form 12180; however, over a month passed and he

never signed the form.    RA Colline summoned Mr. Berkus and

interviewed him.

     On July 26, 1999, RA Colline issued an IDR (July 26 IDR) to

petitioner.    She received none of the requested documents.    All

three items requested concerned the settlement documents for the

litigation between petitioner and UTA regarding UTA’s termination

of petitioner.    RA Colline did not obtain the information

requested in the July 26 IDR from petitioner.    In October 1999,

she obtained this information from Mr. Berkus.

     On November 8, 1999, RA Colline issued an IDR (November 8

IDR) to petitioner.15    The November 8 IDR requested tax return

information regarding petitioner from Hofflund Polone and Bedford



     15
        This document also informed petitioner that his 1997 and
1998 tax years were under examination.
                              - 34 -

Falls Investors, L.P.,16 for 1996, 1997, and 1998.   RA Colline

did not receive any information regarding Hofflund Polone from

petitioner, and Mr. Harbin provided information only for 1998

regarding Bedford Falls Investors, L.P.

     In the November 8 IDR, RA Colline also requested copies of

petitioner’s 1997 and 1998 income tax returns.   Mr. Harbin

eventually sent petitioner’s 1998 return after RA Colline advised

him that she had obtained copies of petitioner’s 1997 return.

     During the examination, RA Colline requested an interview

with petitioner to gather information about, and petitioner’s

explanation of, items on petitioner’s returns that were under

examination.   Mr. Harbin absolutely refused to allow petitioner

to be interviewed.   Petitioner testified for over 4-1/2 hours

during the trial of this case.

Respondent’s Determination and Denial of Petitioner’s
Refund Claim

     On or about February 15, 2000, respondent denied

petitioner’s claim for refund for 1996 (relating to the November

1996 payment).   The reason for disallowance was that the $1

million payment associated with petitioner’s refund request did

not qualify as tax-free income.

     In the notice of deficiency, respondent determined that the

May 1996 payment, the May 1997 payment, and the November 1998



     16
        Bedford Falls Investors, L.P., was listed as a
partnership petitioner received income or loss from on Schedule D
of his 1996, 1997, and 1998 returns.
                                - 35 -

payment were includable in petitioner’s taxable income for 1996,

1997, and 1998, respectively.17    Respondent also determined a

penalty pursuant to section 6662 for all 3 years.

Refund Litigation

     On February 14, 2002, petitioner filed a complaint in U.S.

District Court seeking a refund of the Federal income taxes

attributable to his including the November 1996 payment in income

on his 1996 return.

                                OPINION

I.   Burden of Proof

     The parties vigorously dispute who bears the burden of

proof.    Section 7491(a) places the burden of proof on the

Commissioner with regard to certain factual issues if certain

conditions are met.     Higbee v. Commissioner, 116 T.C. 438, 440

(2001).   Section 7491 applies to examinations commenced after

July 22, 1998.    Id.   Respondent concedes that the examination of

petitioner’s 1996, 1997, and 1998 tax years began after the

effective date of section 7491.

     Section 7491(a)(2) provides that the Commissioner will bear

the burden of proof with respect to an issue pursuant to section

7491(a) if:

          (A) the taxpayer has complied with the
     requirements under this title to substantiate any item;



     17
        Respondent also reduced petitioner’s itemized deductions
for 1996, 1997, and 1998 because of the increase in petitioner’s
income. This adjustment is purely computational.
                               - 36 -

          (B) the taxpayer had maintained all records
     required under this title and has cooperated with
     reasonable requests by the Secretary for witnesses,
     information, documents, meetings, and interviews; and

          (C) in the case of a partnership, corporation, or
     trust, the taxpayer is described in section
     7430(c)(4)(A)(ii).

The burden is on the taxpayer to show that he satisfied these

prerequisites.   H. Conf. Rept. 105-599, at 240, 242 (1998), 1998-

3 C.B. 747, 994, 996.

     Respondent contends, among other things, that petitioner did

not cooperate with respondent’s reasonable requests for

information, documents, and interviews; therefore, the burden of

proof does not shift to respondent.     Respondent’s IDRs and

request to interview petitioner were requests for information,

documents, and an interview.   Thus, we must decide whether

respondent’s requests were reasonable and whether petitioner

failed to cooperate.

     A.   Reasonable Request

     We consider all the surrounding facts and circumstances of

this case in deciding whether respondent’s request for witnesses,

information, documents, meetings, and interviews is reasonable.

Respondent requested information concerning the settlement

documents regarding UTA’s termination of petitioner and regarding

petitioner’s tax return information for the years in issue.     This

information was relevant to the determination of the taxable

amount of the May 1996 payment, the November 1996 payment, the
                               - 37 -

May 1997 payment, and the November 1998 payment, and to the

bottom line amount of taxable income petitioner had during the

years in issue.    Respondent requested an interview with

petitioner to gather information about, and petitioner’s

explanation of, items on petitioner’s returns that were being

examined.    On the basis of the facts and circumstances, we hold

that respondent’s requests in the July 26th IDR, in the November

8th IDR, and to interview petitioner were reasonable requests for

information, documents, and interviews.

     B.     Cooperation

     Whether the taxpayer cooperated with reasonable requests by

the Commissioner for witnesses, information, documents, meetings,

and interviews is based on all the surrounding facts and

circumstances of the case.    The statute itself does not state

what constitutes “cooperation”.    The conference committees’s

report states that the House bill provided:

     [T]he taxpayer must fully cooperate at all times with
     the Secretary (including providing, within a reasonable
     period of time, access to and inspection of all
     witnesses, information, and documents within the
     control of the taxpayer, as reasonably requested by the
     Secretary). Full cooperation also includes providing
     reasonable assistance to the Secretary in obtaining
     access to an inspection of witnesses, information, or
     documents not within the control of the taxpayer
     (including any witnesses, information, or documents
     located in foreign countries). A necessary element of
     fully cooperating with the Secretary is that the
     taxpayer must exhaust his or her administrative
     remedies (including any appeal rights provided by the
     IRS). The taxpayer is not required to agree to extend
     the statute of limitations to be considered to have
     fully cooperated with the Secretary. [H. Conf. Rept
                             - 38 -

     105-599, supra at 239, 1998-3 C.B. at 993; fn. refs.
     omitted; emphasis added.]

The conference committees’s report further states that the Senate

amendment provided:

     [T]he taxpayer must cooperate with reasonable requests
     by the Secretary for meetings, interviews, witnesses,
     information, and documents (including providing, within
     a reasonable period of time, access to and inspection
     of all witnesses, information, and documents within the
     control of the taxpayer, as reasonably requested by the
     Secretary). Cooperation also includes providing
     reasonable assistance to the Secretary in obtaining
     access to an inspection of witnesses, information, or
     documents not within the control of the taxpayer
     (including any witnesses, information, or documents
     located in foreign countries). A necessary element of
     cooperating with the Secretary is that the taxpayer
     must exhaust his or her administrative remedies
     (including any appeal rights provided by the IRS). The
     taxpayer is not required to agree to extend the statute
     of limitations to be considered to have cooperated with
     the Secretary. Cooperation also means that the
     taxpayer must establish the applicability of any
     privilege. * * * [Id. at 240, 1998-3 C.B. at 994; fn.
     refs. omitted; emphasis added.]

Thus, the Senate Amendment changed “full cooperation” to

“cooperation”, “fully cooperate” to “cooperate”, and “fully

cooperate at all times with the Secretary” to “cooperate with

reasonable requests by the Secretary for meetings, interviews,

witnesses, information, and documents”.   The conference agreement

followed the Senate Amendment except for some changes not

relevant to the definition of cooperation.

     Petitioner failed to provide documents within his control

requested in the July 26 IDR and November 8 IDR.   Petitioner

argues that because the documents contained in the July 26 IDR
                                - 39 -

were publicly available (i.e., at a courthouse) and from UTA (the

opposing party in the dispute involving petitioner’s

termination), and because respondent eventually received some of

these documents from Mr. Berkus, albeit several months later, the

fact that petitioner did not provide this information to

respondent does not mean petitioner was uncooperative.

Petitioner also argues that, because petitioner’s 1997 return was

available from the service center, the fact that petitioner did

not provide his 1997 return to respondent does not indicate that

petitioner was uncooperative.    We disagree.

     The fact that respondent could obtain documents and/or

information from another source, and/or did eventually obtain the

documents and/or information from another source, does not

relieve petitioner from his obligation to cooperate if petitioner

desires the benefit of the provisions of section 7491(a).18   If

this were not the case, taxpayers could be affirmatively

uncooperative but still gain the benefit of section 7491(a) so

long as the Commissioner was able to obtain the information that

he sought.

     Mr. Harbin’s conclusory statements that he was cooperative

on behalf of Mr. Polone are unpersuasive.   Mr. Harbin stated that

in cases involving celebrities, it is his business practice to


     18
        We note that it takes the Commissioner between 6 and 8
weeks to obtain return information from his internal
recordkeeping centers. Additionally, the information contained
on a transcript of account is not as clear as the actual return.
                               - 40 -

decline interviews with the taxpayer.   The fact that Mr. Harbin

thought petitioner was “world famous” in Hollywood does not

entitle petitioner to preferential treatment when it comes to

section 7491(a)--petitioner still needed to cooperate with

respondent in order to secure the benefits of section 7491(a).19

     Petitioner’s actions impeded respondent’s examination of

petitioner’s 1996, 1997, and 1998 returns.   Petitioner, by

failing to provide respondent with the information and documents

requested in the July 26 IDR and in the November 8 IDR, and by

refusing to be interviewed, did not provide respondent with

reasonable assistance in obtaining access to witnesses,

documents, and/or information.   On the basis of the facts and

circumstances of this case, we hold that petitioner failed to

cooperate with respondent’s reasonable request for information,

documents, and interviews.   Accordingly, petitioner bears the

burden of proof.20   Sec. 7491(a); Rule 142(a).



     19
        Petitioner argues that the legislative history of sec.
7491 demonstrates that the intent of the section is only to
require sharing documents and other information with respondent.
We disagree. The legislative history specifically mentions
cooperating with requests for interviews and access to all
witnesses. H. Conf. Rept. 105-599, at 240 (1998), 1998-3 C.B.
747, 994. More importantly, the statute specifically provides
that the taxpayer has to cooperate with reasonable requests for
interviews. Sec. 7491(a)(2)(B).
     20
        We note it appears that petitioner did not exhaust his
administrative remedies. This is an alternative reason to hold
that the burden of proof does not shift in this case. H. Conf.
Rept. 105-599, supra at 240, 1998-3 C.B. at 994.
                                - 41 -

II.   Exclusion pursuant to Section 104(a)(2)

      Respondent determined that the May 1996 payment, the May

1997 payment, and the November 1998 payment are not excludable

pursuant to section 104(a)(2).     Respondent also denied

petitioner’s refund claim (relating to the November 1996 payment)

for the same reason.     Petitioner challenges respondent’s

determination and the denial of his refund claim.21

      A.   Section 104

      As a general rule, the Internal Revenue Code imposes a

Federal tax on the taxable income of every individual.      Sec. 1.

Section 61(a) specifies that, “Except as otherwise provided”,

gross income for purposes of calculating such taxable income

means “all income from whatever source derived”.     The Supreme

Court has long reiterated the sweeping scope of section 61.

Commissioner v. Schleier, 515 U.S. 323, 327 (1995); Commissioner

v. Glenshaw Glass Co., 348 U.S. 426, 429-431 (1955).

      Section 104, in contrast, provides an exception with respect

to compensation for injuries or sickness.     Such exclusions from

gross income are construed narrowly.     Commissioner v. Schleier,

supra at 328; United States v. Burke, 504 U.S. 229, 248 (1992)

(Souter, J., concurring in judgment); Banaitis v. Commissioner,

340 F.3d 1074, 1079 (9th Cir. 2003), affg. in part and revg. in

part T.C. Memo. 2002-5.     Before its amendment on August 20, 1996,


      21
         We note that we have jurisdiction to determine whether
there was an overpayment of tax for 1996. Secs. 6512(b),
7422(e).
                                - 42 -

by the Small Business Job Protection Act of 1996 (SBJPA), Pub. L.

104-188, sec. 1605, 110 Stat. 1838, section 104 read in pertinent

part as follows (pre-SBJPA section 104):

     SEC. 104. COMPENSATION FOR INJURIES OR SICKNESS.

          (a) In General.--Except in the case of amounts
     attributable to (and not in excess of) deductions
     allowed under section 213 (relating to medical, etc.,
     expenses) for any prior taxable year, gross income does
     not include--

                *     *     *       *     *     *     *

               (2) the amount of any damages received
          (whether by suit or agreement and whether as lump
          sums or as periodic payments) on account of
          personal injuries or sickness;

The reference to personal injuries in this former version of the

statute did not include purely economic injuries but did embrace

“nonphysical injuries to the individual, such as those affecting

emotions, reputation, or character”.     United States v. Burke,

supra at 235 n.6, 239; see Commissioner v. Schleier, supra at

329-331; Roemer v. Commissioner, 716 F.2d 693 (9th Cir. 1983)

(holding that compensation paid for defamation, as defined by

California law, is excludable from income pursuant to pre-SBJPA

section 104), revg. 79 T.C. 398 (1982); see also Threlkeld v.

Commissioner, 87 T.C. 1294 (1986) (aligning the Court with the

decision in Roemer), affd. 848 F.2d 81 (6th Cir. 1988).

     The SBJPA then amended section 104, as relevant here, to

provide (post-SBJPA section 104):

     SEC. 104. COMPENSATION FOR INJURIES OR SICKNESS.

          (a) In general.--Except in the case of amounts
     attributable to (and not in excess of) deductions
                                - 43 -

     allowed under section 213 (relating to medical, etc.,
     expenses) for any prior taxable year, gross income does
     not include--

                *     *     *       *     *       *     *

               (2) 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;

                *     *     *       *     *       *     *

     * * * For purposes of paragraph (2), emotional distress
     shall not be treated as a physical injury or physical
     sickness. The preceding sentence shall not apply to an
     amount of damages not in excess of the amount paid for
     medical care * * * attributable to emotional distress.

The legislative history accompanying passage of the SBJPA

additionally clarifies that “the term emotional distress includes

symptoms (e.g., insomnia, headaches, stomach disorders) which may

result from such emotional distress.”    H. Conf. Rept. 104-737, at

301 n.56 (1996), 1996-3 C.B. 741, 1041.       Post-SBJPA section 104

is effective for amounts received after August 20, 1996.      SBJPA,

sec. 1605(d), 110 Stat. 1839.

     Regulations promulgated under section 104 further define

“damages received (whether by suit or agreement)” 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.”   Sec. 1.104-1(c), Income Tax Regs.

     For purposes of applying the above statutory and regulatory

text in effect before the SBJPA, the U.S. Supreme Court in
                               - 44 -

Commissioner v. Schleier, supra at 336-337, established a two-

pronged test for ascertaining a taxpayer’s eligibility for the

section 104(a)(2) exclusion.   “First, the taxpayer must

demonstrate that the underlying cause of action giving rise to

the recovery is ‘based upon tort or tort type rights’; and

second, the taxpayer must show that the damages were received ‘on

account of personal injuries or sickness.’”     Id. at 337; Banaitis

v. Commissioner, supra at 1079.    This test has since been

extended to apply to post-SBJPA section 104, with the

corresponding change that the second prong now requires proof

that the personal injuries or sickness for which the damages were

received were physical.   Shaltz v. Commissioner, T.C. Memo. 2003-

173; Henderson v. Commissioner, T.C. Memo. 2003-168; Prasil v.

Commissioner, T.C. Memo. 2003-100.

     B.   Did Petitioner Make a Tort Claim?

     Respondent argues that petitioner’s claims regarding his

termination did not sound in tort.

     The determination of whether a settlement payment is exempt

pursuant to section 104 depends on the nature of the claim

settled and not on the validity of the claim.    Robinson v.

Commissioner, 102 T.C. 116, 126 (1994), affd. in part, revd. in

part and remanded on another issue 70 F.3d 34 (5th Cir. 1995);

Seay v. Commissioner, 58 T.C. 32, 37 (1972).    The determination

of the nature of the claim is a factual one based on an

examination of all the evidence.     Robinson v. Commissioner,
                               - 45 -

supra; Stocks v. Commissioner, 98 T.C. 1, 11 (1992); Seay v.

Commissioner, supra.

     Respondent does not argue that defamation is not a tort

under the law of California.   See Roemer v. Commissioner, supra

(holding that defamation is a cause of action based upon tort or

tort type rights).   Respondent contends that petitioner “did not

have a viable defamation claim against UTA.”    Viability of the

claim is not a factor that controls the determination of

exclusion pursuant to section 104.22    See Robinson v.

Commissioner, supra; Seay v. Commissioner, supra.    We conclude

that petitioner made tort or tortlike claims against UTA.23

     C.   Whether To Respect the Settlement’s Allocation (Whether
          the Payments Were on Account of the Defamation)

     Respondent next argues that the allocation of the payments

made in the employment termination agreement and the defamation

agreement should not be respected because the allocation occurred

in an uncontested, nonadversarial, tax-motivated context.

     Generally, an express allocation in the settlement agreement

of a portion of the proceeds to tort or tort like claims is

binding for tax purposes if the agreement was entered into by the


     22
        Viable is defined as “capable of success or ongoing
effectiveness”. Valid is defined as “legally sound”. Webster’s
II New Riverside University Dictionary 1274, 1285 (1994).
Accordingly, a cause of action could be valid (legally sound) but
not viable (winnable).
     23
        We note that respondent does not refer to the other
claims in addition to defamation, including intentional
infliction of emotional distress and invasion of privacy,
contained in the complaint.
                              - 46 -

parties in an adversarial context at arm’s length and in good

faith.   Bagley v. Commissioner, 105 T.C. 396, 406 (1995), affd.

121 F.3d 393 (8th Cir. 1997); Robinson v. Commissioner, 87

T.C. at 127; Threlkeld v. Commissioner, supra at 1306-1307; Fono

v. Commissioner, 79 T.C. 680, 694 (1982), affd. without published

opinion 749 F.2d 37 (9th Cir. 1984).

     We found the testimony of numerous witnesses who testified

that the settlement negotiations between UTA and petitioner were

adversarial, at arm’s length, and in good faith to be credible.

The settlement negotiations involved two hard-nosed parties who

fought over almost every point in the agreement.   At no time

during the settlement negotiations was petitioner or his counsel

able to dictate settlement terms to UTA or UTA’s counsel, or vice

versa.

     UTA’s principals and UTA’s counsel were formidable and

experienced negotiators and were qualified to handle the

negotiation of all aspects of the defamation agreement and the

employment termination agreement.   Mr. Berkus was a

sophisticated, experienced negotiator.   UTA believed that the

release of petitioner’s defamation claim against UTA was a

necessary and material part of the settlement.   UTA would not

have agreed to settle with petitioner if petitioner had not given

a release of legal claims, including the defamation claim, to UTA

as part of the settlement.
                               - 47 -

     Respondent specifically argues that the allocation of $4

million to the defamation claim was not adversarial.    We

disagree.   The allocation of the $4 million of the settlement

payments to petitioner’s defamation claim was at arm’s length, in

good faith, and part of an adversarial negotiation.24

     Respondent points to the fact that Mr. Dunham did not object

to the allocation of $4 million in the settlement agreement to

the defamation claim.   We see no reason why UTA’s counsel would

object to a term his clients negotiated.    Mr. Dunham stated that

one reason that the $4 million allocation was not contested when

the settlement documents were being exchanged was that the

allocation was consistent with the agreement the parties had

reached.    The record evidences that the agreement was reached as

part of an adversarial confrontation.

     During the negotiations, UTA disputed several issues in the

defamation agreement relating to the tax treatment of the

settlement payments including the allocation of the settlement

payments among petitioner’s defamation and other claims.     Mr.

Berkus initially objected to the allocation of $4 million to the

defamation claim; however, UTA ultimately agreed to this

allocation.   This was just one of many issues on which

compromises were reached.   The allocation contained in the




     24
        We note that UTA did not want to admit to anyone that it
had defamed petitioner.
                               - 48 -

settlement documents was consistent with the agreement reached by

UTA and petitioner.

     The final settlement documents were negotiated back and

forth between petitioner’s and UTA’s attorneys.   The allocation

was negotiated before Mr. Cohen, petitioner’s tax counsel,

prepared the settlement documents, and these documents reflected

the settlement that had already been negotiated between

petitioner and UTA.

     Respondent argues that the following language contained in

the April 24, 1996, letter proves that the allocation was not

arm’s length or adversarial:

     UTA will cooperate with Mr. Polone in his efforts to
     obtain the most favorable tax treatment for the
     payments described above, and in the event that UTA
     incurs liability due to a challenge by the IRS of tax
     treatment requested of UTA by Mr. Polone, Mr. Polone
     will indemnify UTA.

Given the acerbic relationship between petitioner and UTA, it is

understandable why this language was inserted into the April 24,

1996, letter.   Witnesses credibly testified that petitioner

feared that UTA would attempt to sabotage the legitimate tax

treatment petitioner was entitled to under the defamation

agreement.

     We note that petitioner’s attorneys testified that they

estimated the breach of contract claim to be worth $8 million and

the defamation claim to be worth $12 million--i.e., that 60

percent of the total damages should be allocated to the

defamation claim.   The parties settled upon an allocation of $4
                              - 49 -

million for the defamation claim and $2 million plus the back-end

payments for the breach of contract claim.   At the time of the

settlement, the back-end payments were estimated to be worth

approximately $2 million.   This meant that at the time of the

settlement (and allocation), the parties allocated only 50

percent (10 percent less than petitioner initially sought) to the

defamation claim.   By the time of trial, the back-end payments

significantly exceeded $2 million and were continuing to be made

to petitioner.   Accordingly, even less than 50 percent of the

settlement actually was allocated to the defamation claim.

     Upon the basis of all the facts and circumstances, we

believe that UTA intended that the $4 million UTA paid petitioner

pursuant to the defamation agreement was to settle petitioner’s

defamation claim and that this amount was appropriately allocated

to this claim.

     At the end of the trial, respondent conceded that if we

respected the allocation of the settlement, then the May 1996

payment is excludable from income pursuant to pre-SBJPA section

104(a)(2).   Accordingly, this resolves petitioner’s 1996 tax

year.25




     25
        Respondent’s concession also means that there is no
understatement or underpayment for 1996. Accordingly, petitioner
is not liable for the sec. 6662 penalty for 1996. Secs. 6662(a),
(d), 6664(a).
                               - 50 -

     D.     The Remaining Three Payments

     The remaining dispute between the parties mainly turns upon

which version of section 104 is applicable to the November 1996

payment, the May 1997 payment, and the November 1998 payment (the

three payments).    Respondent contends that post-SBJPA section 104

is applicable; petitioner makes two arguments why pre-SBJPA

section 104 is applicable.    If post-SBJPA section 104 applies,

the three payments are not excludable from income because

petitioner did not suffer a physical injury.

            1.   Amount Realized

     Petitioner’s first argument is that post-SBJPA section 104

is inapplicable to the three payments because UTA’s obligation to

make the three payments constituted an amount realized for tax

purposes in May 1996 (before the amendment of section 104 by the

SBJPA).26   This argument fails for several reasons.

     In construing section 104, our task is to give effect to the

intent of Congress.    We begin with the statutory language, which

is the most persuasive evidence of the statutory purpose.     United

States v. Am. Trucking Associations, Inc., 310 U.S. 534, 542-543

(1940); Hospital Corp. of Am. v. Commissioner, 107 T.C. 116, 128

(1996) affd 348 F.3d 136 (6th Cir. 2003).




     26
        Petitioner cites, among other things, private letter
rulings (PLRs) to support this argument. Parties are statutorily
proscribed from citing PLRs as precedent. Sec. 6110(k)(3)
(formerly sec. 6110(j)(3)); Willamette Indus., Inc. v.
Commissioner, 118 T.C. 126, 134 n.10 (2002).
                               - 51 -

     The plain meaning of statutory language ordinarily is

conclusive.    United States v. Ron Pair Enters., Inc., 489 U.S.

235, 241-242 (1989); Hospital Corp. of Am. v. Commissioner,

supra.   If the language of a statute is clear, we look no further

than that language in determining the meaning of the statute.

See Sullivan v. Stroop, 496 U.S. 478, 482 (1990); United States

v. Ron Pair Enters., Inc., supra at 241.   A court looks to

legislative history only if the statute is unclear.    Blum v.

Stenson, 465 U.S. 886, 896 (1984); United States v. Lewis, 67

F.3d 225, 228-229 (9th Cir. 1995).

     The plain language of the statute, both pre- and post-

amendment by the SBJPA, refers to the amount of damages

“received”, not the amount “realized”.   Sec. 104(a)(2); see also

SBJPA sec. 1605(d)(1) (“the amendments made by this section shall

apply to amounts received after the date of the enactment of this

Act, in taxable years ending after such date” (emphasis added)).

Petitioner’s “realization” argument ignores the plain language of

the statute.   Petitioner did not receive the three payments

before August 20, 1996.

     Additionally, amounts are included in gross income for the

taxable year in which they are received by the taxpayer.     Sec.

451(a); Knoll v. Commissioner, T.C. Memo. 2003-277 (applying this

principle in the context of a section 104 case).   Petitioner

received the May 1997 payment and the November 1998 payment in

1997 and 1998 (and the November 1996 payment after August 20,
                                - 52 -

1996).     Accordingly, the receipt of the payments in 1997 and 1998

by petitioner, a cash basis taxpayer, results in income taxable

in petitioner’s 1997 and 1998 tax years.27    See Knoll v.

Commissioner, supra.

     Furthermore, petitioners argue that the three payments had

an ascertainable fair market value in May 1996.     Even if

petitioner’s execution of the settlement agreements constituted a

disposition of property,28 there is no evidence in the record of

the fair market value of the three payments in May 1996.      No

expert reports were submitted, and no experts testified at trial

regarding the fair market value of the three payments in May

1996.     There is not even lay testimony regarding the fair market

value of the three payments in May 1996.     Accordingly, the

evidence does not establish that the three payments, or UTA’s

obligation to make the three payments, had an ascertainable fair

market value in May 1996.29    The evidence does not establish that


     27
        Petitioner does not argue that the $2 million lump-sum
and the back-end payments paid to settle the breach of contract
claim should also be included in petitioner’s income in 1996
(thereby increasing the deficiency for 1996) under his amount
realized theory.
     28
        We have previously rejected the argument that a
taxpayer’s execution of an agreement to settle a lawsuit
regarding his termination by his former employer constitutes a
disposition of property. Alexander v. Commissioner, T.C. Memo.
1995-51, affd. 72 F.3d 938 (1st Cir. 1995); see Nahey v.
Commissioner, 111 T.C. 256 (1998), affd. 196 F.3d 866 (7th Cir.
1999).
     29
        The marketability of these payments is further suspect
given the confidentiality (nondisclosure) provisions contained in
                                                   (continued...)
                                - 53 -

the defamation agreement was a cash equivalent--i.e., that it was

assignable or contained a promise to pay that was frequently

transferred to lenders or investors at not substantially greater

than the generally prevailing premium for the use of money.

Cowden v. Commissioner, 289 F.2d 20 (5th Cir. 1961), revg. 32

T.C. 853 (1959).     We also note that UTA was unwilling to pay the

entire $4 million as a lump sum “up front”.     See Jombo v.

Commissioner, T.C. Memo. 2002-273.

     2.      Constitutionality of Section 104

     Petitioner’s second argument is that post-SBJPA section 104

is unconstitutional because it is retroactive and violates due

process.

     Post-SBJPA section 104 is not retroactive.     Venable v.

Commissioner, T.C. Memo. 2003-240 n.1.     SBJPA section 1605(d)(1)

provides that the amendments made by SBJPA section 1605 shall

apply to amounts received after the date of the enactment of the

SBJPA, in taxable years ending after such date.     SBJPA section

1605(d)(2) provided an exception to this rule for amounts

received under a written binding agreement, court decree, or

mediation award in effect (or issued on or before) September 13,

1995.     Accordingly, post-SBJPA section 104 applies only to

amounts received after its effective date; it does not affect the




     29
      (...continued)
the settlement agreements.
                             - 54 -

inclusion or exclusion from income of amounts received before its

effective date.

     Even if post-SBJPA section were retroactive, it would not

run afoul of the standard for retroactivity of tax laws.   In

Landgraf v. USI Film Prods., 511 U.S. 244, 280 (1994), the

Supreme Court stated the following rule:

          When a case implicates a federal statute enacted
     after the events in suit, the court’s first task is to
     determine whether Congress has expressly prescribed the
     statute’s proper reach. If Congress has done so, of
     course, there is no need to resort to judicial default
     rules. When, however, the statute contains no such
     express command, the court must determine whether the
     new statute would have retroactive effect, i.e.,
     whether it would impair rights a party possessed when
     he acted, increase a party’s liability for past
     conduct, or impose new duties with respect to
     transactions already completed. If the statute would
     operate retroactively, our traditional presumption
     teaches that it does not govern absent clear
     congressional intent favoring such a result.

Hence, the threshold question is whether Congress expressly

provided that the disputed statute should apply retroactively or

prospectively.

     While the Supreme Court has indicated that “A statement that

a statute will become effective on a certain date does not even

arguably suggest that it has any application to conduct that

occurred at an earlier date”, Landgraf v. USI Film Prods., id. at

257, the text of SBJPA section 1605(d)(1) constitutes markedly

more than “the mere promulgation of an effective date”, INS v.

St. Cyr, 533 U.S. 289, 317 (2001).    SBJPA section 1605(d)(1) does

not just state when the law is to take effect.   Rather, the
                               - 55 -

provision explicitly dictates the particular conduct and the

timing thereof to which the amendments “shall apply”.    According

to the express text, receipt of payments after the August 20,

1996, date of enactment falls within the intended scope of the

post-SBJPA section 104, unless the explicit exception for a prior

binding agreement, court decree, or mediation award is

applicable.

     Here, a final, written, and binding settlement agreement was

not entered into until 1996.   Petitioner’s situation therefore

fails to satisfy the requisites for relief under SBJPA section

1605(d)(2).   In that event, SBJPA section 1605(d)(1) explicitly

and unambiguously prescribes the temporal reach of the section

104 amendments to the situation at hand.   We conclude that

Landgraf v. USI Film Prods., supra, would pose no barrier here to

application of post-SBJPA section 104.

     Moreover, less than 2 months after issuing its decision in

Landgraf, the Supreme Court decided United States v. Carlton, 512

U.S. 26 (1994).   The issue in United States v. Carlton, supra at

27, was the propriety of retroactive application of an amendment

to a Federal estate tax statute.   In that context, the Supreme

Court explained as follows:

          This Court repeatedly has upheld retroactive tax
     legislation against a due process challenge. Some of
     its decisions have stated that the validity of a
     retroactive tax provision under the Due Process Clause
     depends upon whether retroactive application is so
     harsh and oppressive as to transgress the
     constitutional limitation. The harsh and oppressive
                              - 56 -

     formulation, however, does not differ from the
     prohibition against arbitrary and irrational
     legislation that applies generally to enactments in the
     sphere of economic policy. The due process standard to
     be applied to tax statutes with retroactive effect,
     therefore, is the same as that generally applicable to
     retroactive economic legislation: * * * that burden is
     met simply by showing that the retroactive application
     of the legislation is itself justified by a rational
     legislative purpose. [Id. at 30-31; internal
     quotations and citations omitted.]

The Supreme Court further noted:

     “Taxation is neither a penalty imposed on the taxpayer
     nor a liability which he assumes by contract. It is
     but a way of apportioning the cost of government among
     those who in some measure are privileged to enjoy its
     benefits and must bear its burdens. Since no citizen
     enjoys immunity from that burden, its retroactive
     imposition does not necessarily infringe due process *
     * * ” [Id. at 33 (quoting Welch v. Henry, 305 U.S.
     134, 146-147 (1938)).]

     In general, the raising of Government revenue is considered

a sufficient and legitimate legislative purpose for supporting a

“modest” period of retroactivity.   Id. at 32-33; id. at 37

(O’Connor, J., concurring in judgment); NationsBank v. United

States, 269 F.3d 1332, 1337-1338 (Fed. Cir. 2002); Quarty v.

United States, 170 F.3d 961, 967 (9th Cir. 1999); Furlong v.

Commissioner, 36 F.3d 25, 27-28 (7th Cir. 1994), affg. T.C. Memo.

1993-191.   The principal exception to this reasoning discernible

from caselaw arises in scenarios involving imposition of a

“wholly new tax”.   See United States v. Carlton, supra at 34;

Quarty v. United States, supra at 966-967; Furlong v.

Commissioner, supra at 27; Wiggins v. Commissioner, 904 F.2d 311,

314 (5th Cir. 1990), affg. 92 T.C. 869 (1989).
                               - 57 -

       The imposition of a wholly new tax is to be distinguished

from changes in the rate of an existing tax.    United States v.

Darusmont, 449 U.S. 292, 298-300 (1981); Quarty v. United States,

supra at 966-967; Honeywell, Inc. v. United States, 973 F.2d 638,

642-643 (8th Cir. 1992); Estate of Ekins v. Commissioner, 797

F.2d 481, 484-485 (7th Cir. 1986); Fein v. United States, 730

F.2d 1211, 1212-1214 (8th Cir. 1984); Estate of Ceppi v.

Commissioner, 698 F.2d 17, 20-21 (1st Cir. 1983), modifying 78

T.C. 320 (1982).    Furthermore, amendments which eliminate an

exemption, exclusion, or tax credit have repeatedly been

construed as “‘closer in kind and in effect to a mere increase in

the tax rate than to the enactment of a wholly new tax.’”

Honeywell, Inc. v. United States, supra at 642-643 (quoting Fein

v. United States, supra at 1213); see also Estate of Ekins v.

Commissioner, supra at 484-485; Estate of Ceppi v. Commissioner,

supra at 17, 21.

       Turning to the case at bar, the SBJPA amendments to section

104 restricted the availability of an exclusion from gross

income.    In that instance, retroactivity would not be

constitutionally objectionable on grounds related to a wholly new

tax.    Accordingly, petitioner’s situation does not present reason

for departure from the standards typically employed to evaluate

tax legislation.
                                - 58 -

     As regards legitimate governmental purpose, the legislative

history accompanying the SBJPA notes that “Courts have

interpreted the exclusion from gross income of damages received

on account of personal injury or sickness broadly in some cases

to cover awards for personal injury that do not relate to a

physical injury or sickness.”    H. Conf. Rept. 104-737, at 300

(1996), 1996-3 C.B. 741, 1040.    Congress’s choice to narrow the

exclusion, and any retroactive application of the change, would

therefore appear to be rationally linked to the legitimate

objective of raising revenue.    The legislative history further

reveals that the change was intended as a curative measure

designed to reduce or eliminate ambiguity in the otherwise

applicable law.   Reference is made to “confusion” that “led to

substantial litigation”, including the Supreme Court cases of

Commissioner v. Schleier, 515 U.S. 323 (1995), and United States

v. Burke, 504 U.S. 229 (1992).    H. Rept. 104-586, at 143 (1996),

1996-3 C.B. 331, 481.

     In addition, the period of “retroactivity” alleged by

petitioner in this case does not exceed what has been upheld in

other tax litigation.   See, e.g., Licari v. Commissioner, 946

F.2d 690 (9th Cir. 1991) (upholding application of tax penalty

passed in 1986 to returns previously filed for years 1982 through

1984), affg. T.C. Memo. 1990-4; Canisius Coll. v. United States,

799 F.2d 18, 26-27 (2d Cir. 1986) (upholding 4-year retroactive

application); Temple Univ. v. United States, 769 F.2d 126 (3d
                                - 59 -

Cir. 1985) (upholding at least a 4-year retroactive application);

Rocanova v. United States, 955 F. Supp. 27 (S.D.N.Y. 1996)

(upholding retroactive application of amendment extending statute

of limitation on tax collection actions from 6 to 10 years),

affd. 109 F.3d 127 (2d Cir. 1997). “The Supreme Court has never

explicitly imposed a time limit on the retroactivity of a tax

statute’s application.”     Wiggins v. Commissioner, supra at 316.

     To the extent petitioner raises issues of retroactivity,

application of the SBJPA amendments to section 104 would not

violate the standards requiring a rational purpose and reasonable

period.   The tests employed to evaluate retroactive legislation

therefore do not justify refusal to apply the law in effect for

the tax years under consideration.       We conclude that post-SBJPA

section 104 is neither retroactive nor unconstitutional.30      See

Young v. United States, 332 F.3d 893 (6th Cir. 2003); Venable v.

Commissioner, T.C. Memo. 2003-240.

     E.    Conclusion

     Petitioner’s arguments for the application of pre-SBJPA

section 104 to the three payments fails.      There is no evidence of

how much, if anything, petitioner spent for medical care for

emotional distress.     Therefore, petitioner failed to meet his


     30
        We note that petitioner also argues that he could have
avoided the application of post-SBJPA sec. 104 by receiving an
up-front payment. We disagree. UTA would not, and did not,
agree to an up-front, lump-sum payment.
                                 - 60 -

burden of proving that any amount was spent for medical care for

emotional distress.     See sec. 104(a) (flush language).

Petitioner did not suffer a physical injury as a result of his

termination by UTA.     Accordingly, the three payments are not

excludable pursuant to post-SBJPA section 104.

       Accordingly, we hold that:   (1) Petitioner is not liable for

the deficiency determined by respondent for 1996; (2) petitioner

is not entitled to an overpayment for 1996; and (3) petitioner is

liable for the deficiency determined by respondent for 1997 and

1998.

III.    Section 6662 Penalty

       Respondent argues that petitioner is liable for the section

6662 penalty for 1997 and 1998.31     Pursuant to section 6662(a), a

taxpayer may be liable for a penalty of 20 percent of the portion

of an underpayment of tax due to negligence or disregard of rules

or regulations or a substantial understatement of income tax.

Sec. 6662(b).     An “understatement” is the difference between the

amount of tax required to be shown on the return and the amount

of tax actually shown on the return.      Sec. 6662(d)(2)(A).   A

“substantial understatement” exists if the understatement exceeds

the greater of (1) 10 percent of the tax required to be shown on




       31
            See supra note 25 regarding 1996.
                              - 61 -

the return for a taxable year or (2) $5,000.   See sec.

6662(d)(1).

     Section 7491(c) provides that the Commissioner shall bear

the burden of production with respect to the liability of any

individual for penalties.   If a taxpayer files a petition

alleging some error in the determination of the penalty, the

taxpayer’s challenge will succeed unless the Commissioner

produces evidence that the penalty is appropriate.    Swain v.

Commissioner, 118 T.C. 358, 364 (2002).    “The Commissioner’s

burden of production under section 7491(c) is to produce evidence

that it is appropriate to impose the relevant penalty”.      Id. at

363; see also Higbee v. Commissioner, 116 T.C. at 446.    The

Commissioner, however, does not have the obligation to introduce

evidence regarding reasonable cause or substantial authority.

Higbee v. Commissioner, supra at 446.

     The evidence establishes that understatements for 1997 and

1998 exceed the greater of 10 percent of the tax required to be

shown on the returns for 1997 and 1998 or $5,000.    Accordingly,

respondent has met his burden of production.

     The accuracy-related penalty is not imposed with respect to

any portion of the underpayment as to which the taxpayer acted

with reasonable cause and in good faith.   Sec. 6664(c)(1).     The

decision as to whether the taxpayer acted with reasonable cause

and in good faith depends upon all the pertinent facts and
                              - 62 -

circumstances.   Sec. 1.6664-4(b)(1), Income Tax Regs.   Relevant

factors include the taxpayer’s efforts to assess his proper tax

liability, including the taxpayer’s reasonable and good faith

reliance on the advice of a professional.   See id.

     The record establishes that petitioner reasonably and in

good faith relied on his return preparers and attorneys.

Petitioner fully disclosed the facts surrounding the settlement

payments to his return preparers and attorneys.   Petitioner

directed his return preparers to report the settlement payments

from UTA in the clearest and most proper way.   His return

preparers consulted with tax attorneys before preparing

petitioner’s returns in issue.

     Consequently, we conclude that for 1997 and 1998 petitioner

had reasonable cause and acted in good faith as to any

underpayment resulting from the exclusion of the May 1997 payment

and the November 1998 payment.   Accordingly, we hold that

petitioner is not liable for the penalty pursuant to section

6662(a).32




     32
        We note that sec. 6662(d)(2)(B) provides an additional
basis for relieving petitioner from the sec. 6662 penalty--
petitioner adequately disclosed the relevant facts regarding the
payments he received pursuant to the defamation agreement on his
1997 and 1998 tax returns.
                             - 63 -

     In reaching all of our holdings herein, we have considered

all arguments made by the parties, and to the extent not

mentioned above, we find them to be irrelevant or without merit.

     To reflect the foregoing,

                                        Decision will be entered

                                   under Rule 155.
