                       T.C. Memo. 2009-132



                      UNITED STATES TAX COURT



          KEVIN F. AND ANN M. HENNESSEY, Petitioners v.
           COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 20484-07.             Filed June 9, 2009.



     Kevin F. and Ann M. Hennessey, pro sese.

     Michael W. Bitner, for respondent.



                        MEMORANDUM OPINION


     MARVEL, Judge:   Respondent determined an $8,688 deficiency

in petitioners’ 2004 Federal income tax.     Petitioners filed a

timely petition contesting respondent’s determination.     The issue

for decision is whether $27,9001 Mr. Hennessey received in 2004


     1
      Kevin F. Hennessey (Mr. Hennessey) received $30,000
                                                   (continued...)
                                   - 2 -

pursuant to a class action settlement agreement is excludable

from gross income under section 104(a)(2).2      We hold it is not.

                                Background

       The parties submitted this case fully stipulated under Rule

122.       We incorporate the stipulated facts into our findings by

this reference.       Petitioners resided in Missouri when they filed

their petition.

       Before 1993 Mr. Hennessey was a commissioned officer serving

on active duty with the U.S. Air Force.       In 1992, because of

congressionally mandated personnel reductions in the Armed

Forces, the Secretary of the U.S. Air Force established the

Fiscal Year 1993 Reduction-in-Force Board (Board).       The purpose

of the Board was to select U.S. Air Force officers for

involuntary separation.

       The Secretary of the U.S. Air Force issued a memorandum of

instruction (memorandum) that provided guidance on screening



       1
      (...continued)
pursuant to a class action settlement agreement, $2,100 of which
represented attorney’s fees, costs, and expenses. In the notice
of deficiency respondent stated that petitioners reported $2,100
of the $30,000 payment and allowed a deduction for this legal
expense. Although in his brief respondent states that it was
questionable whether petitioners were entitled to the $2,100
deduction, he does not assert an increased deficiency. Other
adjustments proposed in the notice of deficiency are
computational.
       2
      Unless otherwise indicated, all section references are to
the Internal Revenue Code, and all Rule references are to the Tax
Court Rules of Practice and Procedure.
                               - 3 -

officers for involuntary separation.    Paragraph 7 of the

memorandum stated that the Board’s “evaluation of minority and

women officers must clearly afford them fair and equitable

consideration.”   The memorandum also stated that in considering

women and minority officers, the Board should be sensitive to the

fact that such officers might have been disadvantaged from a

career perspective because of past individual and societal

attitudes, policies, and practices.    It allowed the Board to

consider these factors in ensuring that minority and female

officers received fair and equitable treatment.

     In 1993, pursuant to the Board’s recommendation, Mr.

Hennessey was removed from active duty status with the U.S. Air

Force and transferred to the U.S. Air Force Reserve.    In

reviewing records the Board considered the memorandum regarding

selection rates for minority and female officers.    Mr. Hennessey

is now a commissioned officer in the U.S. Air Force Reserve.

     On or about December 28, 1998, Mr. Hennessey and other

officers whom the Board selected for involuntary separation filed

a complaint in the U.S. Court of Federal Claims in the case of

Berkley v. United States, case No. 98-943C.    The plaintiffs

claimed that the Board violated their equal protection rights

under the Fifth Amendment to the U.S. Constitution because it

improperly considered race and gender in selecting officers for

involuntary separation.   The court certified plaintiffs as a
                                - 4 -

class under rule 23 of the Rules of the United States Court of

Federal Claims.   See Berkley v. United States, 45 Fed. Cl. 224,

235 (1999).

     The class action case was settled,3 and each member of the

class had an option of (1) receiving a $30,000 lump-sum payment

less attorney’s fees, costs, and expenses of $2,100 or (2)

requesting another retention review.     Mr. Hennessey received the

lump-sum payment in October 2004.   The lump-sum payment was not

compensation for physical injuries or physical sickness that Mr.

Hennessey might have suffered as a consequence of any actions

taken by employees of the U.S. Air Force.

     Petitioners jointly filed their 2004 return.    On their 2004

return petitioners did not include in income the $30,000 lump-sum

payment.

                            Discussion

     The Commissioner’s determinations generally are presumed

correct, and the taxpayer bears the burden of proving those

determinations are erroneous.   Rule 142(a); Welch v. Helvering,


     3
      The Court of Federal Claims first issued a decision in
favor of the Government. See Berkley v. United States, 48 Fed.
Cl. 361, 379 (2000), revd. 287 F.3d 1076 (Fed. Cir. 2002). After
the Court of Appeals for the Federal Circuit reversed the
judgment and remanded the case to the Court of Federal Claims for
further proceedings, see Berkley v. United States, 287 F.3d 1076
(Fed. Cir. 2002), the parties entered into settlement
negotiations. The settlement agreement is not part of the
record, but the parties stipulated the opinion of the Court of
Federal Claims, see Berkley v. United States, 59 Fed. Cl. 675
(2004), approving the settlement agreement.
                               - 5 -

290 U.S. 111, 115 (1933).   Petitioners do not contend that

section 7491(a)(1), which shifts the burden of proof to the

Commissioner if the requirements of section 7491(a)(2) are met,

applies.   Moreover, because this case is fully stipulated, there

are no disputed issues of fact that would be affected by an

allocation of the burden of proof under section 7491(a).

     Section 61(a) includes in gross income “all income from

whatever source derived” unless excluded by a specific provision

of the Code.   This section is construed broadly, whereas

exclusions from gross income are construed narrowly.

Commissioner v. Schleier, 515 U.S. 323, 327-328 (1995); United

States v. Burke, 504 U.S. 229, 233 (1992); Commissioner v.

Glenshaw Glass Co., 348 U.S. 426, 430 (1955).   Section 104(a)(2)

excludes from gross income “the amount of any damages (other than

punitive damages) received (whether by suit or agreement and

whether as lump sums or as periodic payments) on account of

personal physical injuries or physical sickness”.

     In Commissioner v. Schleier, supra at 337, the Supreme Court

stated that to be eligible for the section 104(a)(2) exclusion, a

taxpayer must demonstrate that (1) the underlying cause of action

giving rise to the recovery is based in tort or tort type rights

and (2) the damages were received on account of personal injuries

or sickness.   After the Supreme Court issued its opinion in

Schleier, Congress amended section 104(a)(2) (amendment),
                                 - 6 -

effective for amounts received after August 20, 1996, by adding a

requirement that in order to be excluded from gross income, any

amount received must be on account of personal injuries that are

physical or sickness that is physical.4    See Small Business Job

Protection Act of 1996, Pub. L. 104-188, sec. 1605, 110 Stat.

1838.     Accordingly, the amendment imposed an additional

requirement of physical injury or sickness to the test under

Commissioner v. Schleier, supra at 337.     Where damages are

received pursuant to a settlement agreement, the nature of the

claim that was the basis for the settlement determines whether

the damages are excludable under section 104(a)(2).     United

States v. Burke, supra at 237.

     Petitioners stipulated that the lump-sum payment Mr.

Hennessey received was not compensation for physical injuries or

physical sickness.    Accordingly, under section 104(a)(2)

petitioners may not exclude the lump-sum payment from gross

income.    However, petitioners raise several constitutional

objections to section 104(a)(2).

     Petitioners contend that the lump-sum payment is not income

because there was no accession to wealth and, accordingly, no

gain within the meaning of section 61(a).    Rather, they argue,



     4
      Preamendment personal injuries or sickness included
“nonphysical injuries to the individual, such as those affecting
emotions, reputation, or character”. United States v. Burke, 504
U.S. 229, 236 n.6 (1992).
                                  - 7 -

the payment was intended to make Mr. Hennessey “whole” for his

losses, which, in addition to the loss of wages, consisted of

lost promotional opportunities, lost military pension, damage to

reputation, and stigma of involuntary separation.     A similar

argument was raised by the taxpayer in Murphy v. IRS, 493 F.3d

170, 176-177 (D.C. Cir. 2007).5     The Court of Appeals for the

District of Columbia Circuit held that taxation of awards

received for personal, nonphysical injuries was within the power

of Congress.   Id. at 173, 186.    We agree with the Court of

Appeals, and we reject petitioners’ argument.

     Petitioners also argue that section 104(a)(2) violates the

Equal Protection Clause of the 14th Amendment as applicable to

the Federal Government through the Due Process Clause of the

Fifth Amendment under Bolling v. Sharpe, 347 U.S. 497, 500

(1954).   Petitioners argue that the Code treats taxpayers who

receive compensatory damages as a result of physical injuries

differently from those who suffer and are paid for nonphysical

injuries, with no rational basis for such a distinction.     In

Young v. United States, 332 F.3d 893, 895-896 (6th Cir. 2003),


     5
      The Court of Appeals for the District of Columbia Circuit
first agreed with the taxpayer and held that compensation for
mental distress and loss of reputation was not income within the
meaning of the 16th Amendment. Murphy v. IRS, 460 F.3d 79 (D.C.
Cir. 2006). However, the Court of Appeals then vacated its
decision, Murphy v. IRS, 99 AFTR 2d 2007-396, 2007-1 USTC par.
50,228 (D.C. Cir. 2006), and heard additional arguments before
issuing its decision rejecting that position, Murphy v. IRS, 493
F.3d 170 (D.C. Cir. 2007).
                               - 8 -

the Court of Appeals for the Sixth Circuit reviewed a similar

challenge to section 104(a)(2) on the ground of violation of

equal protection and held the statute constitutional.    We agree

with the Court of Appeals, and we reject petitioners’ argument.

     Petitioners also argue that taxation of the lump-sum payment

violates the Due Process and Takings Clauses of the Fifth

Amendment to the U.S. Constitution.    According to petitioners,

under Missouri State law reputational damage is damage to

property and Mr. Hennessey’s property interest in his employment

and reputation would not have been taxable in the absence of the

Board’s discriminatory actions.   Petitioners contend that taxing

such previously untaxable property interest amounts to an unjust

taking of petitioners’ property and forced conversion of their

assets for the public use.

     This constitutional challenge has no merit.    Generally, the

Fifth Amendment is not a limitation upon Congress’s taxing power.

See Regan v. Taxation With Representation, 461 U.S. 540 (1983);

A. Magnano Co. v. Hamilton, 292 U.S. 40, 44 (1934); Brushaber v.

Union Pac. R.R. Co., 240 U.S. 1, 24 (1916).    The Constitution

simply does not conflict with itself by conferring upon Congress

on the one hand the “power to lay and collect taxes on incomes”,

U.S. Const. amend. XVI, while taking away this power under the

Due Process Clause of the Fifth Amendment, Brushaber v. Union

Pac. R.R. Co., supra at 24.   In some limited circumstances a tax
                                  - 9 -

may be so arbitrary and capricious that it is not a permissible

exercise of the power to tax but rather a constitutionally

impermissible taking.   See id.     Section 104(a)(2), however, is

not arbitrary and capricious.     Congress’s purpose in enacting

section 104(a)(2) was to clarify the law and decrease litigation

for cases that do not involve physical injury or physical

sickness.    H. Conf. Rept. 104-737, at 300-301 (1996), 1996-3 C.B.

741, 1040-1041; H. Rept. 104-586, at 142-143 (1996), 1996-3 C.B.

339, 480-481.   Section 104(a)(2) reflects a reasonable exercise

of Congress’s power to tax, and it does not violate the Fifth

Amendment.   Accordingly, petitioners’ challenge to section

104(a)(2) under the Fifth Amendment fails.

     For reasons discussed above, we hold that the $27,900

payment Mr. Hennessey received in 2004 is not excludable from

income under section 104(a)(2).

     We have considered the parties’ remaining arguments and to

the extent not discussed above, conclude those arguments are

irrelevant, moot, or without merit.

     To reflect the foregoing,


                                          Decision will be entered for

                                  respondent.
