                               T.C. Memo. 2016-34



                        UNITED STATES TAX COURT



         JOSE M. DULANTO AND ANA M. DULANTO, Petitioners v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



      Docket No. 19123-12.                         Filed March 2, 2016.



      Jose M. Dulanto and Ana M. Dulanto, pro sese.

      Michael K. Park and Priscilla A. Parrett, for respondent.



            MEMORANDUM FINDINGS OF FACT AND OPINION


      COHEN, Judge: Respondent determined a deficiency of $28,681 in

petitioners’ Federal income tax and an accuracy-related penalty of $5,736 pursuant

to section 6662(a) for the 2009 tax year. Petitioners do not dispute respondent’s

disallowance of petitioner Ana Dulanto’s individual retirement account (IRA)

contribution deduction for 2009 or her receipt of income from a class action
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[*2] settlement agreement with Sears, Roebuck & Co. in that year. As a result,

these issues are deemed conceded by petitioners. See Rules 34(b)(4), 149(b).

Respondent concedes that petitioners are entitled to a deduction for Jose Dulanto’s

2009 IRA contribution.

       After concessions, the issues for decision are: (1) whether $83,169 of

settlement proceeds received by Ana Dulanto (petitioner) under a settlement

agreement with her former employer, American National Insurance Co. (ANICO),

are excludable from petitioners’ gross income under section 104(a)(2); and (2)

whether petitioners are liable for an accuracy-related penalty pursuant to section

6662(a). Unless otherwise indicated, all section references are to the Internal

Revenue Code in effect for the year in issue, and all Rule references are to the Tax

Court Rules of Practice and Procedure.

                               FINDINGS OF FACT

       Some of the facts have been deemed stipulated pursuant to Rule 91(f). The

case was submitted on the existing record after petitioners failed to appear for trial

or to respond to an order to show cause. The stipulated facts are incorporated in

our findings by this reference. Petitioners resided in California when they filed

their petition.
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[*3] Petitioners were employed by ANICO as sales agents during the years

leading up to 2009, the year in issue. In 2008, petitioners filed separate lawsuits

against ANICO. Jose Dulanto’s lawsuit, case No. BC399246, was filed in the

Superior Court of the State of California for the County of Los Angeles. In his

complaint Jose Dulanto advanced 17 causes of action against ANICO, including:

racial, national origin, and disability discrimination; failure to pay wages; failure

to provide meal periods; engaging in unfair business practices; and intentional

infliction of emotional distress. Jose Dulanto’s allegations of emotional distress

stated that he suffered from insomnia, depression, exhaustion, fatigue, stomach

problems, tension headaches, neck pain, back pain, rashes, and other symptoms.

He stated that he sought medical assistance and was diagnosed with depression

and anxiety and was prescribed medicine as a result of his experiences at ANICO.

Jose Dulanto sought “compensation for his health problems and serious emotional

distress he suffered as a consequence of” ANICO’s actions. Jose Dulanto also

filed worker’s compensation claims against ANICO for injuries suffered in a car

accident while working for the company.

      Also in 2008, petitioner filed a class action lawsuit against ANICO on

behalf of certain current and former sales agents of the company. The lawsuit,

case No. BC401025, was originally filed in the Superior Court of the State of
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[*4] California for the County of Los Angeles but was subsequently removed to

Federal court. The lawsuit was brought “as a nationwide collection action * * *

for claims under the Fair Labor Standards Act (“FLSA”) and a California

statewide class action * * * for claims under California law” and sought to

recover, among other things: unpaid overtime compensation, unpaid additional

pay for the failure to provide meal and rest periods, unpaid statutory amounts for

the failure to provide accurate wage statements, injunctive relief to provide the

required information on wage statements, restitution of unlawfully withheld

wages, reasonable attorney’s fees, and costs of suit. The complaint did not allege

any specific personal physical injuries, either to petitioner or to Jose Dulanto.

      On or about September 24, 2009, petitioners and ANICO executed a

settlement agreement and mutual release. In the settlement agreement petitioners

dismissed all claims for relief alleged or that could have been alleged, including

but not limited to assertions of verbal abuse, workplace harassment, and emotional

distress. The settlement agreement specifically covered the allegations in

petitioners’ separate lawsuits against ANICO. The settlement agreement also

stated that it was intended to encompass the entire agreement between the parties

concerning all matters affecting all claims but stated that it did “not have any

effect whatsoever on Mr. Dulanto’s worker’s compensation claims.” Although a
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[*5] draft unsigned settlement agreement briefly mentioned a waiver and release

of “any claim for damages, including but not limited to loss of consortium”, the

final version did not contain this wording.

      Under the settlement agreement, ANICO agreed to pay petitioners

$501,775. This amount was allocated as follows: 82% to Jose Dulanto and 18%

to petitioner. After taking into account payments previously made to petitioners,

ANICO issued settlement payments of $403,731 and $83,169 to Jose Dulanto and

petitioner, respectively. The settlement agreement did not allocate the payments to

any specific claim or allegation of injury made by petitioners.

      Petitioners timely filed their joint Form 1040, U.S. Individual Income Tax

Return, for 2009. Their return was prepared by a certified public accountant

(C.P.A.).

                                     OPINION

       Section 61(a) defines “gross income” as “all income from whatever source

derived”. Caselaw interprets this definition to be broad in scope and states that

exclusions from gross income must be narrowly construed. Commissioner v.

Schleier, 515 U.S. 323, 328 (1995); Commissioner v. Glenshaw Glass Co., 348

U.S. 426, 429 (1955); Helvering v. Clifford, 309 U.S. 331, 334 (1940). One such

exclusion is found in section 104(a)(2), which provides that gross income does not
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[*6] include the amount of any damages (other than punitive damages) received on

account of personal physical injuries or physical sickness. This rule is meant to

cover all damages that flow from a physical injury or physical sickness, including

damages received by the injured party’s spouse on account of a claim for loss of

consortium. See H.R. Conf. Rept. No. 104-737, at 301 (1996), 1996-3 C.B. 741,

1041. Although emotional distress or the symptoms thereof are not treated as a

physical injury or physical sickness, the cost of medical care attributable to

emotional distress is. Sec. 104(a); see Blackwood v. Commissioner, T.C. Memo.

2012-190; Longoria v. Commissioner, T.C. Memo. 2009-162.

      Where damages are received pursuant to a settlement agreement, the nature

of the claim that was the actual basis for settlement controls whether those

damages are excludable under section 104(a)(2). United States v. Burke, 504 U.S.

229, 237 (1992). The determination of the nature of the claim is usually made by

reference to the settlement agreement. See Knuckles v. Commissioner, 349 F.2d

610, 613 (10th Cir. 1965), aff’g T.C. Memo. 1964-33; Robinson v. Commissioner,

102 T.C. 116, 126 (1994), aff’d in part, rev’d in part, and remanded on another

issue, 70 F.3d 34 (5th Cir. 1995). If the settlement agreement lacks express

statements of the claims that payment was to settle, the intent of the payor is

determined by taking into consideration all of the facts and circumstances,
                                        -7-

[*7] including but not limited to, the amount paid, the circumstances that led to the

settlement agreement, and the original complaint filed by the injured party. Green

v. Commissioner, 507 F.3d 857, 868 (5th Cir. 2007), aff’g T.C. Memo. 2005-250;

Knuckles v. Commissioner, 349 F.2d at 613; Robinson v. Commissioner, 102 T.C.

at 127; Ahmed v. Commissioner, T.C. Memo. 2011-295, aff’d, 498 F. App’x 919

(11th Cir. 2012); Longoria v. Commissioner, T.C. Memo. 2009-162. The burden

of proof is on the taxpayer to establish that the Commissioner’s determination in

the notice of deficiency is erroneous. Rule 142(a); Welch v. Helvering, 290 U.S.

111, 115 (1933). The taxpayer must present objective and credible evidence of the

payor’s intent in order for the burden of proof to shift to the Commissioner. See

sec. 7491(a); Longoria v. Commissioner, T.C. Memo. 2009-162.

      The settlement agreement between ANICO and petitioners does not allocate

the payments to a claim of personal physical injury or physical sickness. The

agreement does not specify any particular claim motivating the settlement.

Petitioners did not present objective and credible evidence that ANICO intended

that any part of their settlement payments be allocated to claims for loss of

consortium.

      The record shows that the settlement was unallocated among the multiple

claims of petitioners. Many of petitioners’ allegations in their respective
                                        -8-

[*8] complaints dealt with discrimination, the failure to pay wages, and a hostile

work environment rather than physical injuries or physical sickness. Petitioner’s

class action lawsuit against ANICO does not allege that she sustained any physical

injuries while employed by the company; and her complaint does not mention a

claim for loss of consortium arising from the personal physical injuries of Jose

Dulanto. The basis of the claims in petitioner’s suit relates to ANICO’s failure to

pay wages and overtime, failure to provide itemized wage statements, and failure

to provide meal and rest periods. We conclude that the damages ANICO paid

petitioner as part of the settlement agreement were mainly for the resolution of

claims in her class action lawsuit and not for speculative claims of loss of

consortium. Therefore, the settlement payment petitioner received as part of the

settlement agreement with ANICO is includible in petitioners’ income for 2009.

Section 6662(a) Penalty

      Section 6662(a) and (b)(2) imposes a 20% accuracy-related penalty on any

underpayment of Federal income tax which is attributable to a substantial

understatement of income tax. An understatement of income tax is substantial if it

exceeds the greater of 10% of the tax required to be shown on the return or

$5,000. Sec. 6662(d)(1)(A).
                                        -9-

[*9] Under section 7491(c), the Commissioner bears the burden of production

with regard to penalties and must come forward with sufficient evidence

indicating that it is appropriate to impose penalties. Higbee v. Commissioner, 116

T.C. 438, 446-447 (2001). It appears that the recomputed understatement of

income tax well exceeds $5,000, which is greater than 10% of the tax required to

be shown on petitioners’ 2009 tax return. Thus, respondent’s burden of

production has been satisfied.

      Once the Commissioner has met the burden of production, the taxpayers

must come forward with persuasive evidence that the penalty is inappropriate

because, for example, they acted with reasonable cause and in good faith. Sec.

6664(c)(1); Higbee v. Commissioner, 116 T.C. at 448-449. The decision as to

whether a taxpayer acted with reasonable cause and in good faith is made on a

case-by-case basis, taking into account all of the pertinent facts and circumstances.

See sec. 1.6664-4(b)(1), Income Tax Regs.

      Petitioners set forth no specific facts to show that the penalty should not

apply. For example, they did not offer any testimony or other evidence to show

that they relied on professional tax advice. Even though their return was prepared

by a C.P.A., they did not provide any evidence that the C.P.A. was a competent

professional, that they provided the C.P.A. with necessary and accurate
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[*10] information, and that they actually relied on the C.P.A.’s judgment. See

Neonatology Assocs., P.A. v. Commissioner, 115 T.C. 43, 99 (2000), aff’d, 299

F.3d 221 (3d Cir. 2002). Accordingly, we sustain respondent’s determination of

the accuracy-related penalty for 2009.

      To reflect the foregoing,


                                                  Decision will be entered

                                         under Rule 155.
