                        T.C. Memo. 2000-344



                      UNITED STATES TAX COURT



    RICHARD D. ANDERSON AND MARY L. ANDERSON, Petitioners v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 13327-97.                 Filed November 8, 2000.



     Robert H. Hishon, for petitioners.

     Roslyn D. Grand, for respondent.



             MEMORANDUM FINDINGS OF FACT AND OPINION

     GERBER, Judge:   Respondent determined income tax

deficiencies of $30,747 and $18,940 for petitioners’ 1993 and

1994 tax years, respectively.   The issue for our consideration is

whether amounts received by petitioners in connection with an
                              - 2 -

action for tortious interference with business relations are

excludable from petitioners’ income under section 104(a)(2).1

                        FINDINGS OF FACT2

     Petitioners resided in Chamblee, Georgia, when their

petition was filed.   Richard D. Anderson was a director,

officer, shareholder, and employee of ARRE Industries, Inc.,

d/b/a Carrera Shocks (Carrera).   Mary Anderson was an officer

and employee of ARRE Industries, Inc.

Carrera Shocks

     In 1964, Mr. Anderson started a highly specialized business

to research, develop, and manufacture high performance

suspension component parts for race cars.   In particular, he

designed shock absorbers.   Mr. Anderson held three patents

related to shock absorbers.   Carrera’s main customers were

distributors of racing equipment who in turn would sell the

shock absorbers to auto racing teams.   Mr. Anderson’s

familiarity with auto racing permitted him access to the pit

crews and provided him with the opportunity to perform

consultations regarding the most efficient use of Carrera shock

absorbers.   While attending approximately 100 races per year


     1
       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, unless otherwise
indicated.
     2
       The stipulation of facts and the attached exhibits are
incorporated herein by this reference.
                              - 3 -

over a period of 16 years, petitioner developed a good working

rapport with various race teams.   Mr. Anderson used his

accumulated knowledge of shock absorbers as a marketing tool to

curry favor with race teams by providing his consulting

services free of charge.   The main thrust of Carrera’s business

was the sale of shock absorbers.

Carrera Employees

    In the late 1970's Mr. Anderson hired George Gillespie

(Gillespie) to head Carrera’s technical department as its

director of racing.   Gillespie worked first as Mr. Anderson’s

consulting assistant and then as Carrera’s primary racing

consultant.

    Timothy Whitehead (Whitehead) began working for Carrera

shortly after Gillespie was hired.    Whitehead was responsible

for all of Carrera’s administrative functions, including

accounts payable, accounts receivable, and payroll operations.

Both Whitehead and Gillespie had worked for Carrera for more

than 3 years when Mr. Anderson learned of their plans to leave

Carrera.   It was not until after they left Carrera that Mr.

Anderson became aware of the damage Whitehead and Gillespie had

done to his business.   In December 1982, while still working

for Carrera, Whitehead and Gillespie conspired to enter into

business for themselves. Using information they acquired while

working for Carrera, Gillespie and Whitehead designed a shock
                               - 4 -

absorber for use in the auto racing industry.    On January 10,

1983, they formed Pro-Formance, Inc., (Pro-Formance).

    Seeking to obtain their own share of the racing market,

Whitehead and Gillespie contacted Carrera’s customers,

suppliers, manufacturers, and company-sponsored race teams.

They used Carrera’s mailing list to solicit and obtain

financing from Carrera’s key customers and manufacturers.   They

misled Carrera-sponsored race teams by telling them that

Carrera would no longer offer shock absorbers free of charge

for sponsorship purposes.    On at least one occasion, Gillespie

falsely conveyed the idea that Carrera had discontinued

manufacturing the type of shock absorber which had given

Carrera its renown.    Whitehead made false statements regarding

Mr. Anderson’s handling of Carrera’s finances.   He told

Carrera’s creditors that Mr. Anderson was doctoring the

company’s accounts receivable in order to increase Carrera’s

line of credit.   On other occasions Whitehead and Gillespie

told Carrera customers that Mr. Anderson was apathetic towards

the company’s future as a going concern, that he was unwilling

to provide Carrera’s customers with the same personal service

as he had in the past, and that he was embezzling money from an

industry trade show.
                             - 5 -

The Lawsuit

    On December 15, 1983, Carrera, through Mr. Anderson, filed

a complaint against Pro-Formance; Whitehead; and Gillespie

(defendants) in the Superior Court of Dekalb County, Georgia.

In the complaint, Carrera alleged tortious interference with

business relations, breach of a fiduciary duty, and defamation.

The defendants answered, counterclaimed, and interpleaded the

Andersons in their individual capacity.

    The Andersons answered and counterclaimed alleging two

separate counterclaims against the defendants:   (1) That

defendants caused “injury to * * * [Mr. Anderson’s] economic

well-being, peace of mind and business reputation”, and (2)

that defendants caused “great injury to * * * [Mr. Anderson’s]

peace, happiness and feelings.”   Pursuant to a consolidated

pretrial order, which was drafted by Mr. Anderson’s attorney,

the court issued verdict pro forma to the jury as follows:     “As

to count 1 of Richard D. Anderson’s counterclaim against Pro-

Formance Shocks, Inc., Timothy M. Whitehead and George T.

Gillespie for alleged intentional injury as a result of alleged

tortious interference with plaintiff’s business relationships,

we the jury find”; and “As to count 2 of Richard D. Anderson’s

counterclaim against Pro-Formance Shocks, Inc., Timothy M.

Whitehead and George T. Gillespie for alleged slander, we the

jury find”.
                              - 6 -

    On April 8, 1988, the jury returned verdicts in favor of

Mr. Anderson, awarding him $2.5 million for tortious

interference with business relationships, to be paid equally by

the defendants, and $1 for slander.   In addition, the jury

returned a favorable verdict for Carrera on all three of its

claims in the original lawsuit.   The jury awarded $3.7 million

to Carrera for tortious interference with its business

relationships and $1 for slander, to be paid equally by the

defendants, and $100,000 for breach of a fiduciary duty, to be

paid in equal shares by Whitehead and Gillespie.   A judgment

was entered to reflect the foregoing.

    The defendants moved for a judgment notwithstanding the

verdict or in the alternative for a new trial.   The court

granted the defendants’ motion for new trial as to damages

only.   Ultimately, by means of a stipulation and consent order,

the court reduced the award for Mr. Anderson’s claim for

interference with his business relationships from $2.5 million

to $210,000, to be paid in equal shares by each defendant.    The

court did not disturb Mr. Anderson’s $1 award for slander.    In

addition, the court reduced the amount awarded for Carrera’s

claim for tortious interference with business relationships

from $3.7 million to $300,000, but it did not disturb Carrera’s

awards for breach of a fiduciary duty or for slander.
                              - 7 -

    The defendants were unable to pay the judgment and

separately filed voluntary petitions for bankruptcy under

Chapter 11 of the U.S. Bankruptcy Code.   On July 12, 1989, the

parties, after considering the bankruptcies and the financial

condition of the defendants, entered into a settlement

agreement under which Carrera received a lump sum payment of

$331,250.   Also, defendants issued a promissory note to Mr.

Anderson and Carrera in the amount of $325,000 to be paid over

5 years along with 10.75-percent interest.   As part of the

settlement agreement Mr. Anderson and Carrera were to be paid

periodically over 60 months with a stipulation that Carrera

would receive payments until its proportionate share of the

damages, as determined by the original verdict, was satisfied

in full.

    During the 1993 tax year petitioners received monthly

payments totaling $74,857.   Petitioners did not include the

payments in their 1993 income tax; however, they submitted a

disclosure statement maintaining that the amount received was

on account of personal injuries and therefore excludable under

section 104(a)(2).

    During the 1994 tax year petitioners received monthly

payments totaling $47,464.   Petitioners did not include the

payments in their 1994 income tax; however, they submitted a

disclosure statement maintaining that the amount received was
                               - 8 -

on account of personal injuries and therefore excludable under

section 104(a)(2).

    On April 10, 1997, respondent mailed petitioners a

statutory notice of deficiency, determining that the payments

were includable in income for the respective tax years.


                              OPINION

    The issue for our consideration in this case requires an

analysis of whether the payments received fit within the

statutory exclusion provided for in section 104(a)(2).     Except

as otherwise specifically provided, gross income includes a

taxpayer’s income from whatever source derived.    See sec.

61(a); see also Commissioner v. Glenshaw Glass Co., 348 U.S.

426 (1955).   Section 61(a) is broadly construed, whereas

specific exclusions from gross income must be narrowly

construed.    See Commissioner v. Schleier, 515 U.S. 323, 327-328

(1995).   For 1993 and 1994, section 104(a)(2) specifically

excluded from gross income “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”.    Section 1.104-1(c), Income Tax Regs.,   provides

that “damages received” is an amount received (other than

workmen’s compensation) through prosecution of an action based

upon tort or tort-type rights.

    The Supreme Court has held that taxpayers may exclude
                               - 9 -

damages received if the underlying cause of action giving rise

to the recovery is based upon tort or tort type rights and the

damages are received on account of personal injuries or

sickness.    See Commissioner v. Schleier, supra at 336-337.

Respondent concedes that Mr. Anderson’s claims sounded in tort,

thus satisfying the first prong of the Schleier test.

Therefore, we focus on the second prong of the test, which

requires petitioners to show that the damages received were on

account of personal injuries or sickness.

    When damages are received pursuant to a suit or settlement

agreement, the nature of the underlying claim determines

whether such damages are excludable under section 104(a)(2).

See United States v. Burke, 504 U.S. 229, 239 (1992); see also

Metzger v. Commissioner, 88 T.C. 834, 847 (1987).    For the

taxable years under consideration, personal injuries included

both physical and nonphysical injuries.     See Commissioner v.

Schleier, supra at 329 n.4.

    Petitioners argue that the damages they received for

tortious interference with business relationships were on

account of an injury to Mr. Anderson’s business reputation, a

personal injury, and, therefore, are excludable under section

104(a)(2).

    The law is well settled that the tax consequences of an

award for damages depend upon the nature of the litigation and
                              - 10 -

on the origin and character of the claims adjudicated, and not

upon the validity of those claims.     See Bent v. Commissioner,

87 T.C. 236 (1986), affd. 835 F.2d 67 (3d Cir. 1987); Glynn v.

Commissioner, 76 T.C. 116, 119 (1981), affd. without published

opinion 676 F.2d 682 (1st Cir. 1982); Seay v. Commissioner, 58

T.C. 32, 37 (1972).   In this case, most of the amounts

petitioners received was for tortious interference with Mr.

Anderson’s business relationships and only a nominal amount was

received for slander.   Both of Mr. Anderson’s claims of action

existed under Georgia law.

    In Georgia, tortious interference with business

relationships requires the plaintiff to show that the

defendant:   (1) Acted improperly and without privilege, (2)

acted purposely and with malice with intent to injure, (3)

induced a third party or parties not to enter into or continue

a business relationship with the plaintiff, and (4) caused the

plaintiff financial injury.   See Renden, Inc. v. Liberty Real

Estate, Ltd., 444 S.E.2d 814 (Ga. Ct. App. 1994).

    Respondent determined that the damages received by Mr.

Anderson for interference with his business relationships were

awarded on account of economic injuries, rather than personal

injuries.    Supporting respondent’s determination, under Georgia

law a person’s business is property in the pursuit of which he

is entitled to protection.    See NAACP v. Overstreet, 142 S.E.2d
                             - 11 -

816 (Ga. 1965).   Tortious interference with business relations

involves interference with the plaintiff’s current and future

property rights derived from current or potential customers.

See id. at 823; see also Renden, Inc. v. Liberty Real Estate,

Ltd., supra at 817.   Petitioners have not shown that the

damages received were for personal injury under Georgia law.

Damages received in a tort action may be excluded from income

only when received on account of personal injury; therefore,

petitioners’ damages received for tortious interference with

business relationships must be included in income.   Even if the

holding in NAACP v. Overstreet, supra, was not intended to

limit tortious interference with business relationships to a

property tort, petitioners have still failed to prove that they

received damages on account of personal injury.    Accordingly,

we sustain respondent’s determination on this issue.

    Petitioners argue that the personal injury to Mr.

Anderson’s business reputation constituted the requisite

“improper means” element of the tortious interference claim.

Georgia courts have held that in order to satisfy all the

elements in a claim for tortious interference with business

relationships, there must be a finding that the defendant used

improper means.   See Contractors’ Bldg. Supply, Inc. v.

Gwinnett, 403 S.E.2d 844 (Ga. Ct. App. 1991).   “Improper means”

may be shown in several ways including:   Fraud,
                             - 12 -

misrepresentation, breach of a fiduciary duty, unauthorized use

of confidential information, defamation, and unwarranted

criminal prosecutions. See id. at 846; see also American Bldg.

Co. v. Pascoe Bldg. Sys., Inc., 392 S.E.2d 860 (Ga. Ct. App.

1990); Architectural Manufacturing Co. of Am. v. Airotec, Inc.,

166 S.E.2d 744 (Ga. Ct. App. 1969) (misrepresentations as to a

company’s financial solvency are improper means and may

constitute an element of tortious interference).   Petitioners

would have us assume that out of the evidence submitted to the

jury the only “improper means” employed by the defendants, and

established at trial, was conduct that injured Mr. Anderson’s

business reputation.   However, the facts in this case do not

permit us to make such an assumption.

    Although the statements by the defendants may have been

slanderous and damaging to Mr. Anderson’s business reputation,

they constituted but one of several sources from which the jury

could have decided the existence of tortious interference with

business relationships.   At trial, Mr. Anderson introduced

copious amounts of evidence in the form of customer lists,

invoices, profit/loss statements, tax returns, and witness

testimony to show how the defendants’ improper conduct

contributed to his loss of business and loss of profits.   The

jury could have concluded from the evidence that the

defendants:   (1) Perpetrated the unauthorized use of Carrera’s
                             - 13 -

customer mailing list, (2) engaged Carrera’s employees to

entice them into employment with Pro-Formance, (3) engaged

Carrera’s suppliers for the purpose of manufacturing a

competing product, (4) breached fiduciary duties owed to

petitioner and Carrera, or (5) defamed Mr. Anderson and Carrera

injuring their respective reputations.   Petitioners have failed

to show which of these improper acts was considered by the jury

to convince it to reach a verdict for Mr. Anderson.3

    Where the award for damages is rendered by a jury verdict

and judgment, and has been clearly allocated to an identifiable

claim, we are guided by the nature of the claim as identified

under State law personal injury concepts.    See Threlkeld v.

Commissioner, 87 T.C. 1294, 1305-1306 (1986), affd. 848 F.2d 81

(6th Cir. 1988).   We find it most telling that the vast

majority of the jury award was for interference with business

relationships and only $1 was for slander.   Petitioners also

argue that their damages were received pursuant to a settlement

agreement and are, therefore, entitled to an alternative

allocation.   The facts do not comport with such a finding.



    3
       Petitioners have offered Fabry v. Commissioner, 223 F.3d
1261 (11th Cir. 2000), revg. 111 T.C. 305 (1998), for the
proposition that injury to business reputation is a personal
injury under sec. 104(a)(2). However, as discussed above,
petitioners have failed to show that Mr. Anderson’s damages
received were on account of a personal injury. Instead, the jury
decided that the vast majority of Mr. Anderson’s injuries
occurred to his property and his property rights associated with
Carrera.
                             - 14 -

    We cannot accept an allocation based on a settlement

agreement which merely facilitated payment in the face of the

judgment debtor’s bankruptcy.   The settlement agreement reduced

the monetary amount of the award, but it did not contain any

language that would establish an allocation contrary to the

jury verdicts or the judgments entered.   We note that, in this

case, the jury verdict forms were drafted at the close of trial

and the language used in the verdict forms came from a pretrial

order that was used as a blueprint for the trial.   The record

reflects that the jury delivered its verdict using language

that was identical to language in the pretrial order that was

drafted by Mr. Anderson’s attorney.   Mr. Anderson was,

therefore, cognizant of and responsible for the formulation of

the claims as they were presented to the jury.

    The vast majority of Mr. Anderson’s award for damages was

received for interference with his business relationships and

not for slander.   The jury awarded Mr. Anderson $2.5 million

(later reduced to $210,000) for the injuries claimed in count

one for tortious interference with business relationships, but

it awarded only $1 for the injuries claimed in count two for

slander.   For the foregoing reasons the award must be allocated

as it was clearly established at trial.

    In sum, petitioners have failed to show that the

compensatory damages awarded on Mr. Anderson’s claim for
                             - 15 -

tortious interference with business relationships were received

on account of personal injuries within the meaning of section

104(a)(2).   Although the facts reflect that the defendants’

conduct may have damaged Mr. Anderson’s business reputation,

the vast majority of the recovery was for property damages

caused by interference with Mr. Anderson’s business

relationships.   In Commissioner v. Schleier, 515 U.S. 323

(1995), the Supreme Court cautioned that there must be a direct

link between the cause of harm and its effect for the section

104(a)(2) exclusion to apply.   Petitioners have failed to show

such a link between an injury to Mr. Anderson’s business

reputation caused by the defendants’ actions and the economic

loss for which Mr. Anderson recovered.   Therefore, petitioners

have failed the second prong of the Schleier test with regard

to the damages received under Mr. Anderson’s claim for tortious

interference with business relationships.   Accordingly we

sustain respondent’s determination on this issue.

    We must now examine the second claim for which petitioners

received damages.   In Mr. Anderson’s second claim, he alleged

that the defendants “intentionally, willfully, and maliciously”

acted to cause injury to petitioner’s ”peace, happiness, and
                             - 16 -

feelings.”   The pretrial order and the jury verdict forms both

denominated this claim as slander.

    Respondent concedes that the damages awarded for slander

constitute an award received for personal injury under section

104(a)(2).   Therefore, the $1 in damages petitioners received

for slander is excludable in accord with section 104(a)(2).

    Petitioner has raised other arguments that we have

considered in reaching our decision.    To the extent that we

have not discussed these arguments, we conclude they are

without merit.

    To reflect the foregoing,

                                     Decision will be entered

                                under Rule 155.
