                      111 T.C. No. 17



                UNITED STATES TAX COURT



  CARL J. FABRY AND PATRICIA P. FABRY, Petitioners v.
      COMMISSIONER OF INTERNAL REVENUE, Respondent



Docket No. 9126-96.                 Filed December 16, 1998.



     Ps sued the manufacturer of an agricultural
chemical, claiming tortious injury to their nursery
business. The suit was settled and Ps received a
payment, of which $500,000 was allocable to their claim
of injury to their business reputation. Ps argue that
damages received on account of injury to business
reputation are, as a matter of law, received on account
of personal injuries within the meaning of sec.
104(a)(2), I.R.C.
     Held: Whether damages received on account of
injury to business reputation are on account of
personal injuries within the meaning of sec. 104(a)(2),
I.R.C., is a question of fact. Held, further, Ps have
failed to prove that the $500,000 payment in question
was received on account of personal injuries within the
meaning of sec. 104(a)(2), I.R.C.



Robert S. MacDonald and Brian J. Moran, for petitioners.
                               - 2 -


      Stephen R. Takeuchi, for respondent.



                              OPINION


      HALPERN, Judge:

I.   Introduction

      By notice of deficiency dated February 14, 1996, respondent

determined a deficiency in petitioners' 1992 Federal income tax

of $201,054 and an accuracy-related penalty of $40,211.

      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.

      After concessions, the sole issue for decision is whether

$500,000 received by petitioners in settlement of a lawsuit

alleging injury to business reputation is excludable from

petitioners’ gross income under section 104(a)(2) as damages

received on account of personal injuries.1

1
     On their 1992 Federal income tax return, petitioners
deducted legal fees incurred in connection with the recovery that
is the subject of this case. By amendment to answer, respondent
added a claim for a reduced deduction for legal fees if the Court
were to conclude that any portion of the recovery was excludable
from gross income. By the reply, petitioners denied the accuracy
of respondent’s method for determining the legal fees allocable
to that recovery. At the conclusion of the trial, the parties
stipulated that $100,000 is allocable to the recovery. Since we
determine that no portion of the recovery is excludable from
gross income, the issue raised by respondent’s amendment to
                                                   (continued...)
                                - 3 -


      Certain facts have been stipulated.    The stipulation of

facts filed by the parties, with attached exhibits, is

incorporated herein by this reference.      We have need to find few

facts in addition to those stipulated and, accordingly, shall not

separately set forth those findings.    We include our additional

findings of fact in the discussion that follows.     Petitioners

bear the burden of proof.    Rule 142(a).

II.   Background

      A.   Residence

      Petitioners resided in Orlando, Florida, at the time the

petition was filed.

      B.   Patsy's Nursery; Petitioners’ Reputations

      In 1976, petitioners started a business known as Patsy's

Nursery, an unincorporated proprietorship located in Orange

County, Florida.    In their nursery, petitioners grew Hoya Carnosa

(Hoyas), ornamental plants commonly known as wax plants, and

citrus trees.

      Petitioner Patricia P. Fabry quickly developed a reputation

for growing quality plants and, because of the high quality and

vivid color of her Hoyas, became known as the “Hoya Lady”.

Petitioner Carl J. Fabry also enjoyed a good reputation in the

agricultural field.

1
 (...continued)
answer is moot, and petitioners are entitled to deduct the legal
fees in question.
                                 - 4 -


     C.    Benlate Damage

     In connection with the operation of Patsy’s Nursery,

petitioners used a fungicide, Benlate, manufactured by

E.I. du Pont de Nemours and Co. (du Pont).     From 1988 to 1991,

petitioners suffered extensive damage to their stock of plants,

which they claim was a result of their use of Benlate.



     D.    The Lawsuit

     In 1991, on account of the claimed Benlate damage,

petitioners began a lawsuit against du Pont in the Circuit Court

of the Ninth Judicial Circuit in and for Orange County, Florida

(the lawsuit).    Petitioners averred that du Pont had allowed the

Benlate used by petitioners to become contaminated so as to cause

the damage in question.     Petitioners demanded a judgment for

monetary damages from du Pont under theories of strict liability

in tort and negligence.     Under both theories, petitioners

claimed:    “[T]he Fabrys have sustained damages in the form of the

lost value of destroyed or injured plants, damage to their

business reputation, lost income and lost value for their

business, the amount of which exceeds $10,000.”     Du Pont answered

the lawsuit, denying knowledge or information sufficient to form

a belief as to the truth of many of petitioners’ allegations and

asserting affirmative defenses.
                                 - 5 -


       After mediation, the lawsuit was concluded pursuant to a

stipulation of the parties, under which, among other things,

du Pont agreed to pay to petitioners the sum of $3,800,000.

Petitioners executed a general release and received the

stipulated payment.     Five hundred thousand dollars of the

stipulated payment (the $500,000 payment) is allocable to

business reputation damages.




       E.   Income Tax Return

       In reporting the proceeds of the lawsuit in their 1992

Federal income tax return, petitioners excluded the $500,000

payment.

III.    Discussion

       A.   Introduction

       Petitioners brought the lawsuit against du Pont, claiming

tortious injury to petitioners’ nursery business as the result of

their use of an agricultural chemical (Benlate) manufactured by

du Pont.     Petitioners received $3,800,000 from du Pont in

settlement of the lawsuit, of which $500,000 is allocable to

damages on account of petitioners’ claim of injury to their

business reputation (the $500,000 payment).     We must decide
                               - 6 -


whether petitioners properly excluded the $500,000 payment from

gross income.

     Petitioners bear the burden of proof.   Rule 142(a).

     B.   General Rules

     Section 61(a) provides that, except as otherwise provided,

“gross income” means “all income from whatever source derived”.

Sec. 61(a).   With an exception not here relevant, section

104(a)(2) provides that “the amount of any damages received

(whether by suit or agreement * * * ) on account of personal

injuries or sickness” is excludable from gross income.   The

regulations promulgated under section 104(a)(2) provide:     “The

term ‘damages received (whether by suit or agreement)’ means 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.      To

determine whether any payment received in settlement of a lawsuit

is excludable under section 104(a)(2), we consider the nature of

the claim that was the basis for the settlement, not the validity

of the claim.   E.g., Metzger v. Commissioner, 88 T.C. 834, 847

(1987), affd. without published opinion 845 F.2d 1013 (1988).

“If the settlement agreement lacks express language stating that

the payment was (or was not) made on account of personal injury,

then the most important fact in determining how section 104(a)(2)
                               - 7 -


is to be applied is ‘the intent of the payor’ as to the purpose

in making the payment.”   Id. at 847-848 (citing Knuckles v.

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

Memo. 1964-33).

     Neither the text nor the legislative history of section

104(a)(2) offers any explanation of the term “personal

injuries”.2   Both the courts and the Commissioner long have

recognized, however, that the section 104(a)(2) reference to

“personal injuries” is not restricted to physical injuries but

encompasses nonphysical injuries to the individual, as well, such

as those affecting emotions, reputation, or character.   See

United States v. Burke, 504 U.S. 229, 235 n.6 (1992).    For

instance, we have on occasion found that damages received on

account of damage to a taxpayer’s business reputation were

excludable damages received on account of personal injury.     E.g.,

Threlkeld v. Commissioner, 87 T.C. 1294, 1308 (1986) (based on

the nature of an action for malicious prosecution as an action

for personal injuries under Tennessee law, settlement payment

allocable to injury to professional reputation excludable from

gross income under section 104(a)(2)), affd. 848 F.2d 81 (6th

Cir. 1988).   Nevertheless, as the Supreme Court recently made

clear in Commissioner v. Schleier, 515 U.S. 323, 329-330 (1995),

2
      United States v. Burke, 504 U.S. 229, 234 (1992); see,
e.g., H. Rept. 1337, 83d Cong., 2d Sess. 15 (1954); S. Rept.
1622, 83d Cong., 2d Sess. 15-16 (1954).
                                  - 8 -


although it is a necessary condition of exclusion under section

104(a)(2) that the damages (or settlement amount) in question be

received on account of the prosecution (or settlement) of a suit

or action based on tort or tort type rights, that is not a

sufficient condition for exclusion under section 104(a)(2).      The

damages or settlement must be received both on account of a

violation of tort or tort type rights and for personal injuries

or sickness.     Id. at 330.   The parties here disagree as to

whether the $500,000 payment was received on account of personal

injuries.

     C.   Arguments of the Parties

     The arguments of the parties are straightforward.

Respondent, while conceding that the $500,000 payment was

received in settlement of a claim for tortious injury to business

reputation, argues that it was not received on account of a

personal injury.    Petitioners argue that injury to business

reputation is, as a matter of law, a personal injury.

     D.   Discussion

            1.   Nature of the Inquiry

     We do not agree with petitioners that injury to business

reputation is, as a matter of law, a personal injury.     In

Threlkeld v. Commissioner, supra, we decided not to follow our

decision in Roemer v. Commissioner, 79 T.C. 398 (1982), revd. 716

F.2d 693 (9th Cir. 1983), in which we distinguished between
                                  - 9 -


injury to personal reputation and injury to business reputation

and held that damages awarded on account of defamation resulting

in injury to business reputation did not give rise to damages

received on account of personal injuries within the meaning of

section 104(a)(2).   We did not, in Threlkeld, adopt a per se rule

that damages received on account of injury to an individual’s

business reputation are excludable under section 104(a)(2).      We

described the necessary determination as presenting a question of

fact.   Threlkeld v. Commissioner, supra at 1305.      We said that

the determination depended on the nature of the claim presented,

and we looked to all the facts and circumstances of the case,

including the State law characterization of the claim in question

(a claim for malicious prosecution) to determine the nature of

that claim.   Id. at 1307-1308.    We found that an action for

malicious prosecution is similar to an action for defamation and

concluded that it would be classified as an action for personal

injuries under Tennessee law.      Id. at 1307.   We concluded that

the payment received for the release of the taxpayer’s claims

against the defendant for damage to the taxpayer’s professional

reputation was excludable under section 104(a)(2).

     Petitioners direct our attention to two recent memorandum

opinions, Knevelbaard v. Commissioner, T.C. Memo. 1997-330, and

Noel v. Commissioner, T.C. Memo. 1997-113, for the proposition

that “business reputation damages arising in tort actions are
                              - 10 -


excludable under [section 104(a)(2)]”.   Petitioners state:    “No

special causation analysis was utilized in the Noel and

Knevelbaard decisions nor was one necessary.”   In the Noel case,

the taxpayer had sued PepsiCo, Inc. (PepsiCo), claiming both

breach of contract and tortious interference with contractual

rights and prospective business advantages.   The case was

settled, and the taxpayer received an undifferentiated amount in

settlement of all of his claims.   We found that PepsiCo’s actions

had caused the taxpayer to suffer emotional distress and had

resulted in damage to the taxpayer’s business reputation.     We

also found that the settlement payment was intended to settle

both the taxpayer’s contract claims and the tort claims.     We

divided the settlement amount between those two categories and

held that the amount allocable to the tort claims was excludable

under section 104(a)(2).   A fair reading of our report is that we

included as a tort claim the claim for damage to the taxpayer’s

business reputation (the business reputation claim).   We did not

state how much (if any) of the tort claim recovery was allocable

to the business reputation claim, but it is a fair reading of our

report that some of it was.   We did not discuss at length our

reasons for concluding that the unstated allocation to the

business reputation claim was on account of personal injuries

within the meaning of section 104(a)(2).   We did find, however,

that, during settlement negotiations, the taxpayer had discussed
                                 - 11 -


with a representative of PepsiCo damages suffered by him,

including harm to his business reputation through adverse

publicity in the press.     In Noel, we did not hold that, in all

events, damages received on account of injury to professional

reputation that results from a tortious act are damages received

on account of personal injuries within the meaning of section

104(a)(2).     Knevelbaard also involved a payment received in

settlement of a lawsuit.     The Commissioner argued that the

payment was in settlement of contract claims, while the taxpayers

argued that it was for emotional distress.     We agreed with the

taxpayers, stating only in passing that harm to reputation is a

traditional harm associated with personal injury.     Knevelbaard

also does not establish the rule of law that petitioners

advocate.

     We must consider all of the facts and circumstances to

determine whether the $500,000 payment was received on account of

personal injuries, as that term is used in section 104(a)(2).

             2.   Facts and Circumstances

     The lawsuit was concluded on March 23, 1992, when

petitioners filed their notice of voluntary dismissal with

prejudice in the court in which the lawsuit was commenced (the

dismissal notice).     Contemporaneously, petitioners and du Pont

executed the “General Release of All Claims” (the release).      The

release recites the consideration to be received by petitioners.
                              - 12 -


It recites that it pertains to the use of certain products during

the cultivation of “Hoya, Carnosa, Citrus Liners and Citrus Trees

During the Years 1988 - 1991".   It contains language releasing

du Pont and certain others from all claims relating to the use of

the products in question.   It contains certain exclusions

relating to (1) crops cultivated after the date of the release

and (2) land on which the products were used.   The release

contains no allocation of the consideration to be received by

petitioners to any cause of action or injury.   Previously, on

March 13, 1992, petitioners and du Pont had executed a document

entitled “Stipulation of the Parties” (the stipulation), which

recites the essential terms of the release but contains certain

other terms.   Among the terms of the stipulation is the

following:   "Excepted from the release shall be:   a. Soil

contamination, b. Personal injury, c. Customer claims."

     The release lacks specific language from which we can

conclude that the $500,000 payment was received on account of

personal injuries.   Although the release purports to be a general

release and contains language releasing du Pont from certain

undisclosed or potential claims, that is not sufficient evidence

on its own that any of the amount paid in consideration of the

release is on account of personal injuries within the meaning of

section 104(a)(2).   See Scheele v. Commissioner, T.C. Memo. 1997-

426; Galligan v. Commissioner, T.C. Memo. 1993-605.    We may,
                               - 13 -


however, consider extrinsic evidence.    Threlkeld v. Commissioner,

87 T.C. at 1306; Church v. Commissioner, 80 T.C. 1104, 1107

(1983); Fono v. Commissioner, 79 T.C. 680, 696 (1982), affd.

without published opinion 749 F.2d 37 (9th Cir. 1984).    We must

determine the nature of petitioners’ claims and the intent of the

payor (du Pont) in making the $500,000 payment.    We look to

petitioners’ First Amended Complaint for Damages and Demand for

Jury Trial (the complaint) to determine the nature of their

claim.   The complaint asks for damages and avers essential facts.

Petitioners claim that the Benlate they purchased was defective

and proved detrimental to their nursery products.    They claim

that, as the direct and proximate result of their use of the

defective Benlate, among other things, they suffered damage to

their business reputation.    They base their claims for damages

against du Pont on theories of strict liability in tort and

negligence.    Nowhere in the complaint, however, do petitioners

use the term “personal injuries” to describe the injuries claimed

to have been suffered as the result of their use of Benlate.

     Petitioners have not argued to us (nor do we believe) that

all injuries attributed to a defendant under a theory of strict

liability in tort or caused by a defendant’s negligence

necessarily are personal injuries within the meaning of section

104(a)(2).    Moreover, as we said supra in section III.D.1.,

damage to business reputation is not, per se, a personal injury
                              - 14 -


within the meaning of section 104(a)(2).    None of the other

injuries alleged in the complaint is a personal injury:    plant

damage, lost profits, or loss of going-concern value.

Petitioners do not claim that the cause of injury, defective

manufacture of an agricultural chemical, necessarily results in a

personal injury within the meaning of section 104(a)(2).

Petitioners did not particularize their claim of injury to

business reputation, so we might work backwards to a claim of

defamation or some other “dignatory” or nonphysical (but

personal) tort.   The plant damage averred by petitioners no doubt

injured their business and, consequentially, their business

reputation.   Nowhere in the complaint, however, is there any

claim of personal injuries as the term is used in section

104(a)(2).

     In addition to examining the release and the complaint, we

have considered the mediation that preceded settlement, as well

as the settlement negotiations between du Pont and petitioners.

We have found no evidence of a claim for personal injuries within

the meaning of section 104(a)(2).   As part of the mediation,

petitioners filed a statement with the mediators (the statement).

The statement recites petitioners’ injuries in much the same

terms as the complaint (i.e., a discussion of plant damage and

the destruction of the nursery business).    None of petitioners’

expert reports accompanying the statement, including the expert
                               - 15 -


report as to damages, describes injuries other than to various

aspects of their business.    In the letters of petitioners'

attorney that summarized the mediation, there is only one mention

of personal injury:    his assertion that the personal injury

exception to the stipulation of the parties applied only to

physical personal injury.    That assertion postdates the release

and fails to explain the absence of a similar exception in the

release.    However, even if we were to assume that the release

contained such an exception, that would not establish that any

claim for personal injuries was made by petitioners.    It only

would establish that no claim for “personal injury” (whatever

that term was intended to mean) was settled.    There is still no

evidence that a claim for personal injury was made during the

lawsuit.3   Our examination of the mediation and settlement

negotiations reinforces our belief that a claim for personal

injuries was not raised in the suit and not addressed by du Pont

in the settlement negotiations (except as noted with respect to

the personal injury exception).


3
     The only place that we noted where petitioners asserted a
claim that may be a personal injury is in a letter to a private
claims adjuster hired by du Pont before commencement of the
lawsuit, in which they described their loss of friends who were
also customers and their belief that they appeared as "lying,
deceiving fools to our customers". That claim never was made
within the context of the lawsuit, and petitioners have failed to
convince us that, when the release was executed, du Pont had in
mind any claim that had been made for personal injuries within
the meaning of sec. 104(a)(2).
                              - 16 -


      Since the record of the lawsuit that is before us does not

include any claim for personal injuries within the meaning of

section 104(a)(2), we do not believe that the claim for injury to

business reputation was on account of personal injuries, as that

term is used in section 104(a)(2).     Indeed, the stipulation on

its face excepts personal injury from its coverage.

           3.   Conclusion

      The $500,000 payment is allocable to business reputation

damages.   Nevertheless, petitioners have failed to prove that the

$500,000 payment was received on account of “personal injuries”,

as that term is used in section 104(a)(2).

IV.   Conclusion

      Petitioners have shown no grounds to exclude the $500,000

payment from gross income.   Respondent’s determination of a

deficiency is sustained to the extent attributable to

petitioners' omission of the $500,000 payment from gross income.


                                           Decision will be entered

                                     under Rule 155.
