                          T.C. Memo. 2000-161



                        UNITED STATES TAX COURT



           ESTATE OF KENNETH F. SCHOENEMAN, DECEASED,
    JOANN METZ AND JAMES J. RILEY, EXECUTORS, Petitioners v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 15230-97.                         Filed May 18, 2000.


     Sudhir R. Patel, for petitioners.

     James Fee and Michael D. Baker, for respondent.



             MEMORANDUM FINDINGS OF FACT AND OPINION


     FOLEY, Judge:     By notice dated April 15, 1997, respondent

determined deficiencies of $38,110, $38,098, and $18,119, and

section 6662(a) penalties of $7,622, $7,620, and $3,624, relating

to Kenneth Schoeneman’s 1993, 1994, and 1995 Federal income

taxes, respectively.    All section references are to the Internal

Revenue Code in effect for the years in issue.      The executors of
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Kenneth’s estate resided, and had a business address, in

Pennsylvania when the petition was filed.

     The issue for decision is whether Kenneth was entitled,

pursuant to section 104(a)(2), to exclude from income payments

received in settlement of a dispute.

                           FINDINGS OF FACT

     Kenneth and his father built a large beauty salon enterprise

(i.e., beauty salons, schools, and supply businesses), comprising

three companies.   Kenneth, who had a reputation for being

impeccably dressed, became an owner and pilot of airplanes,

district governor of the Rotary Club, and a prominent and proud

businessman in Pottsville, Pennsylvania.

     In 1977, Kenneth suffered a debilitating stroke that left

him partially paralyzed.    Kenneth never fully recovered from the

stroke and remained in poor health until his death.     After his

stroke, Kenneth’s businesses began to decline.   At the request of

his sons, Franklin and Dale, Kenneth, in 1980, redeemed his

shares of stock in two of his companies in exchange for annuities

and, in 1982, transferred the annuities, stock in his other

company, and other property to two irrevocable trusts, for the

benefit of himself and his wife, respectively, designating as

trustees his sons and Pennsylvania National Bank and Trust Co.

(bank).   Franklin and Dale took over the businesses.
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     After the transfer of the businesses, Kenneth’s home fell

into disrepair, he had trouble paying for his custom-tailored

clothing, and he regularly ate in a soup kitchen.   When Kenneth

discussed his sons he became so ill that his personal assistant

would have to administer heart medication.

     During and after 1985, Kenneth demanded additional

distributions from the trustees and sought to regain control of

his businesses.   In January 1989, he retained Attorney James

Riley, who filed an action against Dale, Franklin, and the bank

on March 28, 1989, in the Pennsylvania Court of Common Pleas.    On

November 12, 1989, Riley refiled the action in the Orphans’

Court, pursuant to an order of the Court of Common Pleas stating

that “Exclusive jurisdiction over inter vivos trusts and the

removal of fiduciaries of trusts is vested in the Orphans Court

Division.”   Riley prepared, but did not file, a Racketeer

Influenced and Corrupt Organizations Act (RICO) complaint against

the sons and the bank.   Both Riley and the sons’ lawyer believed

that Kenneth probably would not recover damages relating to the

Orphans’ Court and RICO complaints.    Nevertheless, after the suit

was filed, and throughout the course of the litigation, Riley

contended that Kenneth’s sons’ actions were responsible for

Kenneth’s emotional distress and tarnished reputation.

     On December 24, 1991, Kenneth entered into a Settlement

Agreement and Release (settlement) with his sons, pursuant to
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which they agreed to pay, from their personal funds, to their

father, $104,000 per year.   The settlement, in pertinent part,

provided:

           5. Ken Schoeneman’s Injuries and Demands. Ken
     Schoeneman believes, and has alleged in language required to
     bring the matter before the Orphan’s Court, that Dale
     Schoeneman and Frank Schoeneman injured him both physically
     because of the mental distress visited upon him by virtue of
     the inadequate funding of the trusts for which a specific
     claim is barred by the statute of limitations, and in his
     personal reputation in the community by depriving him of
     funds which would have allowed him to live comfortably and
     maintain his place in the community and his status therein;
     degrading his position and his health over a period of time.
     * * *

     *           *       *             *      *         *         *

            7.Tax Consequences.
               (a) It is the intention of the parties to this
     Agreement that all payments to Ken Schoeneman pursuant to
     Paragraph 6 hereof be considered compensation for the
     personal injuries specified in Paragraph 5 and be excluded
     from Ken Schoeneman’s gross income for purposes of Federal
     income taxation pursuant to 26 U.S.C. §104(a), as amended or
     any successor thereto.
               (b) It is the intention of the parties to this
     Agreement that all payments to Ken Schoeneman pursuant to
     Paragraph 6 hereof be considered ordinary and necessary
     expenses of Dale Schoeneman and Frank Schoeneman paid for
     the conservation, maintenance, preservation and protection
     of property held for the production of income and be subject
     to deduction by Dale Schoeneman and Frank Schoeneman for
     purposes of Federal income taxation pursuant to 26 U.S.C.
     §162 and/or §212, as amended; and any successor thereto.
               (c) Notwithstanding the statement of intent
     specified in subparagraphs 7.(a) and 7.(b) above, the
     parties hereto agree the payments to be made to Ken
     Schoeneman pursuant to Paragraph 6 shall not be altered in
     timing or amount if the intended tax effects are not
     realized by Ken Schoeneman and/or Dale Schoeneman and Frank
     Schoeneman.
                               - 5 -

     Kenneth did not report the payments on his returns.    He died

on July 14, 1995, a resident of Pennsylvania.

                              OPINION

     Section 104(a)(2) provides that gross income does not

include “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”.    Thus, a taxpayer may

exclude a recovery from gross income when he can show that:    (1)

The “underlying cause of action giving rise to the recovery is

‘based upon tort or tort type rights’”, and (2) “the damages were

received ‘on account of personal injuries or sickness.’”

Commissioner v. Schleier, 515 U.S. 323, 337 (1995) (quoting

United States v. Burke, 504 U.S. 229, 234 (1992)).

     The estate contends that the settlement payments were

damages received on account of personal injuries and, thus, are

excludable pursuant to section 104(a)(2).    Respondent contends

that the $104,000 payments are not excludable because they were

received on account of economic, rather than personal, injuries.

Respondent further contends that no personal injury was alleged

in a complaint by Kenneth.   In support of his contentions,

respondent asserts that the Orphans’ Court did not have

jurisdiction over tort damages and that Kenneth “could not have

recovered personal injury damages had he actually filed a RICO

complaint.”   We reject respondent’s contentions.   Our focus is
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not on the jurisdiction of the Orphans’ Court or the

unavailability of personal injury damages pursuant to RICO

because the determination of whether a settlement payment is

exempt from taxation depends on the nature of the claim settled

and not on the nature of the claim filed.   See Seay v.

Commissioner, 58 T.C. 32, 37 (1972).

     The settlement’s terms, which are inconsistent, do not

determine whether the payments are excludable.    See Robinson v.

Commissioner, 102 T.C. 116, 129 (1994) (stating that “this Court

will not blindly accept the terms contained in a settlement

agreement,” especially when those terms are tax-motivated), affd.

in part, revd. in part and remanded on other grounds 70 F.3d 34

(5th Cir. 1995).   The testimony of the witnesses, however, leads

us to conclude that the claims settled were in the nature of

personal injury (i.e., stress, infliction of emotional distress,

and damage to health) and based upon tort or tort type rights.

None of the parties believed that Kenneth would recover damages

relating to the Orphans’ Court and RICO claims.   The personal

injury claim, however, while not filed, was viable.    The sons

paid the settlement on account of this claim.    The facts of this

case are consistent with those of Seay, where we held that

damages were excludable, although the claim was not prepared or

filed, when the taxpayer’s attorney believed his client had a

personal injury claim, the payer’s attorney knew of the claim,
                                 - 7 -

the claim was part of the negotiation, and an agreement allocated

proceeds to such claim.   Riley believed that Kenneth had suffered

personal injury, Franklin and the sons’ lawyer testified that

they knew of the personal injury claims and that those claims

were discussed during the course of the litigation, and the

settlement indicates that those claims were part of the

negotiation.   Cf. Commissioner v. Schleier, supra (finding that

the taxpayer asserted, and the parties negotiated, an age

discrimination in employment, but not a personal injury, claim);

United States v. Burke, supra (finding that the taxpayer

asserted, and the parties negotiated, a sex discrimination in

employment, but not a personal injury, claim).

     Accordingly, the payments were received on account of

personal injuries and are excludable pursuant to section

104(a)(2).   Consequently, section 6662(a) is not applicable.

     Contentions not addressed are moot, irrelevant, or without

merit.

     To reflect the foregoing,



                                              Decision will be entered

                                         for petitioners.
