                         T.C. Memo. 1997-125



                      UNITED STATES TAX COURT



LARS E. FREDRICKSON, JR., & DONNA J. FREDRICKSON, Petitioners v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 24751-95.                      Filed March 11, 1997.



     Lars E. Fredrickson Jr., and Donna J. Fredrickson, pro sese.

     Allan D. Hill, for respondent.



                         MEMORANDUM OPINION


     FOLEY, Judge:   By notice dated September 21, 1995,

respondent determined a deficiency in petitioners' 1992 Federal

income tax of $31,071.   The issues for decision are as follows:
                                 - 2 -

     1.   Whether petitioners, pursuant to section 104(a)(2), are

entitled to exclude amounts received in settlement of a class

action suit.    We hold they are not.

     2.   Whether petitioners, pursuant to section 162, are

entitled to an above-the-line deduction for legal fees.    We hold

they are not.

     Unless otherwise indicated, all section references are to

the Internal Revenue Code as in effect for the year in issue, and

all Rule references are to the Tax Court Rules of Practice and

Procedure.

                             Background

     The facts have been fully stipulated under Rule 122 and are

so found.    At the time the petition was filed, petitioners

resided in Eureka, California.

     On June 1, 1979, a class action suit against State Farm

General Insurance Co., State Farm Mutual Automobile Insurance

Co., State Farm Life Insurance Co., and State Farm Fire and

Casualty Co. (State Farm) was filed in the U.S. District Court

for the Northern District of California, Kraszewski, et al. v.

State Farm Gen. Ins. Co..    The plaintiffs alleged that State

Farm, in violation of title VII of the Civil Rights Act of 1964

(Title VII), had discriminated against women in the hiring of its

insurance agents.    On November 6, 1981, the District Court

bifurcated the litigation into a liability and a remedy phase.
                               - 3 -

     On April 29, 1985, the District Court ruled in the liability

phase that State Farm was liable under Title VII for classwide

discrimination on the basis of sex.     Specifically, it ruled that

women who attempted to become trainee agents were "lied to,

misinformed, and discouraged in their efforts to obtain the entry

level sales position."   The court found State Farm liable with

respect to "all female applicants and deterred applicants who, at

any time since July 5, 1974, have been, are, or will be denied

recruitment, selection and/or hire as trainee agents by defendant

companies within the State of California."

     On May 1, 1987, Donna Fredrickson (petitioner) applied to

become a State Farm trainee agent.     State Farm rejected her

application and appointed a male applicant.     Petitioner

subsequently joined the class action suit against State Farm.

The parties to the class action subsequently reached an agreement

in a consent decree as to the remedy phase of the litigation.

The consent decree provided for individual hearings to determine

each claimant's entitlement to damages and the amount of such

damages.

     Petitioner ultimately prevailed in her claim against State

Farm.   In February of 1992, petitioner and State Farm entered

into a settlement agreement entitled "Settlement Agreement and

General Release".   That agreement provided in relevant part:

     The approximate full value of [petitioner's] claim
     under the Consent Decree damage formula as of February
     1, 1992, is $173,057.00, which represents back pay as a
                                   - 4 -

      State Farm agent accrued from the year of the
      challenged appointment to February 1, 1992, plus six
      months of front pay from that date forward.

                b. Settlement Cash at 87.5% Acceptance Rate:
      State Farm offers [petitioner] Settlement Cash of
      $135,000.00, which is approximately 78% of the
      estimated full Consent Decree value of her claim, to
      release her claims against State Farm.

      *         *          *         *        *        *        *

                c. Incentive Cash for Acceptance Rate Above
      90%: The Incentive Cash will be $1,800.00 per claimant
      for each full percentage point by which the Acceptance
      Rate * * * exceeds 90%.

      *         *          *         *        *        *        *

                e. Attorney's Fees: The payments State Farm
      is offering to [petitioner] include her attorneys' fees
      and costs * * *. That is, [petitioner] will have to
      pay her attorneys' fees * * * out of the payment State
      Farm makes to her. * * *

      Petitioner accepted the terms of the settlement agreement.

As a result, in 1992 State Farm issued petitioner and her

attorney a $151,200 check ($135,000 plus a $16,200 Acceptance

Rate bonus amount).      Petitioner's attorney retained legal fees of

$37,841 and the $113,359 balance was paid to petitioner.

      Petitioners reported on their 1992 joint Federal income tax

return $5,270 of the $151,200 amount.        Respondent determined that

the entire $151,200 should have been included in petitioners'

gross income.       The petition in this case was filed on November

24, 1995.

                                Discussion

I.   Excludability of Settlement Proceeds Under Section 104(a)(2)
                                 - 5 -

     Except as otherwise provided, gross income includes income

from all sources.    Sec. 61; Commissioner v. Glenshaw Glass Co.,

348 U.S. 426 (1955).    While section 61(a) is to be broadly

construed, statutory exclusions from income must be narrowly

construed.   Commissioner v. Schleier, 515 U.S. ___, 115 S. Ct.

2159, 2163 (1995).

     Under section 104(a)(2), 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".    Section 1.104-1(c), Income Tax

Regs., provides that "The term 'damages received (whether by suit

or agreement)' means an amount received * * * 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."   Thus, an amount may be excluded from gross income

only when it was received both:    (1) Through prosecution or

settlement of an action based upon tort or tort type rights and

(2) on account of personal injuries or sickness.     Commissioner v.

Schleier, 515 U.S. at ___, 115 S. Ct. at 2166-2167

     Where amounts are received pursuant to a settlement

agreement, the nature of the claim that was the actual basis for

settlement controls whether such amounts are excludable under

section 104(a)(2).     United States v. Burke, 504 U.S. 229, 237

(1992); Robinson v. Commissioner, 102 T.C. 116, 126 (1994), affd.

in part, revd. in part and remanded 70 F.3d 34 (5th Cir. 1995).
                                 - 6 -

The critical question is "in lieu of what was the settlement

amount paid?"     Bagley v. Commissioner, 105 T.C. 396, 406 (1995).

Determination of the nature of the claim is a factual inquiry.

Robinson v. Commissioner, supra at 127.

       The amounts petitioner received under the settlement

agreement were intended to settle petitioner's claim under Title

VII.    Although the settlement agreement does not contain a

specific statement to that effect, the surrounding circumstances

establish that Title VII is the underlying claim.    Petitioner was

a member of a class action suit asserting a claim of

discrimination under Title VII.    The District Court ruled that

State Farm was liable under Title VII to all members of the class

who had been discriminated against and ordered individual

hearings.    State Farm and the plaintiffs to the class action suit

agreed on a procedure and a formula to ascertain the amount owed,

if any, to each individual claimant.     Petitioner's damages under

the consent decree were ascertained, and petitioner was paid an

amount equal to 78 percent of her full claim under the consent

decree, plus a bonus amount.    Thus, the consent decree

implemented the District Court's ruling that State Farm was

liable under Title VII, and the settlement agreement represented

a compromise and settlement of petitioner's rights under the

consent decree.    As a result, we conclude that petitioner's

settlement proceeds were intended to settle her Title VII claim
                                - 7 -

and that the U.S. Supreme Court's decision in United States v.

Burke, supra, controls.

     In Burke, the Court considered whether amounts received in

settlement of a claim under Title VII were excludable under

section 104(a)(2).   The Court analyzed Title VII and concluded

that it did not provide for remedies to recompense claimants for

tort type personal injuries.   Instead, the Court noted that the

statute offered only injunctions, back and front pay, and other

equitable relief.    Id. at 238-239.    As a result, the Court

concluded that Title VII did not redress tort type personal

injuries and consequently that settlement proceeds based on such

a claim are not excludable under section 104(a)(2).

     Petitioner contends that remedies available to her under

other laws redressed tort type personal injuries, and that the

settlement was partially intended to settle these claims.

Petitioner emphasizes that the consent decree indicated that

State Farm was concerned about its liability under other laws and

that the settlement agreement provided that petitioner released

all claims she had against State Farm under Title VII and other

laws.   Petitioner has failed, however, to establish the amount,

if any, attributable to claims under other laws.     As a result,

petitioner has failed to prove that any part of the settlement

proceeds is excludable.   See Getty v. Commissioner, 91 T.C. 160,

175-176 (1988), affd. on this issue, revd. on other issues 913

F.2d 1486 (9th Cir. 1990).
                                  - 8 -

      Accordingly, we conclude that petitioners are not entitled

to exclude any part of the $151,200 settlement proceeds under

section 104(a)(2).

II.   Deductibility of Legal Fees

      Petitioner contends that her legal fees are ordinary and

necessary business expenses deductible under section 162.

Respondent contends that the legal fees are deductible under

section 212(1) as an expense for the production of income and

treated as a miscellaneous itemized deduction under section 67.

We agree with respondent.   Such legal fees are deductible to the

extent they exceed 2 percent of petitioners' adjusted gross

income.   See also sec. 1.67-1T(a)(1)(ii), Temporary Income Tax

Regs., 53 Fed. Reg. 9875 (Mar. 28, 1988).

      We have considered all other arguments made by the parties

and found them to be either irrelevant or without merit.

      To reflect the foregoing,


                                            Decision will be entered

                                       under Rule 155.
