                    T.C. Summary Opinion 2008-97



                      UNITED STATES TAX COURT



         DARRIN F. AND PAMELA J. RUCH SUDER, Petitioners v.
            COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 3245-06S.                Filed August 7, 2008.



     Kevin J. Sommar, for petitioners.

     Ronald S. Collins, Jr., for respondent.



     THORNTON, Judge:   This case was heard pursuant to the

provisions of section 7463 of the Internal Revenue Code in effect

when the petition was filed.1   Pursuant to section 7463(b), the

decision to be entered is not reviewable by any other court, and




     1
       Unless otherwise indicated, section references are to the
Internal Revenue Code of 1986, as amended and in effect for the
year in issue, and Rule references are to the Tax Court Rules of
Practice and Procedure.
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this opinion shall not be treated as precedent for any other

case.

     The issues for decision are:   (1) Whether petitioners are

entitled to exclude from their 2003 gross income certain proceeds

received in settlement of a wrongful termination lawsuit; and (2)

whether petitioners are liable for an accuracy-related penalty

pursuant to section 6662(a).

                             Background

     The parties have stipulated some facts, which we incorporate

herein.    When they petitioned this Court, petitioners resided in

Pennsylvania.

     In 2000 Pamela J. Ruch Suder (petitioner) was hired as a

sales representative for Adelphia Business Solutions (Adelphia).

In 2001 Adelphia terminated her employment.   Petitioner filed a

wrongful termination lawsuit against Adelphia, alleging breach of

contract, violation of Pennsylvania wage payment and collection

laws, and defamation and seeking compensatory and punitive

damages.   Pursuant to a settlement, in 2003 Adelphia paid

petitioner $41,000, from which she paid $4,967.50 in attorney’s

fees and costs.

     In the general release and settlement agreement, petitioner

agreed “to take full responsibility and liability for the payment

of any and all taxes related to the aforementioned payment.”    On

their joint 2003 Federal income tax return petitioners excluded
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the settlement proceeds from gross income.   In doing so,

petitioners did not seek professional tax advice.

     In the notice of deficiency respondent determined that the

$41,000 settlement proceeds were includable in petitioners’ 2003

gross income, resulting in an $11,460 deficiency, and that

petitioners were liable for a $2,293 accuracy-related penalty

pursuant to section 6662(a).

                           Discussion

Taxability of Settlement Proceeds

     Pursuant to section 61(a), gross income generally includes

income from all sources, including settlement payments.     See,

e.g., Commissioner v. Glenshaw Glass Co., 348 U.S. 426 (1955).

As an exception to this general rule, section 104(a)(2) excludes

from gross income “the amount of any damages (other than punitive

damages) received (whether by suit or agreement and whether as

lump sums or as periodic payments) on account of personal

physical injuries or physical sickness”.

     Petitioners contend that although petitioner’s wrongful

termination lawsuit encompassed nontort claims, the settlement

proceeds were entirely for defamation, because during the

settlement negotiations she abandoned the other claims.     The

evidence on this point is inconclusive.    But even if we were to

assume, for sake of argument, that the settlement proceeds were

entirely for the defamation claim, petitioners cannot prevail.
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Petitioners have stipulated that petitioner “did not seek, or

receive, monetary damages for physical injury or sickness in the

underlying lawsuit.”   Accordingly, the settlement proceeds are

not excludable under section 104(a)(2).   See Polone v.

Commissioner, 505 F.3d 966 (9th Cir. 2007) (payment for

settlement of defamation claim was not excludable under section

104(a)(2)), affg. T.C. Memo. 2003-339.

     Appearing tacitly to invoke the short-lived decision in

Murphy v. IRS, 460 F.3d 79 (D.C. Cir. 2006), vacated 99 AFTR 2d

2007-396, 2007-1 USTC par. 50,228 (D.C. Cir. 2006), petitioners

contend that the settlement proceeds were for “the loss of * * *

human capital”.   Consequently, they contend, petitioner’s “award

is not income and §104(a)(2) is therefore unconstitutional

insofar as it would make the award taxable as income.”

Petitioners’ argument is a nonsequitur.   If the settlement

proceeds were not includable in gross income under section 61,

then the constitutionality of section 104(a)(2) would be

irrelevant.   As previously discussed, however, the settlement

proceeds are includable in gross income under section 61.     In any

event, petitioners’ contentions as to the unconstitutionality of

section 104(a)(2) are without merit.   See Murphy v. IRS, 493 F.3d

170 (D.C. Cir. 2007); Ballmer v. Commissioner, T.C. Memo. 2007-

295; Hawkins v. Commissioner, T.C. Memo. 2007-286.
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     Respondent concedes that petitioners may deduct $4,967.50 of

attorney’s fees and costs paid in 2003 in connection with the

lawsuit, subject to the 2-percent limitation on itemized

deductions pursuant to section 67(a) and alternative minimum tax

limitations.

Section 6662 Accuracy-Related Penalty

     Section 6662(a) and (b)(1) and (2) imposes a 20-percent

accuracy-related penalty on any portion of a tax underpayment

that is attributable to, among other things:    (1) Negligence or

disregard of rules and regulations; or (2) any substantial

understatement of income tax.   Negligence includes failure to

make a reasonable attempt to comply with the tax code, to

exercise ordinary care in preparing a tax return, or to

substantiate items properly on a tax return.    Sec.

1.6662-3(b)(1), Income Tax Regs.   The evidence shows that

petitioners’ underpayment is attributable to negligence and

disregard of rules and regulations.     Moreover, even taking into

account respondent’s concession, petitioners clearly have a

substantial understatement of income tax.    Accordingly,

respondent has met his burden of production pursuant to section

7491(c).

     The section 6662 accuracy-related penalty is inapplicable to

the extent the taxpayer has reasonable cause and acted in good

faith.   Sec. 6664(c)(1).   This determination is made considering
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all relevant facts and circumstances.      Sec. 1.6664-4(b)(1),

Income Tax Regs.    “Generally, the most important factor is the

extent of the taxpayer’s effort to assess the taxpayer’s proper

tax liability.”    Id.   The taxpayer bears the burden of proving

that he or she falls within this exception.      Higbee v.

Commissioner, 116 T.C. 438, 447 (2001).

     Petitioners contend that they reasonably believed that the

settlement proceeds were excludable from gross income, consistent

with substantial legal authority.    Petitioners did not consult

with a professional tax adviser, however; nor, insofar as the

record shows, did they take any other action to ascertain the

correct tax treatment of the settlement payment.     Moreover, in

the settlement agreement petitioner agreed to take full

responsibility for any tax liability arising out of the

settlement.   Petitioner testified that she believed the

settlement payment was nontaxable because she was involved in a

“lawsuit years and years ago due to a personal injury that was

not taxable.”    Any such belief as to the nontaxability of a

long-ago personal injury payment does not establish reasonable

cause for petitioners’ failure to report the settlement proceeds

at issue here.

     Petitioners contend that they received no Form 1099 with

respect to the settlement proceeds.      The evidence on this point

is inconclusive; in any event, mere failure to receive a Form
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1099 does not establish reasonable cause or good faith.   Goode v.

Commissioner, T.C. Memo. 2006-48.

     We also reject as without merit petitioners’ contention that

they had substantial authority for excluding the settlement

proceeds from gross income.2   The plain language of section

104(a)(2) limits the exclusion to damages received on account of

“personal physical injuries or physical sickness”.   As previously

discussed, petitioners’ ill-founded arguments as to the

unconstitutionality of section 104(a)(2) have no bearing on the

inclusion of the settlement proceeds in gross income pursuant to

section 61.   We also note that Murphy v. IRS, 460 F.3d 79 (D.C.

Cir. 2006), ultimately vacated by the U.S. Court of Appeals for

the District of Columbia Circuit, had not been issued when

petitioners filed their 2003 return.

     To reflect the foregoing and respondent’s concession as to

the deductibility of attorney’s fees and costs,


                                    Decision will be entered under

                               Rule 155.




     2
       In making this argument, petitioners appear to invoke sec.
6662(d)(2)(B)(i), which provides for a reduction of the amount of
understatement of income tax under sec. 6662(b)(2) to the extent
the understatement is attributable to the taxpayer’s treatment of
an item if there is or was substantial authority for such
treatment.
