                  T.C. Summary Opinion 2001-65



                     UNITED STATES TAX COURT



        MICHAEL R. AND SHELLEY F. FAWCETT, Petitioners v.
           COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 15851-99S.                       Filed May 2, 2001.


     Michael R. and Shelley F. Fawcett, pro sese.

     Julie L. Payne, for respondent.


     GOLDBERG, Special Trial Judge:    This case was heard pursuant

to the provisions of section 7463 of the Internal Revenue Code in

effect at the time the petition was filed.   The decision to be

entered is not reviewable by any other court, and this opinion

should not be cited as authority.   Unless otherwise indicated,

subsequent section references are to the Internal Revenue Code as

amended and in effect for the year at issue.

     Respondent determined a deficiency in petitioners’ Federal

income tax in the amount of $5,526 for the 1995 tax year.
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     The sole issue for decision is whether settlement proceeds

of $30,599 received by petitioners during 1995 constitute damages

excludable from gross income under section 104(a)(2).

Adjustments to wages subject to FICA and Medicare, and itemized

deductions for attorney’s fees and costs are computational and

will be resolved by the Court’s holding on the disputed issue in

this case.

     The stipulation of facts and the attached exhibits are

incorporated herein by this reference.   At the time of filing the

petition, petitioners resided in Kent, Washington.   References to

petitioner in the singular are to Shelley F. Fawcett.

     Petitioners were married in early 1990.   After graduating

from college in June 1990, petitioner was hired by PayLess Drug

Stores, Norwest, Inc. (PayLess) as a supervisor trainee.

Petitioner was initially placed in a PayLess store in Redmond,

Oregon, even though Mr. Fawcett at that time was in the military

and stationed in Washington.   Petitioner directly reported to an

assistant store manager and/or a store manager.

     Approximately 4 months later, petitioner was transferred to

a PayLess store located in Bellevue, Washington, only to be

subsequently transferred in 6 months to Twin Lakes, Washington.

Petitioner worked at the Twin Lakes store for approximately 9

months.   Petitioner was transferred on 2 more occasions to

different stores in Washington.   Within a 3-year period,
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petitioner worked in approximately 5 different PayLess store

locations in Oregon and Washington.

     While employed with PayLess, petitioner was asked to work

long hours, due to understaffing of employees at a given store,

and in different departments within a given store.   As a result,

petitioner felt “rushed * * * and pushed in every direction.”

Petitioner continued to work in this chaotic environment because

she desired a promotion.   However, petitioner never received a

promotion from PayLess.

     During this time, petitioner complained of chest pains, lack

of sleep due to her work schedule,1 and nightmares about her work

environment, and experienced anxiety in both her professional

life and personal life.2

     In October 1993, while petitioner was still employed by

PayLess, she received a notice (class action notice) from B.

Newal Squyers, Esq. and Debra K. Ellers, Esq. of Holland & Hart,

Attorneys for Plaintiffs, notifying her of an “Unpaid Overtime

Compensation Law Suit filed against PayLess”.   This class action

lawsuit was described as follows:




1
     At times, petitioner was scheduled to close the store at
9:30 p.m. and then open the store the next morning at 5 a.m.
2
     The strain of petitioner’s working conditions took a toll on
her new marriage. For instance, at one particular store, Mr.
Fawcett made attempts to visit petitioner at work during her
break and was strictly forbidden to do so.
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     On March 16, 1993, Laurie Sievers, Roy Menges, Twila
     Kelly and Allen Burgess brought this suit against
     PayLess in the United States District Court for the
     District of Idaho, Case No. CV 93-0089-S-HLR, alleging
     that they were employed by PayLess as salaried
     employees with titles such as “floor manager,” “floor
     supervisor,” “senior supervisor,” “supervisor,”
     “supervisor 2" and were required to perform clerking,
     stocking or other tasks in excess of forty hours per
     week without being compensated overtime work.

     Plaintiffs bring this action and allege that PayLess
     violated the Fair Labor Standards Act of 1938 U.S.C. §§
     201-208. Plaintiffs seek compensation for unpaid
     overtime, liquidated damages, attorney fees and costs.

     The class of plaintiffs in the class action consisted of 267

employees of PayLess, including petitioner, who joined on October

27, 1993.   On April 14, 1994, petitioner privately met with

plaintiffs’ attorney, Kurt Holzer (Mr. Holzer) in Tacoma,

Washington, to inform Mr. Holzer of her personal injuries, in

addition to those alleged in the class action lawsuit complaint.

Petitioner was informed at this meeting that the class action

case was under mediation and a jury trial was not likely.

Petitioner was also informed that approximately 30 class members

were deposed and allegedly suffered a number of injuries during

their employment with PayLess, including emotional distress and

physical injuries, and that her alleged injuries were experienced

by other class members.   Petitioner did not submit any medical

bills to Mr. Holzer or provide the same to the Court.

     The class action complaint requested relief for unpaid

overtime compensation and liquidated damages in an amount equal
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to the unpaid overtime compensation under section 16(b) of the

Fair Labor Standards Act of 1938 (FLSA), ch. 676, 52 Stat. 1069,

currently codified at 29 U.S.C. section 216 (1994), and

attorney’s fees and costs.     The complaint was never amended

during any time relevant to the class action lawsuit.

     On January 25, 1995, an Order approving the settlement of

the class action lawsuit was signed by Larry M. Boyle, United

States Magistrate Judge.   The Settlement Agreement and Release

(Settlement Agreement) states:

     3.   Release of PayLess by the Plaintiffs
     In exchange for the payment of the amount set forth in
     paragraph 7 below, and in consideration of the mutual
     promises and covenants contained in this Settlement
     Agreement, the Named Plaintiffs on behalf of themselves
     and the Individual Plaintiffs, upon the signing by each
     Individual Plaintiff of the release required by
     paragraph 9(b) of this document, hereby release and
     discharge PayLess, Thrifty Payless, Inc., their
     parents, agents and assigns from all actions, claims,
     or demands for damages, liabilities, costs, or
     expenses, which the Plaintiffs, individually or
     collectively, have against PayLess on account of, or in
     any way arising out the claims that were asserted or
     that could have been asserted in the Lawsuit by the
     Plaintiffs, which Lawsuit is hereby acknowledged as not
     fully plead, further including, but not limited to,
     claims for personal injuries, intentional infliction of
     emotional distress, negligent infliction of emotional
     distress, and from all known claims, whether based on
     tort, statute or contract, which are based in whole or
     in part, or arise out of, or in any way relate to: (1)
     the Lawsuit; and (2) anything done or allegedly done by
     PayLess arising out of, or in conjunction with or
     relating to, the employment of any and/or all
     Plaintiffs prior to November 1, 1992 by PayLess.

               *    *      *     *       *   *   *
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     8.   Liability Denied and Basis for Settlement
     PayLess denies any liability on its part and enters
     into this agreement solely to avoid litigation and to
     buy its peace. All Settlement Proceeds are paid to
     Plaintiffs on account of personal injuries. * * * None
     of the provisions of this Settlement Agreement and
     nothing contained in this Settlement Agreement shall be
     construed as an admission of any liability whatsoever
     by any party hereto to any other party hereto.
     [Emphasis added.]

A total of $5 million was paid by PayLess to the class in

consideration of the Settlement Agreement.   Specifically,

petitioner received $20,033.58 from Holland & Hart as her “Net

Cash Recovery” from the settlement.   Petitioner’s portion of

attorney’s fees and costs, approximately $10,565, was retained by

Holland & Hart.

     Petitioners timely filed their joint Federal income tax

return for the taxable year 1995.   They did not report any

portion of the settlement proceeds on their return, nor did they

claim a corresponding deduction for attorney’s fees or costs.

     In the notice of deficiency, respondent determined that

petitioners failed to include in gross income the settlement

proceeds of $30,599, of which $9,895 is wages subject to

employment tax, and that petitioner is allowed a Schedule A

deduction for attorney’s fees, which was not claimed on the

original return.

     Petitioners contend that the settlement proceeds were paid

to petitioner to settle claims for personal injury and

intentional infliction of emotional distress; therefore, the
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settlement award of $30,599 is excludable from income under

section 104(a)(2).

     Section 61 broadly defines gross income to include all

income from whatever source derived, except as otherwise

provided.    Statutory exclusions from income are narrowly

construed.    Commissioner v. Schleier, 515 U.S. 323, 328 (1995).

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

include “the amount of any damages received (whether by suit or

by agreement * * * ) on account of personal injuries or

sickness”.    Section 1.104-1(c), Income Tax Regs., provides that

the term “damages received” “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 prosecution.”

Petitioner’s settlement proceeds may be excluded from gross

income only if she shows:    (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, supra at 337.

     The first part of the test “examines the legal basis of the

claim for tort-like characteristics, focusing on the scope of

remedies available under the statutory scheme.”      Dotson v. United

States, 87 F.3d 682, 685 (5th Cir. 1996); see also Brennan v.

Commissioner, T.C. Memo. 1997-317.      The second requirement “tests
                                - 8 -

whether the damages received were due to a personal injury rather

than mere economic loss.”    Dotson v. United States, supra at 685;

see also O’Gilvie v. United States, 519 U.S. 79, 83-84 (1996).

“Personal injury” includes physical injuries and nonphysical

injuries “such as those affecting emotions, reputation, or

character.”    United States v. Burke, 504 U.S. 229, 235 n.6

(1992).

       Whether damages received pursuant to a settlement agreement

are excludable under section 104(a)(2) depends on the nature of

the underlying claim that was the basis for settlement.    Id. at

237.    Determination of the nature of the claim is factual.

Bagley v. Commissioner, 105 T.C. 396 (1995), affd. 121 F.3d 393

(8th Cir. 1997).    We first examine the written terms of the

settlement agreement to determine the allocation of settlement

proceeds.    See Jacobs v. Commissioner, T.C. Memo. 2000-59.    “The

most important fact in determining the purpose of [a settlement]

payment is ‘express language in the agreement stating that the

payment was (or was not) made on account of personal injury.’”

Byrne v. Commissioner, 90 T.C. 1000, 1007 (1988) (quoting Metzger

v. Commissioner, 88 T.C. 834, 847 (1987), affd. without published

opinion 845 F.2d 1013 (3d Cir. 1988)), revd. 883 F.2d 211 (3d

Cir. 1989); see also Beckey v. Commissioner, T.C. Memo. 1994-514.

However, an express allocation may be disregarded if the facts

and circumstances surrounding the payment indicate the payment
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was intended by the parties to be for a different purpose.      See

Bagley v. Commissioner, supra at 406; Robinson v. Commissioner,

102 T.C. 116, 127 (1994), affd. in part, revd. in part, and

remanded on other grounds 70 F.3d 34 (5th Cir. 1995).

     Petitioners rely on section 8 of the Settlement Agreement

that “All Settlement Proceeds are paid to Plaintiffs on account

of personal injuries.”    However, the record clearly shows that

the complaint in the class action was exclusively for the

recovery of “overtime compensation, liquidated damages,

attorney’s fees and costs” under the FLSA.    In Jacobs v.

Commissioner, supra, this Court held that recoveries for claims

based on the FLSA are not excludable from gross income because

FLSA does not provide for personal injury compensation.      The FLSA

was enacted to establish minimum wages and maximum hours for

employees.   See Brooklyn Sav. Bank v. O’Neil, 324 U.S. 697, 707

(1945).   The only relief available under the FLSA for excessive

hours worked is the payment of back wages and payment of

liquidated damages.    See FLSA 29 U.S.C. sec. 216(b) (1994).

Liquidated damages are intended to compensate the employee for

damages “too obscure or difficult to estimate caused by the delay

of late payment.”     Jacobs v. Commissioner, supra; see also

Overnight Motor Transp. Co. v. Missel, 316 U.S. 572, 583-584

(1942).   Also, we note petitioner’s own testimony during trial
                              - 10 -

that the damages awarded were actually based on length of

employment and number of hours worked by petitioner.

     Damages for petitioner’s personal injuries, however real and

distressful for petitioners, were not claimed in the class action

lawsuit against PayLess, nor was the Settlement Agreement

intended to provide relief for such injuries.   The class action

notice informed petitioners that they were not required to join

the class action.   The notice clearly stated that “if you choose

not to join this suit, you are free to file your own lawsuit with

an attorney of your choosing.”

     In order for petitioners to prevail under section 104(a)(2),

both components of the test, as stated above, must be satisfied.

Petitioners failed to show that the settlement award was paid as

compensation for personal injury or sickness.   Therefore, the

entire settlement award is includable in gross income, and

petitioners are entitled to a corresponding deduction for

attorney’s fees and costs under section 67(a), subject to

limitations.

     We have considered all arguments by the parties, and, to the

extent not discussed above, conclude that they are irrelevant or

without merit.
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    Reviewed and adopted as the report of the Small Tax Case

Division.

                                       Decision will be entered

                                  for respondent.
