                       T.C. Memo. 2001-53



                     UNITED STATES TAX COURT



              DEBRA SUSAN DICKERSON, Petitioner v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 24540-97.              Filed March 6, 2001.


     Debra Susan Dickerson, pro se.

     Charles Pillitteri, for respondent.


             MEMORANDUM FINDINGS OF FACT AND OPINION

     ARMEN, Special Trial Judge:     Respondent determined a

deficiency in petitioner's Federal income tax for the taxable

year 1995 in the amount of $5,109.
                                - 2 -

     After concessions by the parties,1 the issues remaining for

decision are as follows:

     (1) Whether petitioner may exclude from gross income under

section 104(a)(2)2 proceeds from the settlement of a lawsuit that

she received in the year in issue.      We hold that she may not.

     (2) Whether petitioner is entitled to an earned income

credit for Amanda Roland.    We hold that she is not.

                           FINDINGS OF FACT

     Virtually all of the facts have been stipulated, and they

are so found.    Petitioner resided in Mobile, Alabama, at the time

that her petition was filed with the Court.

     A. Receipt of Settlement Proceeds From the Lawsuit

     Prior to the year in issue, petitioner purchased various

insurance policies from Liberty National Life Insurance Co. and

Torchmark Corp. (collectively, Liberty Life).     Petitioner

purchased these policies in order to provide comprehensive health

care coverage.   The policies included individual medical expense

policies, hospital accident policies, hospital confinement and


     1
       At trial, petitioner conceded that she failed to report
(1) wages in the amount of $89 and (2) interest income in the
amount of $83, and respondent conceded, inter alia, that
petitioner is entitled to a dependency exemption for Amanda
Roland. See infra note 3 regarding respondent’s additional
concession.
     2
        Unless otherwise indicated, all section references are to
the Internal Revenue Code in effect for 1995, the taxable year in
issue, and all Rule references are to the Tax Court Rules of
Practice and Procedure.
                                - 3 -

surgical policies, hospital intensive care policies, and accident

policies.

     Petitioner ultimately determined that the insurance policies

that she had purchased did not provide the coverage that had been

represented.   Accordingly, petitioner decided to seek legal

redress.

     In November 1993, petitioner retained the law firm of Olen &

McGlothren, P.C. (the Olen law firm) to represent her in

prosecuting her claims against Liberty Life.   Pursuant to the

retainer agreement, petitioner agreed to pay attorney’s fees

equal to 40 percent of whatever money was eventually recovered,

whether by trial or settlement.   Petitioner also agreed to pay

court costs and related legal expenses from such money.

     Thereafter, in 1994, the Olen law firm filed a Complaint on

petitioner’s behalf in the Circuit Court of Mobile County,

Alabama against Liberty Life.   Later, in September 1994, an

amended complaint was filed.

     The amended complaint focused on the various insurance

policies that petitioner had purchased from Liberty Life.    The

amended complaint alleged that these insurance policies contained

restrictive payment provisions limiting the amount of

petitioner’s recovery to benefits available under only one of the

policies, such that the other policies were duplicative and

worthless.
                                - 4 -

       The amended complaint included 4 causes of action.   The

first cause of action alleged that the representations made by

Liberty Life with respect to the insurance policies were made

intentionally, recklessly, or negligently with the intent that

petitioner would rely on such representations.    The first cause

of action also alleged that these representations were part of a

pattern and practice encouraged and sanctioned by Liberty Life.

Finally, the first cause of action alleged, summarily, that

petitioner had suffered “mental anguish”.

       Under the first cause of action, petitioner sought recovery

of an unspecified sum for actual damages, general damages,

punitive damages, and such other damages as authorized by Alabama

law.    Petitioner did not allege how such damages should be

allocated among either the types of damages sought or the claims

made in the first cause of action.

       The second cause of action alleged that Liberty Life

wrongfully concealed and suppressed from petitioner the true

nature of the insurance policies in that Liberty Life never

revealed to petitioner the fact that coverage for payment of

benefits was limited to only one policy of insurance.    The second

cause of action further alleged that Liberty Life wrongfully

concealed and suppressed from petitioner the true nature of the

pattern and practice in which Liberty Life was engaged.
                                - 5 -

       Under the second cause of action, petitioner sought recovery

of an unspecified sum for actual damages, general damages,

punitive damages, and such other damages as authorized by Alabama

law.    Petitioner did not allege how such damages should be

allocated among the types of damages sought.

       The third cause of action alleged that Liberty Life was

guilty of conversion by taking various premium payments that were

made by petitioner as a result of the representations or

concealment and suppression practiced by Liberty Life.     Under

this cause of action, petitioner sought recovery of an

unspecified sum for actual damages, general damages, punitive

damages, and such other damages as authorized by Alabama law.

Petitioner did not allege how such damages should be allocated

among the types of damages sought.

       The fourth cause of action alleged that Liberty Life was

guilty of a breach of fiduciary duty to petitioner by virtue of

committing the acts described in the amended complaint.    Under

this cause of action, petitioner sought recovery of an

unspecified sum for actual damages, general damages, punitive

damages, and such other damages as authorized by Alabama law.

Petitioner did not allege how such damages should be allocated

among the types of damages sought.

       In May 1995, petitioner settled her action against Liberty

Life for $40,000.    The settlement was memorialized by a release,
                                - 6 -

which petitioner signed.

     The release did not allocate the $40,000 recovery among the

four causes of action, nor did it allocate such recovery between

compensatory and punitive damages.      However, in the release,

petitioner acknowledged that the payment represented settlement

of her claims for both compensatory and punitive damages.

Further, the release indicated that “a primary motivation and

consideration” on the part of Liberty Life in agreeing to settle

the case was to eliminate the claims made by petitioner for

punitive damages.

     Pursuant to the terms of the retainer agreement with the

Olen law firm, petitioner received $23,550 from the settlement of

her lawsuit; i.e., $40,000, less attorney’s fees of $16,000 and

court costs and related legal expenses of $450.

     Petitioner did not include in income on her 1995 income tax

return, Form 1040A, any portion of the $40,000 recovery received

from Liberty Life, nor did she deduct thereon any portion of the

attorney’s fees and court costs and related legal expenses that

were paid from such recovery.

     In the notice of deficiency, respondent determined that

petitioner was not entitled to exclude from gross income under

section 104(a)(2) any portion of the $40,000 recovery received

from Liberty Life.   Respondent also determined that petitioner

must include the entire recovery in income and then deduct the
                               - 7 -

portion used to satisfy attorney’s fees and court costs and

related legal expenses.3

     B. Earned Income Credit

     In 1995, petitioner lived with Jeffery S. Roland (Mr.

Roland).   Although petitioner and Mr. Roland were not married,

they lived together as common-law husband and wife.   Mr. Roland’s

younger sister, Amanda Roland (Amanda), lived with petitioner and

Mr. Roland for a portion of the year.   At the time, Amanda was 20

years old.

     Petitioner filed a joint return for 1995 with Mr. Roland.

On that return, petitioner and Mr. Roland claimed both a

dependency exemption for, and an earned income credit with

respect to, Amanda, who was described as their foster child.




     3
       At trial, respondent conceded that the portion of the
$40,000 recovery that was used to pay attorney’s fees and court
costs and related legal expenses does not constitute gross
income. See Davis v. Commissioner, 210 F.3d 1346 (11th Cir.
2000), affg. per curiam T.C. Memo. 1998-248. In Davis, the Court
of Appeals for the Eleventh Circuit followed the Court of Appeals
for the Fifth Circuit and held that under Alabama law, amounts
paid to an attorney, subject to a contingency fee arrangement,
are excludable from gross income. See Cotnam v. Commissioner,
263 F.2d 119 (5th Cir. 1959), affg. in part and revg. in part 28
T.C. 947 (1957). Although we do not share this view, see Kenseth
v. Commissioner, 114 T.C. 399 (2000), under the so-called Golsen
rule we follow the law of the circuit to which a case is
appealable. See Golsen v. Commissioner, 54 T.C. 742 (1970),
affd. 445 F.2d 985 (10th Cir. 1971).
     Consistent with respondent’s concession, petitioner is not
entitled to deduct the portion of the recovery that was used to
pay attorney’s fees and court costs and related legal expenses.
                               - 8 -

                              OPINION

I. Inclusion v. Exclusion of Petitioner’s Settlement Proceeds

     Except as otherwise provided, gross income includes income

derived from all sources.   See sec. 61(a); Commissioner v.

Glenshaw Glass Co., 348 U.S. 426 (1955).   Section 61(a) is to be

broadly construed; in contrast, statutory exclusions from income

are narrowly construed.   See Commissioner v. Schleier, 515 U.S.

323, 336-337 (1995); United States v. Burke, 504 U.S. 229, 233

(1992); Kovacs v. Commissioner, 100 T.C. 124, 128 (1993), affd.

per curiam without published opinion 25 F.3d 1048 (6th Cir.

1994).

     One statutory exclusion appears in section 104(a)(2).    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”.4   The relevant regulation, sec. 1.104-

1(c), Income Tax Regs., provides in pertinent part as follows:




     4
       The Small Business Job Protection Act of 1996, Pub. L.
104-188, sec. 1605(a), 110 Stat. 1755, 1838, amended sec.
104(a)(2) to narrow the exclusion for personal injury damages
received pursuant to a judgment or a settlement after Aug. 20,
1996, for taxable years ending after such date. As such, under
the amendment, personal injury or sickness must be physical in
nature. Moreover, the amendment explicitly excepts punitive
damages from the exclusion provided by sec. 104(a)(2). The
amendment, however, does not apply to the year before us and,
therefore, has no bearing on the instant case.
                               - 9 -

          (c) Damages received on account of personal
     injuries or sickness. * * * 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, damages may be excluded from gross income if a two-

prong test is satisfied.   The taxpayer must show: (1) The

underlying cause of action giving rise to the recovery is based

on tort or tort type rights and (2) damages were received on

account of personal injury or sickness.    See Commissioner v.

Schleier, supra at 336-337;5 Wesson v. United States, 48 F.3d

894, 901-902 (5th Cir. 1995); Bagley v. Commissioner, 105 T.C.

396, 416 (1995), affd. 121 F.3d 393 (8th Cir. 1997).    These two

independent requirements must both be satisfied in order for the

exclusion under section 104(a)(2) to apply.

     Furthermore, the Schleier test has been divided into its

disparate elements by some courts.     Thus, the taxpayer must show:

(1) There was an underlying claim sounding in tort; (2) the claim



     5
       In Commissioner v. Schleier, 515 U.S. 323, 336-337 (1995),
the Supreme Court distinguished the recovery that a taxpayer
receives as a result of an automobile accident from the recovery
that a taxpayer receives as a result of age discrimination under
the Age Discrimination in Employment Act of 1967 (ADEA), Pub. L.
90-202, 81 Stat. 602. Whereas both individuals may suffer
emotional harm as a result of a defendant's wrongdoing, only the
accident victim's recovery can be considered as received "on
account of” personal injury because the ADEA does not provide
recovery for personal injury. Therefore, the recovery received
by the ADEA claimant is not on account of personal injury.
                               - 10 -

existed at the time of settlement; (3) the claim encompassed

personal injuries; and (4) the agreement was executed in lieu of

the prosecution of the tort claim and on account of the personal

injury, rendering it a settlement rather than a mere severance

agreement.    See Greer v. United States, 207 F.3d 322 (6th Cir.

2000).

     If a settlement is attributable to claims based on tort or

tort type rights as well as other rights, the taxpayer must

establish which portion of the settlement is attributable to

damages received based on tort or tort type rights.    Similarly,

if the settlement may be attributable to damages received for

personal injuries or sickness as well as other harm, the taxpayer

must establish which portion of the settlement is attributable to

damages received for personal injuries or sickness.    See

Whitehead v. Commissioner, T.C. Memo. 1980-508.

     When damages are received pursuant to a settlement

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

settlement controls whether such damages are excludable under

section 104(a)(2).    See United States v. Burke, supra; Thompson

v. Commissioner, 866 F.2d 709, 711 (4th Cir. 1989), affg. 89 T.C.

632 (1987); Robinson v. Commissioner, 102 T.C. 116, 126 (1994),

affd. in part, revd. in part on another issue 70 F.3d 34 (5th

Cir. 1995).    Determination of the nature of the claim is factual.

See Bagley v. Commissioner, supra; Stocks v. Commissioner, 98
                                - 11 -

T.C. 1, 11 (1992).    "[T]he critical question is, in lieu of what

was the settlement amount paid."     Bagley v. Commissioner, supra

at 406.   If the settlement agreement does not expressly state the

purpose for which payment was made, the most important factor is

the intent of the payor.    See Knuckles v. Commissioner, 349 F.2d

610, 612 (10th Cir. 1965), affg. T.C. Memo. 1964-33; Robinson v.

Commissioner, supra; Stocks v. Commissioner, supra at 10;

Laguaite v. Commissioner, T.C. Memo. 2000-103.

     A. The Amended Complaint

     The crucial question is whether the net amount; i.e., the

$23,550 settlement payment, was received “on account of” personal

injury or sickness.    When a payment is received pursuant to a

settlement agreement from which we cannot clearly discern why the

payment was made, the underlying complaint is normally examined

as an indicator of the payor’s intent.      See Robinson v.

Commissioner, supra.    Logic dictates that defendants will

ordinarily determine their liability by taking into account the

allegations made in the complaint.       See Threlkeld v.

Commissioner, 87 T.C. 1294 (1986), affd. 848 F.2d 81 (6th Cir.

1988); Church v. Commissioner, 80 T.C. 1104 (1983).         Accordingly,

the payor’s intent may be discerned from the allegations made in

the complaint.

     Petitioner’s settlement agreement with Liberty Life does not

state what the $40,000 amount was paid to settle.      As the
                              - 12 -

settlement agreement does not specifically state why the

settlement proceeds were paid, we must look at surrounding facts,

including the underlying amended complaint, to decide the intent

of Liberty Life in entering into the settlement.

     A careful examination of the amended complaint demonstrates

that the relief requested was not solely for personal injury or

sickness.   Thus, the amended complaint included four counts,

which asserted claims for detrimental reliance, concealment and

suppression, conversion, and beach of fiduciary duty.    The

damages sought for each cause of action were identical in that

petitioner sought recovery of an unspecified sum for actual

damages, general damages, punitive damages, and such other

damages as authorized by Alabama law.

     The amended complaint contained no particularized

allegations regarding personal injury or sickness arising from

Liberty Life’s conduct.   In fact, the only allegation of any type

of personal injury is found in the first cause of action

(regarding detrimental reliance) and that allegation, which is

both conclusory and fleeting, reads in its entirety as follows:

"Further, the Plaintiff has suffered mental anguish and will so

suffer in the future."

     We observe at this point that the mere mention of emotional

harm in a complaint does not, by itself, serve to exclude the

recovery from gross income under section 104(a)(2).   Clearly,
                              - 13 -

such an approach would improperly expand the scope of section

104(a)(2) because language regarding emotional harm could easily

be included in every complaint as standard boilerplate.      See

Kightlinger v. Commissioner, T.C. Memo. 1998-357.    What is more,

the mere fact that a taxpayer suffers "personal" injury from a

defendant's conduct is insufficient to satisfy the "on account of

personal injury or sickness" test.     Commissioner v. Schleier,

supra at 336.   Only recovery that is "attributable to" such

personal injury is excludable from gross income.

     Furthermore, the relief requested by petitioner in the

amended complaint included a claim for punitive damages.      In the

seminal case of O’Gilvie v. United States, 519 U.S. 79 (1996), it

was settled that punitive damages generally are not intended to

compensate “on account of” personal injury or sickness.      Rather,

punitive damages are intended solely to levy private fines to

punish reprehensible conduct and deter its future occurrence.

See O’Gilvie v. United States, supra at 83.

     Thus, based on the amended complaint, we cannot find that

Liberty Life intended to pay petitioner on account of personal

injury to any discernible extent.

     B. The Release

     Where, as here, the settlement agreement does not expressly

state the purpose for which the payment was made, the most

important factor is the payor’s intent.    See Knuckles v.
                               - 14 -

Commissioner, supra at 613.

     The evidence does not demonstrate that Liberty Life

specifically intended to compensate petitioner on account of

personal injury or sickness.    For instance, the record is silent

as to whether the negotiations leading to the settlement

agreement involved any discussion regarding personal injuries

that petitioner may have suffered.      Indeed, there is nothing in

the record to suggest that Liberty Life was aware of any personal

injury that petitioner may have suffered.     In this regard, and as

previously stated, the amended complaint makes no mention of

personal injuries or sickness, other than the tangential

reference to “mental anguish” in the first cause of action.

     The settlement agreement is embodied in the form of a

standardized release, of which “a primary motivation and

consideration on the part of [Liberty Life] * * * in payment of

the settlement amount is to eliminate the punitive damage

claims”.   A standardized release may be indicative that the

payment was not made “on account of” personal injuries.     See

Laguaite v. Commissioner, supra; Gajda v. Commissioner, T.C.

Memo. 1997-345, affd. 158 F.3d 802 (5th Cir. 1998).     Moreover, as

previously stated, punitive damages ordinarily are not received

“on account of” personal injuries or sickness and are therefore

includable in gross income.    See O’Gilvie v. Commissioner, supra.

     When a settlement resolves a number of claims and does not
                                - 15 -

allocate proceeds to specific claims and there is no evidence

that a specific claim was meant to be singled out, we consider

the entire amount taxable.   See Morabito v. Commissioner, T.C.

Memo. 1997-315.

     In Commissioner v. Schleier, 515 U.S. 323 (1995), the

Supreme Court cautioned that there must be a direct link between

the personal injury and the recovery of damages for the exclusion

in section 104(a)(2) to apply.    In the present case, petitioner

has not shown that her claim for mental anguish prompted, to any

discernible extent, the settlement proceeds that she received.

     In agreeing to settle petitioner’s civil action, Liberty

Life appears to have been highly motivated by the possibility of

an award of punitive damages.    Significantly, the release did not

specifically allocate any amount as compensation for personal

injury or sickness.   Further, petitioner has not adduced any

facts upon which she would rely to prove such an allocation.

Under these circumstances, we are unable to find that a specific

portion of the settlement was intended to satisfy any potential

claim for mental anguish that petitioner might have had.   See,

e.g., Ramos v. Davis & Geck, Inc., 224 F.3d 30 (1st Cir. 2000).

As a result, the entire payment is presumptively includable in

gross income.   See Taggi v. United States, 35 F.3d 93, 96 (2d

Cir. 1994).

     In conclusion, petitioner’s amended complaint and the
                               - 16 -

release do not demonstrate that any discernible portion of the

settlement proceeds was paid on account of personal injury or

sickness.   Petitioner has therefore, failed to satisfy the second

prong of the Schleier test.    As a result, no portion of the

settlement proceeds may be excluded from gross income under

section 104(a)(2).

     Because the record does not show that any discernible

portion of petitioner’s recovery was attributable to personal

injury or sickness, we need not decide whether the underlying

civil lawsuit was based on tort or tort type rights.

II. Earned Income Credit

     For the year in issue, petitioner claimed an earned income

credit based on Amanda qualifying as a foster child.

     Section 32(c)(3) defines a "qualifying child" in terms of a

number of tests that must be satisfied.   Among these tests is the

so-called relationship test.   See sec. 32(c)(3)(A)(i), (B).    As

relevant herein, an individual satisfies the relationship test if

he or she is an eligible foster child of the taxpayer.   See sec.

32(c)(3)(B)(i)(III).   In turn, section 32(c)(3)(B)(iii) defines

"eligible foster child" to mean an individual who the taxpayer

cares for as the taxpayer's own child and who has the same

principal place of abode as the taxpayer for the taxpayer's

entire taxable year.

     In the present case we need not decide whether petitioner
                             - 17 -

cared for Amanda as her own child because the record is clear

that Amanda did not have the same principal place of abode as

petitioner for petitioner's entire taxable year.     Petitioner is

therefore not entitled to an earned income credit.     We therefore,

hold for respondent on this issue.

Conclusion

     In order to give effect to our disposition of the disputed

issues, as well as the parties’ concessions, see supra notes 1

and 3,



                                          Decision will be entered

                                     under Rule 155.
