                   T.C. Summary Opinion 2007-126



                      UNITED STATES TAX COURT



              JODY SCHOOLCRAFT-BURKEY, Petitioner v.
           COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 17437-06S.                Filed July 24, 2007.



     Jody Schoolcraft-Burkey, pro se.

     Anita A. Gill and Cathy J. Horner, for respondent.



     JACOBS, 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.1    Pursuant to section 7463(b),




      1
       Unless otherwise indicated, subsequent section references
 are to the Internal Revenue Code in effect for the year in issue,
 and Rule references are to the Tax Court Rules of Practice and
 Procedure.
                               - 2 -

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

and this opinion shall not be treated as precedent for any other

case.

     Respondent determined a $24,823 deficiency in petitioner’s

2003 Federal income tax and a $4,965 accuracy-related penalty

under section 6662.   The issues for decision are:   (1) Whether all

payments petitioner received from his former employer, Mahoning

Valley Economic Development Corp. (MVEDC), pursuant to the

settlement of a lawsuit are includable in income; (2) whether

petitioner may deduct attorney’s fees he paid in bringing a

lawsuit against MVEDC; (3) whether petitioner paid deductible

expenses which would offset income he received in the performance

of consulting services; and (4) whether petitioner is liable for

an accuracy-related penalty under section 6662.

                             Background

     Some of the facts have been stipulated and are so found.    The

stipulation of facts and the attached exhibits are incorporated

herein by this reference.   At the time he filed his petition,

petitioner resided in Niles, Ohio.

     Petitioner, as a married taxpayer filing separately, timely

filed a Form 1040, U.S. Individual Income Tax Return, for 2003 in

which he reported total income of $46,479, tax of $6,416, and tax

payments of $7,586.   Both petitioner and his wife claimed the

standard deduction for 2003 in their separate returns.
                                - 3 -

     On the basis of third-party information reported to the IRS,

respondent determined that petitioner failed to report relatively

small amounts of capital gain/dividend income, interest income,

and pension/annuity income (investment income), as well as $17,818

of nonemployee consulting compensation and $58,000 of the $85,000

he received from MVEDC in connection with settlement of a lawsuit.

See infra.   Petitioner concedes error in his failure to report the

various amounts of investment income, as well as the $17,818 of

nonemployee consulting compensation, but he disputes the

taxability of $58,000 of the $85,000 in settlement proceeds he

received from MVEDC, claiming that portion was nontaxable

compensation for personal injuries.     Moreover, petitioner claims

entitlement to deductions for certain expenses in connection with

his lawsuit against MVEDC and in rendering his consulting

services.

     From 1980 until he was dismissed on July 27, 2000, petitioner

was a loan officer for MVEDC.   For several months before his

dismissal, petitioner had been cooperating with the FBI and the

U.S. Department of Justice in providing files, correspondence, and

other documents pertaining to certain of MVEDC’s activities.     In

2003, petitioner brought suit against MVEDC2 for terminating his




      2
       Petitioner’s lawsuit, in addition to naming MVEDC, included
 MVEDC’s executive director and treasurer and Mahoning Valley
 Industrial Loan Fund as defendants.
                                - 4 -

employment, alleging that his discharge was in retaliation for his

cooperation with Government officials.

     In his complaint against MVEDC, petitioner claimed the

following:    Breach of contract, intentional breach of contract,

infliction of emotional distress, promissory estoppel, principal

and agent relationship–-breach of fiduciary duty, breach of

fiduciary duty, equitable claim for unjust enrichment, public

policy and common law, tortious interference with contractual

relationship, and civil conspiracy.     The complaint made no

reference to any State or Federal statute, such as a whistleblower

protection regime or civil rights legislation, as a possible basis

for relief.    In his complaint, petitioner demanded, in addition to

equitable relief such as reinstatement, “compensatory damages in

an amount in excess of $25,000” and “punitive damages in an amount

in excess of $25,000.”

     In connection with his claim based on intentional breach of

contract, petitioner alleged that he suffered “adverse health

effects”.    In connection with his claim based on infliction of

emotional distress, petitioner alleged that he suffered “physical

injury in the form of adverse health effects.”     In connection with

his claim based on public policy and common law, petitioner

alleged that he suffered “physical pain and distress”.     The

complaint did not allege that petitioner sustained any other

personal physical injury or physical sickness, and it did not
                              - 5 -

explain or describe the “adverse health effects”, “physical

injury”, or “physical pain” petitioner claimed to have suffered.

     Petitioner entered into a settlement with MVEDC on or about

December 1, 2003, in which petitioner agreed to dismissal of his

lawsuit in exchange for $85,000.   The settlement agreement

designated $27,000 of the $85,000 in settlement proceeds as “back

pay” or “lost wages”, and petitioner agrees that the $27,000 is

taxable.

     The settlement agreement designated the remaining $58,000 of

the $85,000 as compensation for:

     any emotional pain, suffering, inconvenience, mental anguish,
     loss of enjoyment of life, fright, nervousness, indignity,
     humiliation, embarrassment and other personal injuries that
     Burkey claims to have suffered, as well as in exchange for
     his release of any common law and statutory causes of action
     for sexual harassment, sex or gender discrimination, age
     discrimination, disability discrimination, personal injury,
     retaliation, wrongful discharge, constructive discharge,
     claims of discrimination or harassment on any basis, claims
     alleging whistleblowing under state or federal law, claims of
     breach of public policy, breach of fiduciary duty, breach of
     express or implied contract, breach of any employment
     agreement, conspiracy, interference with employment contract,
     unjust enrichment, invasion of privacy, fraud, conversion,
     intentional infliction of mental distress, promissory
     estoppel, defamation, intentional interference with any
     contract or business relationship and any other claims of any
     kind that Burkey may possess against MVEDC.


The settlement agreement specified that MVEDC would not withhold

any taxes from the $58,000 portion of the $85,000 payment and that

MVEDC made “no representation or warranty whatsoever concerning

the tax consequences of Burkey’s receipt of any monetary payments
                                   - 6 -

from MVEDC”.       MVEDC reported the $58,000 portion to the IRS by

means of Form 1099-MISC, Miscellaneous Income, as “other income”.

Petitioner did not report the $58,000 portion on his 2003 return.

     At trial, petitioner continued to maintain that the $58,000

portion was compensation for personal injuries and not includable

in income.       He further claimed that he was entitled to a deduction

for attorney’s fees he paid in connection with his lawsuit against

MVEDC.       Additionally, petitioner claimed he paid deductible

expenses in connection with the production of the $17,818 in

consulting income.       Finally, petitioner, who resided in a home

owned by his daughter and paid no rent to her in 2003, claimed

that rent he would have paid had he been required to pay rent,

together with an array of other expenses, was deductible and that

he should have deducted those expenses on a Schedule C, Profit or

Loss From Business,3 with his 2003 return.




         3
       Petitioner did not attach a Schedule C to his 2003 return.
 At trial, petitioner submitted a handwritten page dated Apr. 14,
 2007, captioned “Amended 2003 Schedule ‘C’”, on which deductions
 totaling $14,498 for “rent, phone, advertising/ cards/supplies/
 meals, mileage/travel, misc/membership” were listed. This
 summary was revised during the trial to show a corrected total of
 $11,065.50 of deductions for “rent, mileage/travel” and
 “misc/membership”. In addition, at trial petitioner submitted a
 statement in which he claimed a deduction for the “equivalent of
 lost medical insurance coverage.”
                                  - 7 -

                              Discussion

     Petitioner has neither claimed nor shown that he satisfied

the requirements of section 7491(a) to shift the burden of proof

to respondent.    Hence, petitioner bears the burden of proving that

respondent’s deficiency determinations are incorrect.        See Rule

142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933).

     It is well established that, pursuant to section 61(a), gross

income includes all income from whatever source derived unless

otherwise excluded by the Internal Revenue Code.        See Commissioner

v. Glenshaw Glass Co., 348 U.S. 426, 429-431 (1955).        Exclusions

from gross income are construed narrowly.         Commissioner v.

Schleier, 515 U.S. 323, 327-328 (1995).       Generally, amounts

received for damages are excludable from gross income if:           (1) The

taxpayer demonstrates that the underlying cause of action giving

rise to the recovery is based upon tort or tort type rights, and

(2) the taxpayer shows that the damages were received on account

of personal injuries or sickness.      Id. at 336.

     The specific exclusion upon which petitioner relies is found

in section 104.   Section 104, as relevant here, provides:

     SEC. 104. COMPENSATION FOR INJURIES OR SICKNESS.

          (a) In General.--Except in the case of amounts
     attributable to (and not in excess of) deductions
     allowed under section 213 (relating to medical, etc.,
     expenses) for any prior taxable year, gross income does
     not include--

                      *   *   *    *      *   *    *
                                     - 8 -

                   (2) 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;

                         *   *   *    *      *   *   *

     * * * For purposes of paragraph (2), emotional distress
     shall not be treated as a physical injury or physical
     sickness. * * * [4]

“Damages received” means amounts 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.”      Sec. 1.104-1(c), Income Tax Regs.

     When damages are received pursuant to a settlement agreement,

courts decide the purpose or purposes for which a payment was made

by considering, inter alia, the following:           (1) The underlying

complaint and the nature of the claims; (2) the settlement

negotiations and settlement agreement; and (3) the intent of the

payor.       See United States v. Burke, 504 U.S. 229, 237-239 (1992);

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

89 T.C. 632 (1987); Knuckles v. Commissioner, 349 F.2d 610, 612-

613 (10th Cir. 1965), affg. T.C. Memo. 1964-33; Bagley v.




         4
       Sec. 104 was amended by the Small Business Job Protection
 Act of 1996, Pub. L. 104-188, sec. 1605, 110 Stat. 1838, to
 provide, with respect to amounts received after Aug. 20, 1996,
 that the personal injury or sickness for which the damages are
 received must be physical in nature.
                                    - 9 -

Commissioner, 105 T.C. 396, 406 (1995), affd. 121 F.3d 393 (8th

Cir. 1997).

     Petitioner’s complaint does not specify the physical injury

he suffered as a result of MVEDC’s conduct.       There is nothing in

the record to indicate that petitioner either suffered a

particular physical injury or physical sickness or informed MVEDC

that he was suffering from a particular physical injury or

physical sickness as a result of his discharge.       In fact, the

settlement agreement does not refer to physical injury or physical

sickness.       Rather, it enumerates other types of injuries such as

emotional pain, suffering, inconvenience, mental anguish, etc., as

well as injuries that petitioner never alleged, such as sexual

harassment and discrimination.       Hence, it appears that MVEDC’s

intent in entering into the settlement agreement was to secure a

broad, general release from petitioner, rather than to compensate

him for physical injury or sickness.

     Petitioner did not submit any medical records showing that he

received treatment for physical injuries, and the record is devoid

of any detailed description of what those injuries might have

been.5       In sum, we do not find any basis in this record upon which


         5
        In a posttrial memorandum filed with the Court, petitioner
  described having symptoms such as “anxiety, chronic pain (with
  physical symptoms such as high blood pressure, increased pulse
  and respiration), compulsions, delusions, denial and depression.”
  Stress-related symptoms such as these relate to emotional
  distress and not to physical sickness. See Lindsey v.
                                                     (continued...)
                               - 10 -

we could make a rational allocation of MVEDC’s $58,000 payment to

compensation for physical harm, if indeed petitioner suffered

physical harm within the meaning of section 104.    Therefore, the

entire $85,000 settlement payment is includable in petitioner’s

income.

     In bringing his lawsuit against MVEDC, petitioner retained an

attorney whom he compensated on an hourly basis.    Petitioner made

periodic payments to his attorney beginning in 2002, and he paid

$11,920 in legal fees during 2003.   At trial, petitioner claimed

that his 2003 legal fees were deductible.

     Generally, legal fees are deductible under section 162 only

if the matter with respect to which the fees were paid originated

in the taxpayer’s trade or business and only if the claim is

sufficiently connected with that trade or business.    See United

States v. Gilmore, 372 U.S. 39 (1963); Biehl v. Commissioner, 118

T.C. 467, 479 (2002), affd. 351 F.3d 982, 985 (9th Cir. 2003);

Test v. Commissioner, T.C. Memo. 2000-362, affd. 49 Fed. Appx. 96

(9th Cir. 2002).   Expenses not incurred in a trade or business

activity but in the production or collection of income are

deductible as miscellaneous itemized deductions on Schedule A,

Itemized Deductions.   Secs. 67(b), 212(1).   Further, it is well

established that even though a taxpayer’s employee status may be


     5
     (...continued)
 Commissioner, T.C. Memo. 2004-113, affd. 422 F.3d 684 (8th Cir.
 2005).
                               - 11 -

regarded as a trade or business, legal fees stemming from a

taxpayer’s employee status are to be treated as miscellaneous

itemized deductions, subject to the 2-percent floor.6    See sec.

62(a)(1); see also Commissioner v. Banks, 543 U.S. 426, 432

(2005); McKay v. Commissioner, 102 T.C. 465, 493 (1994), vacated

on other grounds without published opinion 84 F.3d 433 (5th Cir.

1996); Test v. Commissioner, supra; Alexander v. Commissioner,

T.C. Memo. 1995-51, affd. 72 F.3d 938 (1st Cir. 1995).

     It is undisputed that petitioner was an employee of MVEDC and

that the legal fees petitioner paid stemmed from that

relationship.   Therefore, the legal fees of $11,920 petitioner

paid to his attorney relating to the settlement of petitioner’s

claims against MVEDC would have been deductible on Schedule A,

Itemized Deductions.

     Petitioner did not file a Schedule A with his 2003 return but

instead claimed the standard deduction.   Petitioner’s spouse also

filed a separate return for 2003 and claimed the standard

deduction.   As a consequence, respondent contends that petitioner




      6
       The excess unreimbursed employee and other miscellaneous
 expenses deduction is claimed on Schedule A, Itemized Deductions.
 The amount of the deduction equals the sum of: (1) Unreimbursed
 employee expenses--job travel, union dues, job education, etc.;
 (2) tax preparation fees; and (3) other expenses--investment,
 safe deposit box, etc., less an amount equal to 2 percent (the 2-
 percent floor) of the taxpayer’s adjusted gross income. See sec.
 67(a).
                               - 12 -

is precluded from itemizing his deductions by the provisions of

section 63(e) and section 6013(b).

     Section 63(e) provides that taxpayers must elect to itemize

deductions, and this election is to be made on the taxpayer’s

return.   Sec. 63(e)(1) and (2).   A taxpayer may change his

election after filing the return, but if the taxpayer’s spouse

filed a separate return for the same taxable year, section

63(e)(3) provides:

     the change shall not be allowed unless * * *
          (A) the spouse makes a change of election with respect
     to itemized deductions, for the taxable year covered in such
     separate return, consistent with the change of treatment
     sought by the taxpayer, and
          (B) the taxpayer and his spouse consent in writing to
     the assessment (within such period as may be agreed on with
     the Secretary) of any deficiency, to the extent attributable
     to such change of election * * *

     Petitioner did not elect to itemize deductions either on his

original return or by means of an amended return.     Even were we to

construe petitioner’s submissions at trial as an attempt to elect

itemization under section 63(e), the statutory requirements of

that section have not been met.    See Boyd v. Commissioner, T.C.

Memo. 2003-286.   Therefore, petitioner is not entitled to itemize

his deductions for 2003; consequently, he cannot claim any

deduction for legal fees he paid.

     Petitioner concedes that he received nonemployee compensation

of $17,818 for consulting services.     Petitioner did not report

this income on his 2003 return, nor any expenses associated with
                                 - 13 -

the production of that income.    The “Amended 2003 Schedule ‘C’”

that petitioner submitted at trial, see supra note 3, was prepared

shortly before trial and represents a reconstruction of expenses

petitioner believed he paid.   Amounts shown on the Schedule C were

revised at trial to show a rent expense of $5,369,7 a

mileage/travel expense of $5,546.50, and a misc./membership

expense of $150.

     Petitioner testified that although he used portions of his

dwelling for purposes of meeting clients for the first 9 months of

2003, he neither owned nor paid rent for the premises.     Moreover,

he did not pay specifically for utilities, telephone, or Internet

services.   Rather, he contributed to the general upkeep of the

home, where he resided with his wife.     The amount he determined

deductible as rent was the amount that he theoretically would have

paid for that portion of the home he used for his consulting

activities had there been a third-party landlord, as well as a

portion of the utilities, telephone, and Internet services that

were allocable, in petitioner’s view, to his consulting

activities.   Petitioner did not submit any documentary

substantiation (such as utility bills or telephone bills) in

support of his claimed deduction for expenses paid in using a

portion of his home for his consulting activities.



      7
       Petitioner clarified that $5,369 represents the total
 amount for rent, utilities, telephone, and Internet services.
                               - 14 -

     While we accept that petitioner used a portion of his

dwelling for consulting activities, we are unable to determine the

amounts, if any, of expenses he paid in connection with that

activity.   The fact that petitioner contributed to general

household expenses does not suffice to convert those personal

living expenses into home office business expenses.    Moreover, it

is not clear that any transfer of funds actually took place in the

first 9 months of 2003, and no other taxpayer (i.e., petitioner’s

daughter, who held title to the home, or his wife) reported any

rental income from the dwelling.    In sum, petitioner has not

proven entitlement to any deduction for rent for the first 9

months of 2003 or to a deduction for utilities, telephone, or

Internet services.

     For the last 3 months of 2003, petitioner moved his place of

business to different premises.    Petitioner credibly testified

(and substantiated) that he paid rent of $600 per month for the

last 3 months of 2003 to an unrelated third-party landlord.

Petitioner is therefore entitled to a $1,800 deduction for a rent

expense in carrying on his consulting activity in 2003.

     Petitioner claimed a $5,546 deduction for “mileage/travel”

expenses paid in connection with his consulting activity.     In

support of the claimed deduction, petitioner submitted records

showing the number of miles he traveled each month and a

description of the purpose of the travel.    The records were
                               - 15 -

prepared contemporaneously with the travel.   Petitioner testified

that he kept the travel records in an effort to determine, during

2003, whether the income from his consulting activity was

sufficient to cover his expenses.

     Section 274 provides that expenses paid or incurred with

respect to travel and certain listed property are deductible only

if the taxpayer meets the stringent substantiation requirements of

section 274(d).   See sec. 280F(d)(4)(A).   For these expenses, only

certain types of documentary evidence will suffice.   Passenger

automobiles are listed property under section 280F, and therefore

strict substantiation for their use as transportation is required.

Sec. 274(d).   No deduction is allowed for any travel or

transportation expense unless the taxpayer substantiates by

adequate records or by sufficient evidence corroborating the

taxpayer’s own statement the amount of the expense, the mileage

for each business use of the automobile and the total mileage for

all use of the automobile during the taxable period, the date of

the business use, and the business purpose for the use.    Sec.

1.274-5T(b)(6), Temporary Income Tax Regs., 50 Fed. Reg. 46016

(Nov. 6, 1985).   Adequate records include the maintenance of an

account book, diary, log, statement of expense, trip sheets,

and/or other documentary evidence, which, in combination, are

sufficient to establish each element of expenditure or use.    Sec.
                               - 16 -

1.274-5T(c)(2)(i), Temporary Income Tax Regs., 50 Fed. Reg. 46017

(Nov. 6, 1985).

     Petitioner submitted a travel log consisting of 12 pages, one

for each month of 2003.   The purpose for the claimed travel

expense is indicated on every page as “Travel from Niles to

Steubenville and return” or “Travel from Niles to

Steubenville/Lisbon et al and return”.     The description of the

travel is shown on every page as “Client calls at

Chamber/Commerce” and/or “Client calls at One Stop Center”.

Actual travel on specific days is not shown; rather, monthly

totals are given.   Specific client names are not provided (or

itemized with identifying information redacted).     The nature of

the business discussions petitioner conducted is not shown.       We

are unable to conclude from petitioner’s travel log that the

strict substantiation requirements of section 274 have been met.

Accordingly, the claimed mileage/travel expenses are not

deductible.

     At trial, petitioner claimed that he is entitled to a

deduction for “lost medical insurance coverage”.     Petitioner

testified that during 2003 he did not have insurance coverage and

did not pay any amounts for medical insurance.     His claimed

deduction is based on amounts he estimated that he would have paid

if he had purchased such insurance.     Because petitioner did not

pay this expense, he is not entitled to this deduction.
                                - 17 -

     Finally, petitioner claimed that he is entitled to a $150

deduction for the membership fee to join the Jefferson County

Chamber of Commerce.   Petitioner testified, and we believe, that

he joined the Chamber of Commerce in order to achieve more

recognition for his business.   This expense is deductible under

section 162.

     As noted supra, respondent determined a section 6662(d)

penalty of $4,965 for 2003.   Pursuant to section 6662(a) and

(b)(2), a taxpayer may be liable for a penalty of 20 percent of

the portion of an underpayment of tax attributable to a

substantial understatement of income tax.     The term

“understatement” means the excess of the amount of tax required to

be shown on a return over the amount of tax imposed which is shown

on the return, reduced by any rebate (within the meaning of

section 6211(b)(2)).   Sec. 6662(d)(2)(A).    Generally, an

understatement is a “substantial understatement” when the

understatement exceeds the greater of $5,000 or 10 percent of the

amount of tax required to be shown on the return.     Sec.

6662(d)(1)(A).   The Commissioner has the burden of production with

respect to the accuracy-related penalty.     Sec. 7491(c).    To meet

this burden, the Commissioner must produce sufficient evidence

indicating that it is appropriate to impose the penalty.       See

Higbee v. Commissioner, 116 T.C. 438, 446 (2001).        Once the

Commissioner meets this burden of production, the taxpayer must
                               - 18 -

come forward with persuasive evidence that the Commissioner’s

determination is incorrect.   Rule 142(a); see Higbee v.

Commissioner, supra at 447.   The taxpayer may meet this burden by

proving that he or she acted with reasonable cause and in good

faith.   See sec. 6664(c)(1); see also Higbee v. Commissioner,

supra at 448; sec. 1.6664-4(b)(1), Income Tax Regs.

     Respondent has met his burden of production under section

7491(c).   Petitioner’s 2003 return contains an understatement of

tax greater than $5,000 (which is greater than 10 percent of the

amount of tax required to be shown on the return).    See sec.

6662(d)(1)(A)(ii).   Accordingly, petitioner bears the burden of

proving that the accuracy-related penalty should not be imposed

with respect to any portion of the underpayment for which he acted

with reasonable cause and in good faith.    See sec. 6664(c)(1);

Higbee v. Commissioner, supra at 446.   Petitioner did not carry

his burden of showing that his omissions from income which

resulted in the underpayment were made with reasonable cause and

in good faith.   Accordingly, petitioner is liable for the section

6662(a) penalty.



                                           Decision will be entered

                                    under Rule 155.
