                             T.C. Memo. 1996-26



                        UNITED STATES TAX COURT



                   ALEX MORGAN FOSTER, Petitioner v.
             COMMISSIONER OF INTERNAL REVENUE, Respondent



        Docket No. 489-94.                   Filed January 24, 1996.



        Alex Morgan Foster, pro se.

        Lloyd T. Silberzweig and Debra K. Moe, for respondent.



                             MEMORANDUM OPINION


        DEAN, Special Trial Judge:    This case was assigned pursuant

to the provisions of section 7443A(b)(3) and Rules 180, 181, and

182.1




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

     Respondent determined a deficiency of $7,197 in petitioner's

1989 Federal income tax and an accuracy-related penalty under

section 6662(a) in the amount of $1,439.40.

     After concessions,2 the issues for decision are:   (1)

Whether the proceeds of a settlement entered into between

petitioner and his former employer are excludable from income

under section 104(a)(2); (2) whether petitioner is liable for

self-employment tax under section 1401 with respect to such

proceeds; and (3) whether petitioner is liable for an accuracy-

related penalty for negligence or disregard of rules or

regulations pursuant to section 6662(a).

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

The stipulation of facts and attached exhibits are incorporated

herein by this reference.   Petitioner resided in Danville,

California, at the time he filed his petition.

Background

     From October 18, 1988, through February 27, 1989, petitioner

worked as an attorney for the legal department of American

Building Maintenance Industries, Inc. (hereinafter ABMI).

     During the period of his employment, petitioner worked under

the supervision of the General Counsel to ABMI, Harry Kahn




     2
      The parties have stipulated that, during the taxable year
at issue, petitioner: (1) Received dividend income in the amount
of $219.97, received interest income in the amount of $466.27,
and received additional capital gains in the amount of $282.03;
and (2) incurred ordinary and necessary business expenses in the
amount of $2,902.
                               - 3 -

(hereinafter Kahn).   Petitioner's responsibilities consisted

primarily of reviewing various service contracts.

     Within a short time of his hiring, a strained relationship

developed between petitioner and Kahn.   As demonstrated by the

record, the two:   (1) Differed as to the need for a "computerized

management information system";   (2) disagreed as to the proper

means of settling a particular lease dispute; and (3) discussed a

clash of personalities between petitioner and Kahn's secretary.

     On January 17, 1989, Kahn apprised petitioner that his

performance at ABMI was "unsatisfactory".   Shortly thereafter, on

February 24, 1989, Kahn fired petitioner.

     On March 1, 1989, petitioner sent two personal and

confidential letters to David Anacker (hereinafter Anacker), the

president and chief executive officer of ABMI.   Petitioner opined

in both letters that Kahn's termination of his employment had

been wrongful under the law.   In support, petitioner recounted

the incidents listed previously, and, in pertinent part, wrote

that:


     General Counsel's action of termination came as a
     surprise in view of my short tenure, the huge backlog
     which was worked off and the problems which were
     necessary to overcome to accomplish a smooth
     functioning of the Legal Department. In my opinion I
     should have been given professional guidance if my work
     was not satisfactory. Time for me to make corrections
     and implementation of criticisms by General Counsel
     should have been allowed before precipitous action such
     as termination.

          I fear that irreparable harm has been done to my
     near term job hunting success. It will be difficult at
     best to explain to prospective new employers such a
     short tenure at ABMI. Given that I have already
                               - 4 -

     started to accrue damages such as lost wages I suggest
     you consider the following offer of settlement. This
     is not to be construed as an admission of liability but
     merely as an offer of settlement.

          * * *

          A lump sum payment to me amounting to 8 months
     salary and benefits, ignoring deductions which would
     normally be made under payroll conditions, should be
     paid to me forthwith. In my opinion a court or jury
     would find at least one years salary would be in order
     as damages if it is found that General Counsel breached
     an employment agreement to employ me.


     Shortly after his receipt of the March 1, 1989, letters,

Anacker instructed Kahn to prepare a memorandum detailing the

events surrounding petitioner's termination.     A copy of this

memorandum was introduced at trial.    Bearing the date March 2,

1989, the memorandum essentially sets forth Kahn's belief that

petitioner had produced substandard work while at ABMI.    Kahn

states therein that petitioner was given several opportunities to

improve his performance, but failed to do so.

     At some point, soon after Kahn prepared his memorandum,

Anacker met with petitioner.   During this meeting, the two

apparently reached an understanding regarding petitioner's

grievances.   Thereafter, Anacker had a proposed settlement

agreement executed on behalf of ABMI and sent to petitioner.      In

relevant part, the proposed agreement provided petitioner a lump-

sum payment in the amount of $20,000 to satisfy any and all

claims, known or unknown, against ABMI.

     Subsequent to his receipt of the proposed settlement

agreement, petitioner sent two additional personal and
                               - 5 -

confidential letters to Anacker on March 21, 1991.   In one of

these letters, petitioner stated that:


     We discussed that this settlement would be in payment
     of my tort claim thereby making the settlement non-
     taxable. This is very important to me. In my opinion
     such a settlement can be made and therefore I must
     insist on such terms.


In the second letter, petitioner wrote:


     I have also revised the lump sum settlement amount
     pursuant to our conversations to account for deductions
     made from my last check. Moreover, I have shortened
     the period that ABMI would pay for my medical/dental
     benefits. In effect, the gross number is $21,000, less
     than a hundred dollar rounding bias in my favor.
     Clearly too, a round number would be a great asset in
     beating an IRS audit should I be challenged.


     On April 18, 1989, petitioner and Anacker signed a final

settlement agreement (hereinafter the agreement).    In pertinent

part, the agreement provides that:


     A.   CONDITIONS OF AGREEMENT

          1. This AGREEMENT is based on the fact that
     FOSTER may otherwise institute or continue actions or
     participate in actions against ABMI arising from
     FOSTER'S employment or the severance thereof and/or
     conduct affecting in any way their relationships to
     date. FOSTER and ABMI desire to completely resolve and
     settle any and all such disputed claims FOSTER may have
     against ABMI.

          2. The terms of this AGREEMENT set forth the full
     obligations of the parties. The parties have no
     further obligations aside from those expressed in this
     AGREEMENT.

          3. It is agreed and understood by the parties
     that neither the fact that settlement has occurred nor
     the fact that ABMI provides consideration for the
     release of claims can be construed as an admission of
                           - 6 -

any liability or wrongdoing on the part of ABMI. Both
parties expressly deny any liability to the other
party. The parties enter into this AGREEMENT in order
to resolve disputed claims and to avoid unnecessary
litigation. No admission of liability of either party
can be applied [sic] from FOSTER'S separation or the
fact or terms of Settlement. Consideration payable
under the terms of this AGREEMENT shall be deemed by
the parties as settlement of said disputed claim
between the parties.

B.   TERMS OF SETTLEMENT

     1. ABMI shall pay to FOSTER the sum of TWENTY
THOUSAND DOLLARS ($20,000.00) payable as set forth
below.

     2. Settlement payment shall be paid to FOSTER
personally in four installments on April 14, 1989
(receipt of which is hereby acknowledged) by 12:00 p.m.
and on the 15th day of the ensuing three months, May,
June and July. ABMI may file an IRS form 1099 if
required by law for the 4 installments required by this
paragraph B.2.

      * * *

     6. The parties agree that upon execution by the
parties to this AGREEMENT, FOSTER shall be an
independent contractor and may represent himself as "Of
Counsel" to ABMI. Permissive use of this title does
not signify that FOSTER is actually employed by ABMI.
"Of Counsel" status shall terminate at the earliest of
FOSTER'S permanent employment or July 31, 1989. * * *

      * * *

     9. FOSTER agrees to and hereby does voluntarily
release and forever discharge ABMI from any and all
claims, demands, damages and actions and causes of
every kind, known, or unknown, arising out of or any
way connected with FOSTER'S employment * * *. FOSTER
agrees that he will not continue, institute or
participate in any legal proceedings of any kind
whatsoever in any forum, agency, court or tribunal
against ABMI * * * occurring prior to the execution by
the parties of this AGREEMENT.

     10. "Claims" as used herein shall include all
actions, claims, and or grievances, whether actual or
potential, known or unknown and specifically but not
exclusively, all claims which FOSTER may have arising
                               - 7 -

     out of his employment or severance thereof. All such
     claims are forever barred by this AGREEMENT regardless
     of the forum in which such claim(s) might be brought.
     * * *

                The parties expressly acknowledge that this
           AGREEMENT is intended to include all claims which
           FOSTER does not know or expect to exist in his
           favor at the time of execution of this AGREEMENT
           which claims are hereby extinguished. * * *


     Pursuant to the terms of the agreement, petitioner received

payments from ABMI totaling $20,000 during the taxable year 1989.

On or about January 15, 1990, ABMI issued to petitioner an

Internal Revenue Service (IRS) Form 1099-MISC, which reported

nonemployee compensation paid to him in the amount of $20,000 for

1989.

     Petitioner reported the $20,000 settlement received as

"Gross receipts or sales" on Schedule C of his 1989 Federal

income tax return.   He claimed as an offset against this amount a

deduction for "PERSONAL INJURY SETTLEM [sic]" in the amount of

$15,000.   This deduction was claimed to reflect the judgment of

petitioner's accountant that $5,000 of the settlement was

attributable to lost wages, and that $15,000 was attributable to

tort like claims excludable under section 104(a)(2).   Petitioner

now claims, however, that his method of reporting the settlement

was erroneous, and that the entire amount received should have

been excluded from income under section 104(a)(2).

Exclusion of Settlement Proceeds

     Respondent determined in the notice of deficiency that no

part of the $20,000 settlement was excludable from petitioner's
                               - 8 -

income.   According to respondent, petitioner has not established

that this amount was received as damages on "account of personal

injuries", as defined under section 104(a)(2).      Petitioner

disagrees, arguing that the settlement was meant to address a

plethora of tort claims against ABMI, including "wrongful

termination of employment under California law * *      * retaliatory

discharge, First Amendment claims, malicious prosecution,

defamation, disparagement, trade libel, emotional distress, and

national origin discrimination."

     Although section 61(a) defines gross income to include "all

income from whatever source derived," an exception may be found

under section 104(a)(2) and the regulations thereunder.      Section

104(a)(2) provides that "the amount of any damages received

(whether by suit or agreement * * *) on account of personal

injuries or sickness" is excludable from gross income.      Section

1.104-1(c), Income Tax Regs., provides that:


     The term "damages received (whether by suit     or
     agreement)" 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
     such prosecution.


     In determining whether a settlement payment was intended to

compensate for personal injuries, we are not concerned with the

validity of the claims settled by the settlement or legal suit.

Seay v. Commissioner, 58 T.C. 32, 37 (1972).      Rather, we focus on

the nature of the matter settled.      Id.   For purposes of section

104(a)(2), we look to State law (here, California law) to decide
                               - 9 -

the "nature" of a claim.   See United States v. Mitchell, 403 U.S.

190, 197 (1971).

     In a case such as this where the settlement lacks express

language stating that the payment was made on account of personal

injuries, the intent of the payor in making the payment is the

most important factor to be discerned.   Knuckles v. Commissioner,

349 F.2d 610 (10th Cir. 1965), affg. T.C. Memo. 1964-33.     This is

a factual determination, and is made based upon an examination of

all the evidence.   Seay v. Commissioner, supra at 37.

     Petitioner argues that a host of tort claims were settled by

his agreement with ABMI.   Petitioner has not demonstrated,

however, that Anacker, as representative of ABMI, the payor, was

aware of such claims at the time the agreement was negotiated.

See Galligan v. Commissioner, T.C. Memo. 1993-605.     Based on the

record, the most that can be said is that petitioner apprised

Anacker of a potential action for breach of the covenant of good

faith and fair dealing implied in a claimed employment contract

with ABMI.   Even if we accept, arguendo, that petitioner's

employment was not at-will,3 and that there was a breach of an

implied covenant, the relief for such a breach is limited under

California law to traditional contractual remedies.4     See Mundy

     3
      California Labor Code sec. 2922 (West 1989) provides in
relevant part, "An employment, having no specified term, may be
terminated at the will of either party on notice to the other".
     4
      We note that, even in the case of at-will employment, tort
remedies are available to an employee if he or she is terminated
in contravention of "public policy". E.g., Tameny v. Atlantic
Richfield Co., 610 P.2d 1330, 1331 (Cal. 1980) (Employer's
                                                     (continued...)
                                 - 10 -

v. Household Finance Corp., 885 F.2d 542, 544 (9th Cir. 1989),

citing Foley v. Interactive Data Corp., 765 P.2d 373 (1988).

Section 104(a)(2) excludes only damages received on account of

the prosecution or settlement of tort or tort type claims, not

the prosecution or settlement of economic rights arising out of

a contract.      Commissioner v. Schleier, 515 U.S. ____, 115 S. Ct.

2159.

     To the extent petitioner argues that the broad definition of

a "claim" in the agreement with ABMI covers potential claims for

personal injuries, thereby qualifying the settlement for

exclusion under section 104(a)(2), we are not persuaded.     The

existence of an agreement that contains a release of undisclosed

or potential claims is not sufficient evidence, in and of itself,

that the amounts paid under that agreement are eligible for

section 104(a)(2) exclusion.      Galligan v. Commissioner, supra.

     Furthermore, even if we were to set aside the question of

the payor's intent, we find that, based on the record,

petitioner's claims of tortious injury from his firing were

motivated in this matter "not by actionable injury to petitioner,

but rather by the tax advantage resulting to him for settlement

on that ground."      Knuckles v. Commissioner, T.C. Memo. 1964-33,

affd. 349 F.2d 610 (10th Cir. 1965).




(...continued)
authority over its employee does not include the right to demand
that the employee commit a criminal act to further its
interests). Petitioner has failed to demonstrate, however, that
it was ever the "intent of the payor" to settle such a claim.
                                - 11 -

     Based on the foregoing, we find that the proceeds of

petitioner's settlement with ABMI are not excludable under

section 104(a)(2).     Accordingly, respondent is sustained on this

issue.

Self-Employment Tax

     Respondent determined in the notice of deficiency that, due

to adjustment to petitioner's Schedule C income, petitioner was

liable for self-employment tax under section 1401 in the amount

of $2,902.    In opposition, petitioner argues that the settlement

was excludable under section 104(a)(2), and, therefore,

improperly reported by ABMI as nonemployee income on IRS Form

1099.    We find, however, that petitioner's arguments on this

point are moot, as we have already held for respondent on the

question of whether the settlement was excludable from

petitioner's income.     Accordingly, respondent is sustained on

this issue as well.5

Section 6662(a) Penalty

     Respondent determined an accuracy-related penalty under

section 6662(a) with respect to petitioner's 1989 Federal income

tax return for negligence or disregard of rules or regulations.

     In pertinent part, section 6662 imposes an accuracy-related

penalty equal to 20 percent of the portion of an underpayment of

tax that is attributable to negligence or disregard of rules or

     5
      In computing petitioner's self-employment income in the
Rule 155 computation, allowance will be made for respondent's
concession that petitioner is entitled to Schedule C deductions
for 1989 in the amount of $2,902.
                                - 12 -

regulations.    Sec. 6662(a), (c).   Section 6662(c) defines

"negligence" as including any failure to make a reasonable

attempt to comply with the provisions of the Internal Revenue

Code, and defines "disregard" as including any careless,

reckless, or intentional disregard.

     Petitioner has conceded that he failed to report the receipt

of interest, dividends, and capital gains during the taxable year

1989.    Petitioner seeks to avoid imposition of a penalty under

section 6662(a) for this omission by arguing that it was

attributable to the late receipt of a Form 1099 from Merrill

Lynch.    We find this explanation to be self-serving and lacking

credibility.    Furthermore, petitioner failed to offer any

evidence as to why an amended return was not filed to report this

income once the Form 1099 was received.

     Based on the record, we also find that petitioner was

negligent in reporting his receipt of the settlement from ABMI.

     Accordingly, respondent's determination of an accuracy-

related penalty is sustained.

                                              Decision will be entered

                                         under Rule 155.
