                        T.C. Memo. 2011-186



                      UNITED STATES TAX COURT



  JULIE MARIE MCGOWEN AND JOHN MICHAEL MCGOWEN, Petitioners v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 22619-08.               Filed August 4, 2011.



     Julie Marie McGowen and John Michael McGowen, pro sese.

     Guy H. Glaser and Jeffery D. Rice, for respondent.



             MEMORANDUM FINDINGS OF FACT AND OPINION


     FOLEY, Judge:   After concessions, the issues for decision,

relating to petitioners’ 2006 joint Federal income tax return,

are whether a payment received pursuant to a settlement agreement
                               - 2 -

is taxable income and whether petitioners are subject to a

section 6662(a)1 accuracy-related penalty.

                         FINDINGS OF FACT

     In 2004 Julie Marie McGowen worked as a financial analyst

for PacifiCare Health Systems, Inc., and PacifiCare of California

(collectively, PacifiCare).   From August to December 2004 Mrs.

McGowen was harassed at work by Kevin Bulrice.     Mr. Bulrice

created an intimidating, hostile, and offensive work environment

and, on one occasion, threw a binder at Mrs. McGowen.     Mrs.

McGowen reported these incidents to her superiors, but her

superiors did not take action to prevent Mr. Bulrice from

continuing to harass Mrs. McGowen.     Mrs. McGowen’s work

conditions became intolerable and she began to develop symptoms

of emotional distress (e.g., shaking, sweating, anxiety,

sleeplessness, panic attacks, depression, etc.).     On December 19,

2004, Mrs. McGowen elected to take a medical leave of absence due

to stress.

     During her leave of absence Mrs. McGowen remained in contact

with PacifiCare and periodically updated PacifiCare on the status

of her health.   On March 23, 2005, Mrs. McGowen requested an

extended leave of absence and informed PacifiCare that she would



     1
      Unless otherwise indicated, all section references are to
the Internal Revenue Code in effect for the year in issue, and
all Rule references are to the Tax Court Rules of Practice and
Procedure.
                               - 3 -

be undergoing counseling for her stress-related problems.     On

April 19, 2005, PacifiCare notified Mrs. McGowen that her

employment had been terminated effective April 15, 2005.

     On September 26, 2005, Mrs. McGowen filed a complaint

against PacifiCare and several PacifiCare employees with the

Superior Court of the State of California, County of Orange

(complaint).   In the complaint Mrs. McGowen alleged sexual

harassment, failure to prevent sexual harassment, disability

discrimination, failure to prevent discrimination, intentional

infliction of emotional distress, and other causes of action.

Mrs. McGowen also described how she was mistreated and requested

“compensatory damages for emotional distress and other economic

and non-economic losses”.

     On April 11, 2006, Mrs. McGowen and PacifiCare entered into

a settlement agreement and general release of claims (settlement

agreement), which provided that PacifiCare, as consideration for

the release of claims set forth in the agreement, would make

payments totaling $125,000 to Mrs. McGowen and her attorneys.      In

particular, the settlement agreement provided that PacifiCare

would pay Mrs. McGowen’s attorneys $39,750 “for attorneys fees on

account of * * * [Mrs. McGowen’s] statutory claims under

California’s Fair Employment and Housing Act” and pay Mrs.

McGowen $42,625, “less withholding required by law, for lost

income” (lost income payment) and $42,625 “for physical injury
                                - 4 -

caused by emotional distress” (emotional distress payment).      On

May 31, 2006, PacifiCare’s attorney sent Mrs. McGowen’s attorney

three checks relating to the payment obligations described in the

settlement agreement and a letter stating that the settlement was

complete.   Subsequently, United HealthCare Services, Inc., which

at the time of the lost income payment was in the process of

merging with PacifiCare, issued Mrs. McGowen a Form W-2, Wage and

Tax Statement, and PacifiCare issued Mrs. McGowen a Form 1099-

MISC, Miscellaneous Income, for the lost income payment and the

emotional distress payment, respectively.

     In 2007 petitioners timely filed a joint Federal income tax

return relating to 2006 (2006 return).    On petitioners’ 2006

return they reported, among other things, the $42,625 lost income

payment, but did not report the $42,625 emotional distress

payment.    On June 16, 2008, respondent issued petitioners a

notice of deficiency relating to 2006 (year in issue).    In the

notice, respondent determined that petitioners underreported

their income, were liable for a $12,618 deficiency, and were

liable for a $2,467 section 6662(a) accuracy-related penalty

relating to 2006.    On September 15, 2008, petitioners, while

residing in California, filed a petition with the Court.2


     2
      On Mar. 15, 2010, the Court granted respondent’s motion to
dismiss for lack of prosecution as to petitioner’s husband, John
Michael McGowen. The decision we enter with respect to
petitioner John Michael McGowen will be consistent with the
decision we enter with respect to petitioner Julie Marie McGowen.
                               - 5 -

                              OPINION

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

include 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”.   See also sec. 61(a); Commissioner v.

Schleier, 515 U.S. 323, 328 (1995) (stating that section 61(a) is

broad in scope and exclusions from gross income must be narrowly

construed).   Thus, a taxpayer may exclude damages from gross

income when the taxpayer establishes that (1) the underlying

cause of action giving rise to the damages is based upon tort or

tort-type rights and (2) the damages were received on account of

personal physical injury or physical sickness.   See sec.

104(a)(2); Commissioner v. Schleier, supra at 337 (citing United

States v. Burke, 504 U.S. 229, 234 (1992)); sec. 1.104–1(c),

Income Tax Regs.3   Section 104(a)(2) further provides that

emotional distress shall not be treated as a physical injury or

physical sickness, except to the extent that damages attributable




     3
      Pursuant to sec. 7491(a), Mrs. McGowen has the burden of
proof with respect to the factual issue affecting her liability
for tax unless she introduces credible evidence and satisfies
other requirements that would shift the burden relating to that
issue to respondent. See Rule 142(a). Our conclusions, however,
are based on a preponderance of the evidence, and thus the
allocation of the burden of proof is immaterial. See Estate of
Bongard v. Commissioner, 124 T.C. 95, 111 (2005).
                               - 6 -

to the emotional distress were used to pay for medical care, as

described in section 213(d)(1)(A) or (B).

     Mrs. McGowen contends that the emotional distress payment

constitutes damages received on account of physical injuries and

is excludable pursuant to section 104(a)(2).   We disagree.   There

is no evidence that the binder physically injured Mrs. McGowen or

that Mrs. McGowen suffered other than the symptoms of emotional

distress.   Moreover, pursuant to the settlement agreement, Mrs.

McGowen received damages on account of her emotional distress and

not as a result of “a physical injury or physical sickness” as

defined in section 104(a).4   See United States v. Burke, supra at

237 (stating that where damages are received pursuant to a

settlement agreement, the nature of the claim that was the actual

basis for settlement controls whether those damages are

excludable pursuant to section 104(a)(2)); Seay v. Commissioner,

58 T.C. 32, 37 (1972).   Accordingly, the $42,625 emotional

distress payment to Mrs. McGowen is not excludable pursuant to

section 104(a)(2).




     4
      The legislative history shows that “It is intended that the
term emotional distress includes symptoms (e.g., insomnia,
headaches, stomach disorders) which may result from such
emotional distress.” H. Conf. Rept. 104-737, at 301 n.56 (1996),
1996-3 C.B. 741, 1041. Therefore, to be excludable from gross
income pursuant to sec. 104(a)(2), a settlement award must be
paid to a taxpayer on account of physical injury or physical
sickness, which does not include emotional distress or symptoms
thereof.
                                 - 7 -

     Respondent further determined that Mrs. McGowen is liable

for a section 6662(a) accuracy-related penalty relating to the

year in issue.   Section 6662(a) imposes a 20-percent penalty on

the amount of any underpayment of tax attributable to negligence

or a substantial understatement of income tax.       See sec.

6662(b)(1) and (2).   Respondent bears, and has met, the burden of

production relating to this penalty.       See sec. 7491(c); Higbee v.

Commissioner, 116 T.C. 438, 446 (2001).       Section 6664(c)(1),

however, provides that no penalty shall be imposed if a taxpayer

demonstrates that there was reasonable cause for the underpayment

and that the taxpayer acted in good faith.       See also sec.

7491(c); Higbee v. Commissioner, supra at 446.       Mrs. McGowen, who

lacked knowledge and experience in tax law, reasonably believed

that a portion of her settlement payment was not taxable and in

good faith did not report that portion of the settlement payment

on her 2006 return.   See sec. 6664(c); sec. 1.6664-4(b)(1),

Income Tax Regs.   Accordingly, Mrs. McGowen is not liable for the

section 6662(a) accuracy-related penalty.

     Contentions not addressed are moot, irrelevant, or without

merit.

     To reflect the foregoing,


                                              Decision will be entered

                                         for respondent.
