                        T.C. Memo. 1998-435



                      UNITED STATES TAX COURT



           MICHAEL J. AND CARRIE L. WOODS, Petitioners
         v. COMMISSIONER OF INTERNAL REVENUE, Respondent

                 JACQUELYN WOODS, Petitioner v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket Nos. 12783-94, 12784-94.      Filed December 10, 1998.



     Arthur I. Fixler, for petitioners.

     Carmino J. Santaniello, for respondent.



                        MEMORANDUM OPINION


     COLVIN, Judge:   Respondent determined that petitioners

Michael J. and Carrie L. Woods had a $13,454 deficiency in income

tax for 1992, and that petitioner Jacquelyn Woods had a $190,777

deficiency in income tax for 1992.
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     The sole issue for decision is whether part of the proceeds

petitioners received in settlement of a tort action is

prejudgment interest, and, if so, whether it is excludable from

gross income as damages for a personal injury under section

104(a)(2).   We hold that $78,190 (42.53 percent of the $183,852

payment to Michael and Carrie Woods) and $790,587 (42.53 percent

of the $1,858,948 payment to Jacquelyn Woods) was prejudgment

interest and is not excludable from income under section 104.

     Unless otherwise specified, section references are to the

Internal Revenue Code in effect for the year in issue.     Rule

references are to the Tax Court Rules of Practice and Procedure.

                            Background

     The parties submitted these cases fully stipulated under

Rule 122.

A.   Petitioners

     Petitioners Michael and Carrie Woods (the Woodses) lived in

Warwick, Rhode Island, when they filed their petition.     Jacquelyn

Woods (Jacquelyn) is the minor child of the Woodses.

     Jacquelyn was born on September 25, 1985.     Jacquelyn's

shoulder was injured during birth.     This injury resulted in

stunted growth of her arm and permanent weakness and restricted

motion of her arm and shoulder.

B.   The Tort Action, Judgment, and Interest

     The Woodses were represented by Mark Decof (Decof), who

filed a medical malpractice suit in the Superior Court of Rhode
                                - 3 -

Island on July 1, 1986, individually and on behalf of Jacquelyn

against Dr. Christos H. Erinakes (Dr. Erinakes) and Kent County

Hospital.    Dr. Erinakes was represented by Dennis J. McCarten

(McCarten).    Dr. Erinakes' medical malpractice insurer was Joint

Underwriting Association (JUA).

     In December 1991, the Woodses and Jacquelyn settled their

claim against the hospital for an unspecified amount of damages.

The settlement proceeds from the hospital are fully excludable

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

     On December 11, 1991, a jury awarded damages against Dr.

Erinakes of $1.2 million to Jacquelyn and $120,000 to the

Woodses.    The clerk of the court added statutory prejudgment

interest of $888,000 as required by R.I. Gen. Laws section 9-21-

10 (1997) to Jacquelyn's award, totaling $2,088,000.    The jury

award for Jacquelyn of $1.2 million is 57.47 percent of

$2,088,000.    The statutory prejudgment interest of $888,000 is

42.53 percent of $2,088,000.    The clerk of the court added

statutory prejudgment interest of $88,800 as required by R.I.

Gen. Laws section 9-21-10 to the Woodses' award, totaling

$208,800.    The jury award for the Woodses of $120,000 is 57.47

percent of $208,800.    The statutory prejudgment interest of

$88,800 is 42.53 percent of $208,800.

     On December 20, 1991, Dr. Erinakes moved for a new trial on

all issues, or, alternatively, on the issue of damages.    The

trial court denied the motion on February 28, 1992.    Dr. Erinakes
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appealed the judgments and the trial court's denial of his motion

for a new trial to the Rhode Island Supreme Court.

C.   The Settlement

     While the appeal was pending, Dr. Erinakes agreed to pay

Jacquelyn $1,858,948 and the Woodses $91,926 each for a release

and discharge of any and all past or future claims.   The Woodses

for themselves and on behalf of Jacquelyn, and Decof, signed the

releases on April 14, 1992.   The parties did not discuss tax

consequences during settlement negotiations.

     On April 14, 1992, the Woodses and Dr. Erinakes filed a

stipulation and stipulation of dismissal with the trial court.

On April 16, 1992, the trial court granted the parties' motion to

approve the settlement of Jacquelyn's personal injury claim,

subject to the creation of a trust fund which would provide for

the receipt, investment, and disbursement of the net settlement

proceeds paid to Jacquelyn.   The proceeds of the settlement were

held in escrow by Decof pending approval of the settlement by the

judge.   The Woodses created the Jacquelyn R. Woods Trust, which

the trial court approved on July 15, 1992.   Neither the judgment

nor the jury award was an enforceable final judgment under Rhode

Island law because both were voided by the parties' settlement

and stipulation of dismissal.

     JUA issued a check for $183,852 to the Woodses and Decof on

July 23, 1992.   JUA issued a check for $1,858,948 payable to

Jacquelyn and Decof on July 23, 1992.   JUA did not issue a Form
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1099 to the Woodses, Jacquelyn, or respondent regarding the

proceeds.

     Decof paid himself $63,379.81 for legal fees and costs and

paid the Woodses $120,472.19.        Decof paid himself $640,840.39 for

legal fees and costs and paid Jacquelyn $1,218,107.61.

D.   Petitioners' 1992 Tax Returns and Respondent's Determination

     The Woodses and Jacquelyn timely filed their 1992 Federal

income tax returns.      They did not report any of their settlement

proceeds on their returns or deduct any legal fees or costs from

the lawsuit.

     Respondent issued a notice of deficiency in which respondent

determined that Jacquelyn's deficiency in income tax was

attributed to unreported interest income of $790,587, computed as

follows:

                    Original award           Percentage1   Settlement

     Damages          $1,200,000          57.4712643       $1,068,361
     Interest            888,000          42.5287356          790,587
       Total          $2,088,000         100.0000000       $1,858,948
     1
         Rounded.

     Respondent allowed Jacquelyn to deduct legal fees of

$256,729 under section 212(1).        The parties do not dispute this

amount.

     Respondent determined the Woodses' income tax deficiency was

attributable to unreported interest income of $78,190, computed

as follows:
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                    Original award           Percentage1    Settlement

     Damages           $120,000           57.4712643          $105,662
     Interest            88,800           42.5287356            78,190
       Total           $208,800          100.0000000          $183,852
     1
         Rounded.

     Respondent allowed the Woodses to deduct legal fees of

$25,143 under section 212(1).        The parties do not dispute this

amount.

                                  Discussion

A.   Whether Petitioners Received Prejudgment Interest, and If
     So, Whether It Is Excludable From Income Under Section 104

     Petitioners contend that (1) their settlement is excludable

under section 104(a), (2) they did not receive prejudgment

interest, and (3) if they did receive prejudgment interest, it is

excludable from income under section 104(a)(2).            We disagree.

     A taxpayer may exclude from income "damages received

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

injuries or sickness".      Sec. 104(a)(2).        However, prejudgment

interest is not excludable from income under section 104(a)(2).

Rozpad v. Commissioner, 154 F.3d 1, 6-7 (1st Cir. 1998), affg.

T.C. Memo. 1997-528; Kovacs v. Commissioner, 100 T.C. 124 (1993),

affd. without published opinion 25 F.3d 1048 (6th Cir. 1994);

Delaney v. Commissioner, T.C. Memo. 1995-378, affd. 99 F.3d 20

(1st Cir. 1996); Forest v. Commissioner, T.C. Memo. 1995-377,

affd. without published opinion 104 F.3d 348 (1st Cir. 1996).
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     Respondent's determination is presumed to be correct, and

petitioners bear the burden of proving otherwise.   Rule 142(a).

     We must decide whether, and, if so, to what extent the

settlement petitioners received was prejudgment interest, and

whether it is excludable from income under section 104(a)(2).

     In Rozpad v. Commissioner, supra, the U.S. Court of Appeals

for the First Circuit, the circuit in which this case is

appealable, approved the Tax Court's allocation of the

prejudgment interest component of a settlement under Rhode Island

law where the parties did not allocate any amount to prejudgment

interest.   The allocation of prejudgment interest in Rozpad was

calculated by applying a ratio based on the judgment of the State

court, to apportion the total settlement between prejudgment

interest (added to the State court's tort damage award under R.I.

Gen. Laws section 9-21-10) and compensatory damages.     Rozpad is

indistinguishable from this case.

     The clerk of the Rhode Island court calculated a prejudgment

interest component of $88,800 to the Woodses' award and $888,000

to Jacquelyn's award under R.I. Gen. Laws section 9-21-10, which

was 42.53 percent of each total award.   Respondent determined

that $78,190 of the $183,852 settlement with the Woodses and

$790,587 of the $1,858,948 settlement with Jacquelyn was

prejudgment interest by using as the ratio of prejudgment

interest to total settlement the same ratio that the clerk of the
                                - 8 -

State court had used to calculate the prejudgment interest

portion of the total judgment (that is, damages plus prejudgment

interest).   Respondent correctly applied the Rozpad allocation

formula.

B.   Petitioners' Other Contentions

     Petitioners contend that prejudgment interest is part of

damages under Rhode Island law and is therefore excludable under

section 104(a)(2).   We disagree.   The Court of Appeals for the

First Circuit concluded that prejudgment interest is separate and

distinct from damages under Rhode Island law.    Rozpad v.

Commissioner, supra at 6.

     In Kovacs v. Commissioner, supra at 130, we held that

statutorily imposed interest in a wrongful death case under

Michigan law is not excluded from income under section 104.

Petitioners contend that Kovacs v. Commissioner, supra, was

wrongly decided, in part because it is inconsistent with the

legislative history of section 104(a)(2).    We disagree with this

argument, which was rejected by the Court of Appeals for the

First Circuit in Rozpad v. Commissioner, supra at 5.

     Petitioners rely on McShane v. Commissioner, T.C. Memo.

1987-151, where we found that a settlement did not include

interest.    However, McShane does not control because in that case

the parties agreed in a bona fide arm's-length negotiated
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settlement that the settlement amount did not include costs or

interest.

     In contrast, the parties here did not agree that the

settlement amount did not include costs or interest.       Petitioners

point out that the stipulation to dismiss the tort action filed

with the Superior Court specified "No costs.       No interest" and

contend that the stipulation to dismiss controls the allocation

of interest in the settlement at issue.       We rejected this

argument in Rozpad v. Commissioner, T.C. Memo. 1997-528, where we

said:   "the stipulations are not part of the settlement and do

not relate to the allocation of settlement proceeds.       They are

merely requests for the court to dismiss the * * * [action]

without imposing interest or costs."

C.   Conclusion

     Applying the allocation formula in Rozpad, we conclude that

$78,190 (i.e., 42.53 percent of $183,852) of the settlement paid

for the Woodses and $790,587 (i.e., 42.53 percent of $1,858,948)

of the settlement paid for Jacquelyn was prejudgment interest and

is not excludable from income under section 104.

     To reflect the foregoing,


                                              Decisions will be entered

                                         for respondent.
