                        T.C. Memo. 1999-394



                      UNITED STATES TAX COURT



             STEVEN P. AND MAUREEN CADE, Petitioners v.
            COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 22819-97.             Filed December 3, 1999.



     Charles W. Becker, for petitioners.

     Thomas A. Dombrowski, for respondent.



                         MEMORANDUM OPINION


     LARO, Judge:   This case is before the Court fully

stipulated.   See Rule 122.   Respondent determined a $646,800

deficiency in petitioners’ 1993 Federal income tax.    Respondent

later asserted in his amended answer that the deficiency was

$651,000.
                                - 2 -

     We must decide whether section 104(a)(2) allows petitioners

to exclude from their gross income certain proceeds received in

settlement of a lawsuit.   We hold it does not.    Unless otherwise

indicated, section references are to the Internal Revenue Code

applicable to 1993, and Rule references are to the Tax Court

Rules of Practice and Procedure.   The term “petitioner” refers to

Steven P. Cade.

                            Background

     All facts have been stipulated.     The stipulation of facts

and the exhibits submitted therewith are incorporated herein by

this reference.   Petitioners are husband and wife, and they

resided in Carlsbad, California, when we filed their petition.

They filed a joint 1993 Federal income tax return.

     On August 17, 1990, petitioner agreed with CG Merger Corp.

(CG Merger) to sell to it for $850,000 all of the stock of Cade-

Grayson Co. (CGC).   CGC Merger’s shareholders were John R. Heller

(Mr. Heller), Heller Seasonings & Ingredients, Inc. (Heller

Seasonings), and the James R. Heller Trust (Heller Trust)

(collectively, Heller Group).   Petitioner and CGC also agreed on

that date that petitioner would serve as CGC’s president and

chief executive officer for five years in exchange for (1) an

annual salary, (2) incentive compensation, (3) supplemental

incentive compensation, (4) life, disability, and health

insurance, (5) perquisites and expense reimbursements, and (6)
                                 - 3 -

all employee benefits.    CG Merger financed its purchase of

petitioner’s CGC stock with Harris Trust and Savings Bank

(Harris).

     CGC fired petitioner on December 5, 1991, in contravention

of their employment agreement.    Two years later, petitioner filed

a lawsuit (lawsuit) against CGC, CG Merger, the Heller Group,

Harris, and Does 1 through 40 (collectively, defendants) in the

Superior Court for the State of California for the County of San

Diego (superior court).    Petitioner alleged in his first amended

complaint the following causes of action:    (1) CGC breached its

employment agreement with him, (2) Harris, Mr. Heller, Heller

Seasoning, and Does 1 through 10 purposely and with malicious

intent interfered with and induced the breach of that agreement,

(3) Harris, Mr. Heller, Heller Seasonings, and Does 1 through 10

purposely and with malicious intent interfered with petitioner’s

prospective economic advantage as to the employment agreement and

his sale of CGC, (4) Mr. Heller, Heller Seasonings, CG Merger,

and Does 11 through 20 made false representations to petitioner

to induce him to sell his stock and to enter into the employment

agreement, with the understanding that he would never receive the

benefits promised with respect thereto, (5) CGC and CG Merger

breached their duty to deal fairly and in good faith with

petitioner as to the employment and stock purchase agreements,
                              - 4 -

(6) CGC breached its statutory duty to pay petitioner the

compensation due him under the employment agreement, (7) CGC, Mr.

Heller, Heller Seasonings, and Does 21 through 30 unlawfully

retained and converted to their own use petitioner’s personal

belongings, (8) CGC, Mr. Heller, Heller Seasonings, and Does 31

through 40 invaded petitioner’s privacy by inspecting and copying

his personal files, (9) the conduct of each defendant was

outrageous and pursued to inflict severe emotional distress upon

petitioner, (10) CGC, CG Merger, Mr. Heller, Heller Seasonings,

and the Heller Trust were alter egos of each other so that each

of them lost his or its individuality or separateness as to each

other, and (11) Mr. Heller, CGC, and Does 1 through 10 published

defamatory statements about petitioner.

     With the exception of the first, second, sixth, and seventh

causes of action, petitioner did not allege in his first amended

complaint that he suffered any specific damages as a result of

the asserted conduct underlying a cause of action.   The first

cause of action alleged that CGC’s breach of the employment

agreement caused petitioner to lose salary of approximately

$676,000, incentive compensation of approximately $1,250,000,

supplemental incentive compensation of approximately $500,000,

and an unspecified amount of other significant benefits.    The

second cause of action alleged that the named defendants’

interference with the employment agreement caused petitioner to
                                - 5 -

suffer emotional distress, loss of reputation, and consequential

damages of an unspecified amount.   The sixth cause of action

alleged that CGC’s breach of its statutory duty made it liable to

petitioner for unpaid wages plus penalties.   The seventh cause of

action alleged that petitioner was entitled to recover from the

named defendants both his personal belongings and damages.

     Rule 2.5 of the San Diego Superior Court Local Rule Division

II requires that all plaintiffs and cross-complainants in an

action in superior court complete and serve a “Case Management

Conference Questionnaire” (questionnaire) on all parties 10 days

before the date set for case management conference.   Among other

things, the questionnaire asks each plaintiff and cross-

complainant to list the amount of damages which he or she is

claiming for personal injuries vis-a-vis nonpersonal injuries.

In August 1992, petitioner filed a questionnaire with the

superior court.   The questionnaire listed no claim for damages

for personal injury.   The questionnaire listed only petitioner’s

claim for nonpersonal injuries in the amount of $2.5 million plus

general and punitive damages.

     Following a jury trial, the jury returned a special verdict

finding among other things that:    (1) CGC breached its employment

agreement with petitioner by terminating him contrary to the

terms thereof, (2) the Heller Group and Harris wrongfully induced

CGC to breach that agreement, (3) the Heller Group and Harris
                               - 6 -

wrongfully interfered with petitioner’s prospective economic

advantage, (4) CGC breached an obligation of good faith and fair

dealing owed to petitioner, (5) the Heller Group committed fraud

on petitioner, (6) the Heller Group and CGC took petitioner’s

personal property and converted it to their own use, (7) the

Heller Group and CGC invaded petitioner’s privacy, (8) CGC and

Mr. Heller defamed petitioner, (9) each member of the Heller

Group was the alter ego of CGC in connection with the matters

contained in the lawsuit, and (10) the conduct of the Heller

Group, CGC, and Harris was malicious, oppressive, or fraudulent.

On the basis of those findings, the jury found that petitioner

was entitled to the following damages:

     Loss of past and future
       compensation and employment benefits        $2,315,000
     Emotional distress                               500,000
     Conversion of personal property                   10,000
     Invasion of privacy                               10,000
     Defamation                                     1,000,000
       Total                                        3,835,000

The jury made the $2,315,000 finding pursuant to an instruction

that directed them to find damages upon making any one of the

five findings set forth in 1 to 5 above.   The jury made the

$500,000 finding pursuant to an instruction that directed them to

find damages upon making any one of the three findings set forth

in 2,3, and 5 above.   The jury’s $10,000 finding for conversion

of personal property stemmed from its finding in 6 above.   The

jury’s $10,000 finding for invasion of privacy stemmed from its
                               - 7 -

finding in 7 above.   The jury’s $1 million finding stemmed from

its finding in 8 above.   The jury made no finding of damages with

respect to its findings in 9 and 10 above.

     On July 6, 1993, petitioner and Harris filed with the

superior court a stipulation in which they agreed that petitioner

would receive $665,000 of punitive damages, for a total award of

$4.5 million.   Petitioner and Harris agreed in the stipulation

that Harris would pay petitioner the $4.5 million to settle all

of his claims related to the lawsuit and that CGC and the Heller

Group would remain fully liable to Harris for all payments made

by Harris.   The stipulation contained numerous provisions

designed to protect Harris’ right to proceed against CGC and the

Heller Group to recover amounts that Harris paid on their

behalf.1   Harris agreed to fund the settlement by itself on

account of its banking relationship with and as an accommodation

to CGC and the Heller Group.

     Harris paid petitioner $1,125,000 of the settlement proceeds

on July 7, 1993, and it paid him the balance approximately 5

months later.   On his 1993 Federal income tax return, petitioner


     1
       Among other things, petitioner promised that he would work
with Harris in its collection and enforcement efforts against the
other defendants. Petitioner and Harris also agreed that the
superior court should retain jurisdiction of their case to enter
judgment in Harris’ favor as to the other defendants. The court
agreed to retain jurisdiction and set the matter for status on
Dec. 15, 1993. The record does not disclose what, if anything,
happened at that status hearing, or if, in fact, the status
hearing was ever held.
                               - 8 -

included in his gross income only the $665,000 of proceeds which

he received as an award of punitive damages.    Petitioner excluded

from his gross income the rest of the settlement proceeds on the

grounds that he had received those amounts as compensation for

personal injuries.

     Respondent determined that petitioner could exclude from his

gross income only the following amounts:

               Defamation                  $1,000,000
               Emotional distress             500,000
               Invasion of privacy             10,000
                 Total                      1,510,000

Respondent determined that petitioner’s gross income includes:

(1) The $2,315,000 that he received for loss of past and future

compensation and employment benefits and (2) the $10,000 that he

received for conversion of personal property.

                            Discussion

     We are faced once again with a determination as to the

taxability of proceeds received through the prosecution or

settlement of a lawsuit.   Petitioner obviously wants to maximize

his recovery by paying the least amount of taxes thereon.

Section 104(a)(2) and the regulations thereunder allow him to

exclude from his gross income the proceeds of a settlement when

two conditions are met.2   First, the cause of action giving rise



     2
       Sec. 104(a)(2) generally provides that gross income does
not include "the amount of any damages received (whether by suit
or agreement * * *) on account of personal injuries or sickness".
                               - 9 -

to the proceeds must have been based upon tort or tort type

rights.   Second, the tort-feasor must have paid the proceeds to

petitioner on account of personal injuries or sickness.   To the

extent that petitioner fails either condition, section 104(a)(2)

will not operate to exclude the disputed amounts from his gross

income.   See sec. 104(a)(2); O’Gilvie v. United States, 519 U.S.

79 (1996); sec. 1.104-1(c), Income Tax Regs.; see also

Commissioner v. Schleier, 515 U.S. 323, 333-334 (1995); Banks v.

United States, 81 F.3d 874, 876 (9th Cir. 1996); Bagley v.

Commissioner, 105 T.C. 396, 416 (1995), affd. 121 F.3d 393 (8th

Cir. 1997).

     Petitioner argues that section 104(a)(2) reaches all of the

$2,315,000 awarded to him for loss of past and future

compensation and employment benefits.   According to petitioner,

the underlying causes of action giving rise to his recovery of

that amount are tortlike by virtue of the fact that Harris was

found liable to him only for causes of action which are torts.

Petitioner asserts that the second condition for exclusion under

section 104(a)(2) also is met because he suffered damages to his

person rather than to a property interest of his.   Respondent

argues that section 104(a)(2) does not apply to any of the

$2,315,000 because none of it was received on account of a

personal injury.   Respondent asserts that petitioner received the

$2,315,000 as compensation for economic damages.
                              - 10 -

     We agree with respondent that none of the $2,315,000 falls

within the section 104(a)(2) exclusion.    We apply the two

conditions for excludability set forth above.    As to the first

condition, we ascertain whether the claims alleged in the lawsuit

have tortlike characteristics, placing our focus on the scope of

remedies available for those claims.   See United States v. Burke,

504 U.S. 229, 234-236 (1992); Dotson v. United States, 87 F.3d

682, 685 (5th Cir. 1996); Robinson v. Commissioner, 102 T.C. 116,

125-126 (1994), revd. on an issue not relevant herein 70 F.3d 34

(5th Cir. 1995).   As for the second condition, we analyze the

damages recovered on the tortlike claims to ascertain whether

those damages were recovered for personal injuries.    See O'Gilvie

v. United States, supra; see also Dotson v. United States, supra

at 685.   Because petitioner recovered damages under the terms of

a settlement agreement, we examine that agreement in light of the

facts and circumstances surrounding it to ascertain the nature of

the claims underlying the recovery.    We ask ourselves: “What is

the payor’s intent in making the payment?”, see Knuckles v.

Commissioner, 349 F.2d 610, 613 (10th Cir. 1965), affg. T.C.

Memo. 1964-33; Agar v. Commissioner, 290 F.2d 283, 284 (2d Cir.

1961), affg. per curiam T.C. Memo. 1960-21, and "In lieu of what

were the damages awarded?", see Robinson v. Commissioner, supra

at 126-127, and the cases cited thereat.    We bear in mind the
                               - 11 -

fact that the jury had awarded petitioner damages as part of its

special verdict.

     Harris paid the $2,315,000 to petitioner as part of a larger

package of consideration that settled all of his claims related

to his termination from CGC.    The jury had found that Harris and

the other defendants were liable to petitioner for $2,315,000 by

virtue of the fact that each of the defendants was connected to

one or more of the first five causes of action set forth above.

Petitioner looks solely to the claims that he had made against

Harris and concludes that the payment was entirely for those

claims.   We disagree with this conclusion.   We read the

settlement agreement to indicate that Harris paid the $2,315,000

to petitioner intending to satisfy all of his claims set forth in

the first five causes of action and not merely those claims which

he had made against Harris.    To be sure, Harris designed the

settlement agreement specifically to preserve the claims that it

had against the other defendants by virtue of its payment of the

$4.5 million and to assure the cooperation of petitioner and the

superior court in pursuing and collecting on those claims.

     As to the first and fifth causes of action (breach of

contract and breach of the implied covenant of good faith and

fair dealing), any proceeds which petitioner received for

settlement of those claims do not meet the first condition for

exclusion under section 104(a)(2); i.e., both claims are

contractual in that any damages which could be recovered on them
                              - 12 -

would be limited to traditional contractual type remedies.   See

United States v. Burke, supra at 234 ("A 'tort' has been defined

broadly as a 'civil wrong, other than breach of contract, for

which the court will provide a remedy in the form of an action

for damages.'" (quoting Keeton et al., Prosser and Keeton on the

Law of Torts 2 (5th ed. 1984)); Mundy v. Household Fin. Corp.,

885 F.2d 542, 544 (9th Cir. 1989) (a breach of the implied

covenant of good faith and fair dealing under California law is

not a tort).   To the extent that Harris’ payment of the

$2,315,000 was intended to satisfy either the first or fifth

cause of action, it will not qualify for exclusion under section

104(a)(2).

     As to the other three of the first five causes of action

(namely, interference with contract, interference with

prospective advantage, and fraud), those claims did involve a

tort.   None of them alleges breach of contract, and each of them,

in and of itself, would, under California law, allow for the

recovery of damages for emotional distress.   Given that a

recovery for emotional distress is not a traditional contractual

type remedy, we conclude that the second through fourth causes of

action satisfy the first condition for exclusion under section

104(a)(2).

     We turn to analyze whether petitioner received any of the

$2,315,000 as compensation for those three torts so as to satisfy

the second condition for exclusion under section 104(a)(2) asking
                              - 13 -

ourselves whether Harris paid any portion of the $2,315,000 on

account of personal injuries or sickness.   We answer those

questions “No”.   Harris paid petitioner none of that amount “by

reason of, or because of, * * * [a tortlike claim for] personal

injuries”.   O’Gilvie v. United States, 519 U.S. at 83.

Petitioner’s recovery of that amount arose out of his employment

agreement with CGC, and the $2,315,000 that petitioner received

as compensation was slightly less than the approximate amount of

salary, incentive compensation, and supplemental compensation

that petitioner claimed he was entitled to by virtue of CGC’s

breach of his employment agreement with it.   Moreover, petitioner

listed in the questionnaire no claim for damages from a personal

injury, classifying the total amount that he was pursuing through

the lawsuit as that from a nonpersonal injury, and the jury

awarded the $2,315,000 to petitioner as damages for loss of past

and future compensation and employment benefits.   Under the facts

at hand, we conclude that petitioner received the portion of the

$2,315,000 attributable to the torts as “‘legal injuries of an

economic character’”, and, accordingly, that the recovery of that

portion was not for personal tortlike injuries.    United States v.

Burke, supra at 239 (quoting Albemarle Paper Co. v. Moody, 422

U.S. 405, 418 (1975)); see also Commissioner v. Schleier, 515

U.S. at 331 (economic injuries are not personal injuries for

purposes of section 104(a)(2)); Fabry v. Commissioner, 111 T.C.

305 (1998); Robinson v. Commissioner, supra at 126 (section
                             - 14 -

104(a)(2) does not exclude damages which are “received pursuant

to the settlement of economic rights arising out of a contract

(e.g., lost profits)”); Gregg v. Commissioner, T.C. Memo. 1999-

10; Kightlinger v. Commissioner, T.C. Memo. 1998-357.     We hold

that section 104(a)(2) does not operate to exclude from

petitioner’s gross income any of the $2,315,000 at issue.

     As to the $10,000 in dispute, petitioner was paid that

amount by virtue of the fact that the jury had concluded that his

personal property had been converted by CGC and the Heller Group.

Petitioner was paid the $10,000 as a compensation for property

damage and not on account of a personal injury.   We conclude and

hold that the $10,000 is not excluded from petitioner’s gross

income by virtue of section 104(a)(2).

     We have considered all of the parties’ arguments and, to the

extent not discussed above, find them to be without merit.    To

reflect the foregoing,

                                         Decision will be entered

                                   under Rule 155.
