                         T.C. Memo. 1998-32



                       UNITED STATES TAX COURT



               STEPHEN WILLIAM DAHLGREN, Petitioner v.
            COMMISSIONER OF INTERNAL REVENUE, Respondent


       Docket No. 5002-94.                    Filed January 26, 1998.


       Joseph Y. Holman, for petitioner.

       Dennis R. Onnen, for respondent.


                         MEMORANDUM OPINION


       CARLUZZO, Special Trial Judge:     This case was heard pursuant

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

182.    Unless otherwise indicated, section references are to the

Internal Revenue Code in effect for the year 1990.      Rule

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

       Respondent determined a deficiency in petitioner's 1990

Federal income tax in the amount of $5,594.      The issue for
                                 - 2 -


decision is whether $20,000 paid to petitioner in 1990 by his

former employer is excludable from gross income under section

104(a)(2).   The resolution of this issue depends upon whether

petitioner's former employer intended the payment to compensate

him for personal injury arising from a tort or tort type claim.

Undisputed Factual Background

     Some of the facts have been stipulated, and they are so

found.   At the time the petition was filed, petitioner resided in

Springfield, Missouri.

     In June 1989, petitioner, an attorney who apparently did not

practice law during the year in issue, was hired as the vice

president of institutional marketing and sales for Comprehensive

Marketing Systems, Inc. (CMS).    During the relevant periods CMS

specialized in subservicing poorly performing loans for other

financial institutions.   During 1990, CMS earned gross receipts

totaling approximately $12 million from 8 to 10 different loan

servicing contracts.

     Petitioner was hired by James Griffin, the president and

sole shareholder of CMS, to develop a plan to market loan

servicing to financial institutions in the mortgage lending and

servicing business.    CMS anticipated that petitioner's sales and

marketing plan would generate revenues through the acquisition of

additional loan servicing contracts.
                                - 3 -


     On June 12, 1989, petitioner entered into a 2-year

employment contract with CMS.   In accordance with the terms of

the employment contract, petitioner was entitled to the following

compensation:   (1) A salary of $7,500 per month for the first

3 months of employment; (2) a salary of $5,000, plus a "loan" of

$2,500 per month for the remaining 21 months;1 and (3) a

commission of 1 percent of the gross revenues generated during

the initial term of any loan servicing contracts he secured

through his sales and marketing plan, plus ½ percent of the gross

revenues with respect to the renewal period of any such contract.

In the event that petitioner's employment with CMS terminated

(for any of a variety of reasons), he was entitled to receive

earned but unpaid salary and commissions.   Throughout his

employment with CMS, petitioner did not earn any commissions.

     As an employee of CMS, petitioner had access to certain

confidential information and trade secrets that were the property

of CMS.   He was obligated to use his "best efforts and the utmost

diligence to guard and protect such confidential information and

trade secrets", and was bound not to "disclose or permit to be

disclosed to any third party or other person by any method




     1
      The loans were evidenced by promissory notes and accrued
interest at the rate of 11 percent per year. Principal and
interest were payable from future commissions earned by
petitioner.
                               - 4 -


whatsoever, any of such confidential information or trade secrets

of CMS" without the prior written consent of CMS.

     Apparently, petitioner's term of employment with CMS began

with a 90-day probationary period, which he successfully

completed.   His "Probationary Employee Performance Evaluation",

dated October 17, 1989, reflected that he had met the

requirements of four out of five separate areas of performance,

and he was recommended for "regular status".   Rather than a check

the box rating with respect to an area of performance designated

"Knowledge", the following comments were made on the evaluation:

     It has been determined that you meet requirements for
     the purpose of attaining regular employee status,
     except in the area of knowledge where you require
     significant support to augment your minimal knowledge
     of the industry. However, as you are aware, the most
     critical measure of performance for this position is
     the generation of new business. Your performance in
     this area is vital to the company's growth and
     development, and will be the primary basis for future
     evaluations.

     According to a Managerial Performance Evaluation, dated

January 2, 1990, petitioner failed to meet the overall

requirements for his job because he had failed to secure any loan

servicing contracts.   The evaluation indicated that petitioner's

objective was to increase the loan servicing portfolio by a

minimum of 60,000 new loans through subservicing contracts with

other financial institutions on or before the second quarter of

1990, which he apparently failed to do.   Consequently, petitioner

received a "Fails to Meet Requirements" rating.
                               - 5 -


     In a February 6, 1990, memorandum to an executive vice

president of CMS, petitioner disputed the January 2, 1990,

evaluation and provided detailed examples of how he believed that

he had fulfilled his responsibilities at CMS.   In this

memorandum, among other things, petitioner represented:

          My own planning indicates that it is realistic to
     expect that 20,000 loans can be brought on by the end
     of the second quarter, 1990. That the total of new
     loans to be added by the end of calendar 1990 will be
     95,000.

CMS responded to petitioner's memorandum; however, the "Fails to

Meet Requirements" rating was not changed because petitioner's

department "did not meet the principal requirements of generation

of new business during the period under review."

     By the end of February 1990 petitioner was aware that his

employment with CMS would soon be terminated.   At a meeting on or

about May 18, 1990, petitioner and Mr. Griffin discussed

petitioner's termination and signed an Agreement for Separation

of Employment (the agreement) wherein petitioner agreed to resign

voluntarily from CMS.   Pursuant to the agreement, "as

consideration for cancellation of the remaining portion of the

employment contract", CMS agreed to pay petitioner $35,348.84.

This amount consisted of (1) a lump-sum payment of $20,000 (which

petitioner and CMS agreed would be subject to all "ordinary and

necessary payroll deductions", resulting in a net payment of

$15,070 made to petitioner as of the signing of the agreement),
                                - 6 -


and (2) $15,348.84 "in the form of a discharge of * * *

[petitioner's] indebtedness to CMS".        In addition, the agreement

provided that petitioner would be paid all unused vacation pay

and earned but unpaid salary.   The agreement further provided:

     4. In consideration for the promises referred to
     herein, * * * [petitioner] * * * does hereby fully,
     finally and unconditionally release and forever
     discharge CMS and its affiliates and their respective
     former and present officers, agents, employees,
     directors and shareholders, * * * in their personal and
     corporate capacities, from any and all liabilities,
     claims, rights, obligations, charges, damages, costs,
     expenses, attorneys' fees, suits, actions, causes of
     action and demands, of any and every kind, nature and
     character, known or unknown, liquidated or
     unliquidated, absolute or contingent, in law or in
     equity, enforceable under any local, state or federal
     order, including without limitation Title VII of the
     Civil Rights Act of 1964, as amended, 42 U.S.C. section
     1001 et seq., and the District of Columbia Human Rights
     Law, as amended, D.C. code section 1-2511 et seq.,
     which * * * [petitioner] * * * may now have, [has] ever
     had or may in the future have, which arise out of or
     are in any way connected with * * * [petitioner's] past
     employment with CMS or the termination of said
     employment or which arise out of or are in any way
     connected with any past actions or omissions of CMS,
     its affiliates, or their former and present officers,
     agents, employees, directors or shareholders, including
     without limitation retaliatory discharge claims,
     contract claims, tort claims and claims for wages,
     compensation, benefits, compensatory damages, punitive
     damages and reinstatement. * * *

                    *   *   *    *      *     *   *

     6. As further consideration for the promises referred
     to herein, * * * [petitioner] agrees that, without the
     express written authorization of an officer of CMS,
     * * * [petitioner] will not directly or indirectly
     disclose to any third party, * * * any of CMS's trade
     secrets or other confidential information not known to
     the general public with respect to the business
     operations of CMS or its affiliates, including, but not
                                  - 7 -


     limited to the, information relating to management,
     operations, financial affairs, legal affairs, * * *
     bids, contracts, licensing and investment
     opportunities, acquisition and joint venture
     candidates, business plans, and business opportunities.

                     *   *    *    *      *     *   *

     9. This Agreement sets forth all terms and conditions
     of the agreement between the parties. The parties
     understand and agree that the terms of this Agreement
     are contractual and not a mere recital. * * *

     During his employment with CMS, petitioner was instrumental

in the development of a relationship between CMS and Signet Bank

(Signet).   Petitioner introduced CMS executives to an "old pal"

of his at Signet and ultimately CMS and the bank formed a

business relationship.   Signet provided the necessary "credit

facility" that allowed CMS to contract with the Department of

Housing and Urban Development (HUD).          A "credit facility" is

similar to a revolving line of credit.          The credit facility in

place between Signet and CMS during the relevant period could

only be used by CMS in connection with its contract with HUD.

     In May 1990, CMS was attempting to secure a contract with

the Government National Mortgage Association (GNMA).          Apparently

to qualify for the contract CMS had to demonstrate certain

financial responsibility.    In a May 4, 1990, letter to GNMA (the

GNMA letter) that included a business plan and proposal, CMS

represented:

     Currently, CMS has a $300,000 credit facility that can
     be utilized for advances necessary to meet monthly
     remittance requirements. The credit facility can be
                                - 8 -


     increased if necessary. Reimbursement for advances
     will be facilitated through subsequent collections.

     The credit facility that CMS had in place with Signet at

that time was in the amount of $300,000; however, the Signet

credit facility could not be used in connection with prospective

GNMA business, nor was it subject to increase.

     Many years prior to the year in issue, petitioner had been

employed for a brief period of time as a staff attorney for a

company involved in marketing franchises and other securities.

As a result of this employment, petitioner was named as a

defendant in a law suit brought by certain clients or customers

of this company under various provisions of the Securities Act of

1933.   Petitioner was named as a defendant in the suit merely

because his name appeared on the letterhead of his former

employer.   Although the outcome of that proceeding has not been

made part of the record, it does not appear that petitioner

incurred any liability as a result of it.

Petitioner's 1990 Federal Income Tax Return

     CMS issued a Form W-2 for the year 1990 to petitioner

reflecting wages in the amount of $45,751.20.    Federal income tax

and FICA withholdings were computed based upon the entire amount

and withheld.   On his 1990 Federal income tax return, petitioner

reported wages of $25,751.20.   In an attachment to his 1990

return, petitioner explained that $20,000 of the amount he
                               - 9 -


received from CMS during 1990 was not taxable because the $20,000

represented payment for:

     [P]ersonal injuries sustained as a result of the
     tortious conduct of * * * CMS * * * who knowingly
     [made] false statements in writing to a U.S. Government
     official for the purpose of obtaining U.S. Government
     agency * * * [GNMA] approval of the purchase of a loan
     servicing portfolio by CMS.

The Notice of Deficiency

     In the notice of deficiency, respondent increased

petitioner's taxable income by $20,000, characterizing the

payment as "separation pay" and explaining:

     It is determined * * * that the employment contract
     separation pay of $20,000 which was included in your
     Form W-2 from * * * [CMS] was not reported on your tax
     return. Accordingly, taxable income is increased
     $20,000 for 1990.

Controlling Legal Principles

     Separation or severance pay, like other forms of

compensation for services, is generally includable in the income

of the recipient.   Sec. 61(a)(1); Brennan v. Commissioner, T.C.

Memo. 1997-317; sec. 1.61-2(a)(1), Income Tax Regs.   In general,

section 104(a)(2) excludes from gross income "the amount of any

damages received * * * on account of personal injuries".   Only

damages that are received:   (1) In connection with a claim based

upon a tort, or tort type right; and (2) on account of personal

injury or sickness, are excludable from the recipient's income.

Sec. 104(a)(2); Commissioner v. Schleier, 515 U.S. 323, 337

(1995).
                              - 10 -


     In a situation such as presented here, where payment to a

former employee has been made pursuant to some agreement, the

nature of the claim that led to the agreement and payment must be

examined in order to determine whether the provisions of section

104(a)(2) apply.   United States v. Burke, 504 U.S. 229, 237

(1992).

Dispute Between the Parties

     There is no disagreement between the parties with respect to

the above-stated general principles of Federal income taxation.

The dispute between the parties focuses upon the nature of the

claim, if any, that petitioner had against CMS, and the

characterization of the $20,000 payment petitioner received from

CMS in 1990.

     Respondent argues that the $20,000 payment constitutes

severance pay petitioner received in satisfaction of any future

commissions he might have been entitled to receive, and

consequently must be included as such in petitioner's income.

Petitioner maintains that he had a tort claim (intentional

infliction of mental distress) against CMS, and argues that the

payment represents the settlement of that tort claim.   Therefore,

according to petitioner, the payment is of the type that is

excludable from income under section 104(a)(2), and his 1990

Federal income tax return reflects his correct Federal income tax

liability for that year.
                               - 11 -


       In advancing their respective arguments regarding the nature

of the claim petitioner had against CMS and the characterization

of the payment here under consideration, neither party relies

entirely upon the express language of the agreement, no doubt due

to the manner in which it was drafted.    Not unlike releases we

have examined in other cases involving the application of section

104(a)(2), the agreement is all encompassing, covering all

contract and tort claims that petitioner potentially had against

CMS.    In such situations, we look to the intent of the payer in

order to determine whether the provisions of section 104(a)(2)

are applicable, Knuckles v. Commissioner, 349 F.2d 610, 613 (10th

Cir. 1965), affg. T.C. Memo. 1964-33; Agar v. Commissioner, 290

F.2d 283 (2d Cir. 1961), affg. per curiam T.C. Memo. 1960-21, and

focus upon the May 1990 meeting between petitioner and Mr.

Griffin that apparently formed the basis for the agreement and

the payment here under consideration.

       Both parties presented their respective versions of what

took place during that meeting.    Petitioner did so through his

own testimony.    Respondent did so through the testimony of Mr.

Griffin.    After listening to and reviewing the testimonies of

these individuals, the Court cannot help but wonder if they were

describing the same event.

        Petitioner's account centers on the GNMA letter, which

contained a bid on a loan servicing contract and indicated that a
                              - 12 -


$300,000 credit facility was available for the contract.     During

the meeting petitioner allegedly asked Mr. Griffin "how he [Mr.

Griffin] could publish this letter with what was clearly a

misleading statement in it to a government official", and whether

he had any "appreciation for the harm" done to petitioner by that

statement.   Petitioner considered the statement about the

available credit facility to be "false" and "misleading" because

he assumed that the statement referred to the credit facility set

up by Signet, which credit facility could only be used in

connection with the HUD contract.    Petitioner claims that he was

concerned about the possibility of somehow being held accountable

for what he believed to be the misstatement.   He further claims

that due to the above-described experience with his prior

employer, he was concerned that he might be sued, or otherwise

suffer some damage or harm to his professional reputation.

Nothing in petitioner's version of the meeting suggests that

future commissions were discussed.

     Mr. Griffin's version of the meeting focuses on petitioner's

employment performance and employment contract.   According to Mr.

Griffin, petitioner voluntarily resigned because he agreed that

his performance had not met CMS's expectations.   According to Mr.

Griffin, during the meeting petitioner indicated that he had

contacted certain financial institutions, and claimed entitlement

to potential future commissions that would result if CMS secured
                               - 13 -


any contracts as a result of these contacts.    To resolve any

potential disputes regarding commissions which petitioner might

have been entitled to receive, Mr. Griffin claims that he agreed,

after some negotiation as to the amount, to pay petitioner

$20,000 and cancel petitioner's $15,000 indebtedness to CMS.

According to Mr. Griffin, the GNMA letter was not discussed

during this meeting.   Moreover, according to Mr. Griffin, the

statements in the GNMA letter were accurate because the letter

did not refer to the credit facility then in place with Signet,

but was a reference to an arrangement with a different financial

institution.   According to Mr. Griffin, the GNMA letter was

reviewed and discussed among CMS employees and contained no false

information.

Resolution of the Dispute

     After hearing and reviewing the testimonies of petitioner

and Mr. Griffin, having observed each witness during the trial,

we are not convinced that either was entirely candid with the

Court.    By the time of the May 1990 meeting and agreement,

petitioner had been aware for several months that his employment

with CMS was going to be terminated.    Obviously his relationship

with CMS and Mr. Griffin had deteriorated significantly by May

1990.    By his own account in his response to his poor managerial

performance evaluation, petitioner indicated that he expected

that "95,000" new loans could be added to CMS's portfolio by the
                              - 14 -


close of 1990.   Presumably such an occurrence would have entitled

petitioner to some, if not substantial, commissions.   We find it

highly unlikely that the May 1990 meeting between petitioner and

Mr. Griffin did not include any discussion about potential future

business that might have resulted from petitioner's efforts while

employed by CMS.   We are unwilling to accept petitioner's version

of what took place at the May 1990 meeting and his explanation as

to why the $20,000 payment was made to him.   Furthermore,

petitioner's explanation as to why he received the $20,000

payment is inconsistent with the provisions of the agreement

subjecting the payment to payroll deductions.

     On the other hand, we are not completely satisfied with Mr.

Griffin's version of the May 1990 meeting either.   Mr. Griffin

testified that the GNMA letter was not discussed.   It is clear

from the record that if the reference in the GNMA letter was to

the Signet credit facility, the letter contained false

statements.   Knowing that his employment with CMS was soon to

end, we find it more likely than not that petitioner, believing

the GNMA letter to contain false representations, called it to

Mr. Griffin's attention, for whatever doing so might have been

worth to petitioner.   We are somewhat disturbed that Mr. Griffin

could not support his claim regarding the accuracy of the GNMA

letter with supporting documentation, and also with the amount of

the payment made to petitioner upon termination of employment
                                - 15 -


with CMS.   According to Mr. Griffin, the entire amount paid to

petitioner pursuant to the agreement constituted payment for

potential future commissions.    Mr. Griffin did not explain why

CMS would agree to pay petitioner what appears to be so generous

an amount given petitioner's failure prior to that point in time

to earn any commissions.

     Nevertheless, considering the entire record, although we

would be reluctant to exactly characterize the nature of the

$20,000 payment, we are satisfied that CMS did not intend the

payment to compensate petitioner for any personal injury arising

from any tort or tort type claim that petitioner had against CMS.

The provisions of section 104(a)(2), therefore, do not apply.      It

follows, and we hold, that petitioner may not exclude the $20,000

payment from his 1990 income, and respondent's determination in

this regard is sustained.

     Based on the foregoing,

                                          Decision will be

                                     entered for respondent.
