       IN THE UNITED STATES COURT OF APPEALS
                FOR THE FIFTH CIRCUIT United States Court of Appeals
                                               Fifth Circuit

                                                                  FILED
                                                               November 7, 2007

                           No. 06-60597 & 06-60779           Charles R. Fulbruge III
                                                                     Clerk

GEORGE G. GREEN

                                           Petitioner-Appellant
v.

COMMISSIONER OF INTERNAL REVENUE

                                           Respondent-Appellee



                  Appeal from the United States Tax Court


Before GARWOOD, JOLLY, and STEWART, Circuit Judges.
CARL E. STEWART, Circuit Judge:
      This appeal involves a final order of the United States Tax Court finding
that Petitioner-Appellant George Green (“Green”) failed to properly report
settlement proceeds as taxable income and improperly deducted certain
expenditures and losses as business expenses and losses. The Tax Court also
sustained the Commissioner’s assessment of accuracy-related penalties for these
deficiencies. We affirm.
I.    FACTUAL AND PROCEDURAL BACKGROUND
      The income at issue in this case resulted from a whistleblower lawsuit that
Green brought against the Texas Department of Human Services (“TDHS”), the
failure of the state of Texas to pay the resulting judgment, and ultimately, a
                                 No. 06-60597 & 06-60779

monetary settlement between Green and Texas. The following facts, except
where noted, are taken from the Tax Court’s Findings of Fact.
       A.      Whistleblower Lawsuit
       While working as an architect for TDHS, Green came to believe that
officials with TDHS were engaged in a pattern of fraud and corruption. Green
discussed the misconduct with his supervisors, and when they failed to act, he
advised numerous TDHS employees that he intended to report the misconduct
to authorities outside of the department. On December 12, 1989, Green was
fired for allegedly abusing sick leave, falsifying official documents, and misusing
his business phone.1
       On March 9, 1990, Green filed suit against TDHS under the Texas
Whistleblower Act.         Green’s suit was tried before a jury in August and
September of 1991. The jury found that Green was fired in retaliation for
reporting misconduct at TDHS, and awarded Green $3,459,832 in compensatory
damages and $10,000,000 in punitive damages.2 On October 10, 1991, the trial
court entered judgment in favor of Green in the amount of $13,773,461.96.3

       1
          TDHS also referred the matter to the district attorney for prosecution of alleged
criminal violations, and Green was indicted for falsifying documents, a third-degree felony.
After the filing of Green’s whistleblower suit, the district attorney offered to drop the criminal
charges against Green if he would drop his lawsuit. Green refused. Shortly before the trial
of the criminal case, the district attorney dismissed the charges under the indictment, pending
further investigation.
       2
        The jury’s award of compensatory damages was allocated as follows:
               Loss of earning capacity:        $928,000
               Past mental anguish:             $1,000,000
               Future mental anguish:           $1,500,000
               Out-of-pocket expenses:          $31,832
In addition, the trial court awarded prejudgment in interest in the amount of $154,246.57
through September 24, 1991, with an additional $237.97 per day until the judgment was
signed. The judgment bore post-judgment interest of 10 percent per annum until paid.
       3
         The Tax Court’s opinion states that judgment was entered in the amount stated
above, $13,773,461.96. However, according to the parties’ First Stipulation of Facts submitted
to the Tax Court, as well as the Government’s brief, judgment was entered in the amount of
$13,775,000. The difference is immaterial for our purposes.

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       B.     Green’s Efforts to Collect the Judgment
       After the entry of the judgment in October, 1991, Texas failed to pay Green
any portion of the judgment awarded.4 In 1993, after discharging his trial
attorney, Green instituted legal proceedings and attempted to secure a
legislative appropriation to obtain satisfaction of the judgment. His efforts were
unavailing.
       In February of 1994, to assist him in the collection of the judgment, Green
hired new counsel, John C. Augustine (“Augustine”), and a team of consultants
to help him by raising public consciousness of his plight and getting the
attention of lawmakers. In order to fund the collection attempts, Green sold an
interest in $1,000,000 of his ultimate recovery, if any, to James U. King (“King”)
for $500,000. In 1995, Green formed Green Capital Corp. (“Green Capital”) and
TS Capital Asset, LLC (“TS Capital”) for the purpose of employing consultants
and advisers, including legal consultants, publicists, and other professionals, to
attempt to collect the judgment from Texas.                 In connection with these
businesses, Green maintained an office.
       During 1994 and 1995, Green filed abstracts of judgments in several
counties against Texas, all of which were unsuccessful in securing payment.
Green and his representatives attempted to influence public opinion with
newspaper articles, magazine articles, and television broadcasts about Green’s


       4
         Under Texas law, when an individual is awarded a judgment against the state, he
must seek a legislative appropriation to collect the damages awarded to him. See Tex. Dept.
of Human Servs. v. Green, 855 S.W.2d 136, 145 (Tex. App. 1993). The Texas Legislature, a
bicameral body, convenes only in odd-numbered years. All bills that affect revenues or
expenditures are referred to the Legislative Budget Board which estimates the probable
revenue cost of a bill. The legislature may choose, through the appropriation process to pay
all, some, or none of an individual’s judgment against the state. See Tex. Civ. Prac. and
Remedies Code Ch. 109, et seq.; Fed. Sign v. Tex. S. Univ., 951 S.W.2d 401, 415 (Tex. 1997)
(Hecht, J. concurring). When the legislature is not in session, the Governor of Texas or the
Legislative Budget Board may, by emergency measure, propose an expenditure or distribution
of funds by a state agency. Tex. Const. art. XVI, § 69; Tex. Gov’t Code Ann. § 317.002(b); §
317.003(a).

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                             No. 06-60597 & 06-60779

struggle to obtain satisfaction of his judgment. Green also filed a declaratory
judgment action in a Texas trial court against Texas and the attorney general.
Additionally, Green attempted to secure a legislative appropriation to pay the
judgment. In 1995, two bills were introduced during the 74th regular session of
the Texas Legislature to appropriate funds to satisfy the judgment, but neither
of the bills were enacted.
      During this time, Green was involved in a lawsuit with Allied Interests,
Inc. (“Allied”), in which Green was being sued for expenses owed to Allied for
services it rendered in connection with Green’s attempt to collect the judgment.
In 1996, a judgment in favor of Allied was entered against Green and Green
Capital. In 1998, Green paid Allied $753,629, including punitive damages of
$365,000, in satisfaction of Allied’s judgment.
      Between 1991 and 1995, while engaged in his efforts to collect the
judgment, Green’s mental and physical health deteriorated significantly,
requiring repeated hospitalization for a bleeding ulcer.
      C.    Settlement
      After the legislature failed to appropriate funds for payment of the
judgment, Green approached the Legislature Budget Board (“LBB”). Green and
Augustine worked with Lieutenant Governor Bob Bullock (“Bullock”), the
chairman of the LBB, in order to convince the LBB that an emergency
warranted the issuance of a budget execution order authorizing TDHS to expend
funds to satisfy the taxpayer’s judgment. Green met with Bullock on several
occasions to discuss Green’s unsuccessful efforts to collect the judgment and his
continued stress and failing health. Augustine informed Bullock that Green was
willing to negotiate some sort of settlement and that at that point, the judgment
had reached over $20,000,000 because of the accruing interest.
      Although not noted by the Tax Court, the foreman of the jury in the
whistleblower lawsuit, Richard G. Fogg (“Fogg”), also advocated on Green’s


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                           No. 06-60597 & 06-60779

behalf. Fogg attended one of Bullock’s meetings with Green and discussed
Green’s ongoing health problems stemming from the collection of the judgment.
During this meeting, Bullock told Green and Fogg that “there wasn’t enough
money in the State treasury to pay [you] for what you went through.”
      Green and Texas entered into a written Release and Settlement
Agreement (“settlement agreement”) dated November 8, 1995. Augustine and
Harry G. Potter, III (“Potter”), a special assistant attorney general for Texas,
were responsible for drafting the agreement. In relevant part, the settlement
agreement provided:
            4.    The State shall make a cash payment of
                  $3,427,999.87 to Plaintiff for damages for loss of
                  earning capacity, mental anguish and suffering
                  (past) and suffering (future), in accordance with
                  the findings specified and incorporated into the
                  Final Judgment in Cause No. 480,701.
                  [(“Paragraph Four”)]
            5.    The State shall fund annuities for additional
                  damages associated with the Final Judgment in
                  Cause No. 480,701, which in turn shall pay to
                  Plaintiff monthly installments, commencing
                  January 4, 1996 and continuing until December
                  4, 1998, each in the amount of $13,499 with a
                  final judgment payable on January 4, 1999 in the
                  amount of $3,000,000. The State shall purchase
                  the annuity contracts described herein naming
                  Plaintiff as payee in order to ensure that these
                  monetary obligations are met. [(“Paragraph
                  Five”)]
            6.    For all other damages, including punitive,
                  prejudgment and post-judgment interest, the
                  State shall fund an annuity or annuities, which
                  in turn shall pay to Plaintiff monthly
                  installments, commencing on January 4, 1996
                  and continuing until December 4, 1998, each in
                  the amount of $7,924 with a final payment
                  payable on January 4, 1999 in the amount of
                  $1,761,000. [(“Paragraph Six”)]


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                               No. 06-60597 & 06-60779

A quorum of the LBB met on November 15, 1995 and proposed a budget
execution order that authorized TDHS to pay Green: “a settlement, including
attorneys fees . . . in the amount of $13,775,000, contingent on the fact that
acceptance of this amount by George Green constitutes a complete release by
George Green of all claims and causes of action that George Green may have
against the state of Texas arising from the case of George Green v. Department
of Human Services.” On November 15, 1995, the LBB adopted the proposed
budget execution order, which was ratified by then Governor George W. Bush.
      On November 17, 1995 Green received a payment for $3,427,999. Green
received $13,455 per month from January, 1996, through December, 1998, under
the first annuity, and $7,924 per month during the same period from the second
annuity. Additionally, in January, 1999, Green received the final payments of
$3,000,000 and $1,761,000 under the respective annuities. The total amount
paid under Paragraphs Five and Six of the settlement agreement was
$10,347,000.13.
      D.       Green’s Tax Returns
      On his 1995 federal tax return, Green excluded the payment of
$3,427,999.87 that he received under § 104(a)(2) of the Internal Revenue Code
(“Code”), which provides an exclusion for “damages received . . . on account of
personal injury or sickness.” On his federal tax returns for 1996, 1997, and
1998, Green reported the annual payment of $95,088 ($7,924 per month) from
the second annuity, made under Paragraph Six of the settlement agreement, as
taxable income. In those three years, Green did not report the $161,988 ($13,499
per month) received under the first annuity and Paragraph Five as taxable. In
statements attached to the 1997 and 1998 returns,5 Green asserted that the
$161,988 was not taxable because it represented additional damages other than



      5
          Green’s 1997, 1998, and 1999 returns were prepared by Hunter & Atkins Inc.

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                           No. 06-60597 & 06-60779

punitive and interest and is excluded from income under § 104(a)(2) of the Code.
Green did not report the lump-sum payments of $3,000,000 and $1,761,000 as
taxable income on his tax return for 1999. Instead, he attached a statement to
his return claiming that the $3,000,000 constituted “additional damages”
received from Texas and that the $1,761,000 constituted “all other damages” and
asserting that both payments were excludable under § 104(a)(2) of the Code.
      For each of the years 1995 through 1996, Green claimed losses with
respect to his interests in Green Capital and/or TS Capital. These claimed losses
arose from expenses incurred by Green in attempting to collect his judgment and
defend himself in the Allied litigation. Such expenses consisted of, among other
things, payments to attorneys and consultants and office expenses. Green
deducted all of these expenses as trade or business expenses under § 162 of the
Code. As a result of the claimed losses, totaling $1,470,789, Green reported no
tax due for any years at issue except 1997, for which Green reported a tax due
of $8,066.
      In July, 2001, Green filed amended federal income tax returns for the
years 1996, 1997, and 1998. On the amended returns, Green claimed that
$95,088 of reported income was not includable as income under § 104(a)(2). This
resulted in Green requesting a refund of $7,654 for 1997.
      E.     Legal Proceedings
      Upon auditing Green’s return, the Commissioner of Internal Revenue
(“Commissioner”) issued two notices of deficiency to Green, one for 1995 through
1998, and one for 1999. The Commissioner determined that all of the payments
received by taxpayer from Texas during the years at issue were includable in
Green’s income. The Commissioner also disallowed all losses claimed by Green
with respect to his interests in Green Capital and TS Capital for the years at
issue. In addition, the Commissioner determined that Green was liable for



                                       7
                             No. 06-60597 & 06-60779

accuracy-related penalties under § 6622(a) of the Code for all of the years at
issue.
         Green filed two petitions in the Tax Court seeking redetermination of the
deficiencies. The Commissioner conceded that the $3,427,999.87 received by the
taxpayer under Paragraph Four of the settlement agreement, which provided for
the payment of compensatory damages to taxpayer, was excludable from his
gross income under § 104(a)(2) of the Code. As to the excludability of the
payments under Paragraphs Five and Six of the settlement agreement; the
deductibility of the business expenses; and the appropriateness of the accuracy-
related penalties, the Tax Court conducted a trial.
         First, the Tax Court found that Green had failed to establish that
Paragraph Five of the settlement agreement was intended to compensate Green
for personal injuries or sickness arising out of the whistleblower lawsuit. The
court found that “all compensatory damages awarded in the final judgment [of
the whistleblower] lawsuit were expressly allocated in paragraph 4 of the
settlement agreement.” Accordingly, Green was required to include in gross
income the $3,485,964 in payments he received under Paragraph Five of the
settlement agreement for “additional damages” during the years in issue.
Second, the court found that the payments made under Paragraph Six of the
settlement agreement were not excludable from Green’s income under §
104(a)(2) of the Code. Third, the court concluded that Green’s losses and
expenses resulting from Green Capital and TS Capital, were not deductible
under § 162 of the Code as trade or business expenses, but instead were only
deductible under § 212 of the Code as expenses related to the production or
collection of income. The Court found that Green’s payment of punitive damages
to Allied was not deductible under either section. Finally, the court held that
Green was liable for 20% accuracy-related penalties under § 6662 of the Code
because he had no reasonable basis for excluding from his income the full


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                           No. 06-60597 & 06-60779

amount of payments under the settlement agreement. Green timely appealed
the decision of the Tax Court.
II.    STANDARD OF REVIEW
       We apply the same standard of review to decisions of the Tax Court that
we apply to district court decisions. Arevalo v. Comm'r, 469 F.3d 436, 438 (5th
Cir. 2006). Findings of fact are reviewed for clear error and issues of law are
reviewed de novo. Id. Clear error exists when this court is left with the definite
and firm conviction that a mistake has been made. Streber v. Comm’r, 138 F.3d
216, 219 (1998).
III.   ANALYSIS
       Green argues the following on appeal: (1) the Tax Court erred in finding
that the payments under Paragraph Five of the settlement agreement were not
excludable income under § 104(a)(2) of the Code; (2) the Tax Court erred in
concluding that the expenses incurred by Green in collecting the judgment and
the punitive damages paid to Allied are not deductible as business expenses
under § 162 of the Code; and (3) the Tax Court erred in concluding that Green
was liable for 20% accuracy-related penalties. Green conceded at oral argument
that the Tax Court was correct in finding that the payments received by Green
under Paragraph Six of the settlement agreement were not excludable from
Green’s income. We address the remaining issues in turn.
       A.    § 104(a)(2) and Payments Made Under Paragraph Five of the
             Settlement Agreement
       Paragraph Five of the settlement agreement provided that “[t]he State
shall fund annuities for additional damages associated with the Final
Judgment” in Green’s whistleblower case. (emphasis added) At issue is whether
the $3,485,964 in payments for “additional damages” under Paragraph Five are
excludable under § 104(a)(2) Code as “damages received. . . on account of
personal injury or sickness. The Tax Court’s finding that Green failed to


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                               No. 06-60597 & 06-60779

establish that payments under Paragraph Five were allocable to personal injury
or sickness is a finding of fact that we review for clear error. See Robinson v.
Comm’r, 70 F.3d 34, 38 (5th Cir. 1995); Srivastava v. Comm’r, 220 F.3d 353, 365
(5th Cir. 2000) (“We review the allocations made by the Tax Court only for clear
error.”), overruled on other grounds by Comm’r v. Banks, 543 U.S. 426 (2005).
       Green argues that the payments are excludable under § 104(a)(2) of the
Code. That section states, in relevant part, that “gross income does not include
. . . any damages received (whether by suit or agreement and whether as lump
sums or as periodic payments) on account of personal injury or sickness.”6 The
Supreme Court has held that amounts are excludable under § 104(a)(2) only
when: (1) the underlying cause of action giving rise to the recovery is based on
tort or tortlike rights; and (2) the damages were received on account of personal
injury or sickness. Comm’r v. Schleier, 515 U.S. 323, 336-37 (1995); see also
Chamberlain v. Unites States, 401 F.3d 335, 341 (5th Cir. 2005). To constitute
damages received “on account of” personal injury, an amount must be awarded
“by reason of” or “because of” personal injury, and must compensate a victim for
the loss of personal or financial capital. Chamberlain, 401 F.3d at 341; see also
United States v. O’Gilvie, 519 U.S. 79, 86-87 (1996). There is no dispute that the
claims underlying Green’s claims were tort-like, or that Green suffered personal
injury. Thus, the issue is whether Green satisfied prong two’s requirement that
the payments under Paragraph Five for “additional damages” were received on
account of Green’s personal injuries or sickness.




       6
        In 1996, Congress amended § 104(a)(2). As amended, the section excludes from gross
income only damages paid on account of “personal physical injuries or physical sickness.”
However, the legislation included a transition rule applicable to “any amount received under
a written binding agreement, court decree, or mediation award in effect on (or issued on or
before) September 13, 1995.” Because the parties agreed below that the pre-1996 law
governed the taxability of the settlement payments at issue, we will apply that version.

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                           No. 06-60597 & 06-60779

      When determining the tax treatment of a settlement, we must ask “in lieu
of what was the . . . settlement awarded?” Srivastava, 220 F.3d at 365 (citing
Knuckles v. Commissioner, 349 F.2d 610 (10th Cir. 1965)); see also Treas. Reg.
§ 1-104.1(c) (as amended in 1970) (defining “damages received” as “an amount
received . . . through a settlement agreement entered into in lieu of [a]
prosecution” of tort). Where damages are received under a written settlement
agreement, “the focus is on the origin and characteristics of the claims settled
in determining whether such damages are excludable under § 104(a)(2).”
Pipitone v. United States, 180 F.3d 859, 862 (7th Cir. 1999); see also Francisco
v. United States, 267 F.3d 303, 319 (3d Cir. 2001) (“It is a tenet of federal law
that income received in settlement of a claim should be taxed in the same
manner as if it had been received in court.”). Therefore, to succeed Green was
required to establish that the payments under Paragraph Five were made “in
lieu” of damages for personal or physical injuries, not for punitive damages or
economic loss. See O’Gilvie, 519 U.S. at 83 (finding that punitive damages are
not “on account of” personal injuries or sickness).
      We first look to the language of the agreement itself for indicia of purpose.
See Greer v. United States, 207 F.3d 322, 329 (6th Cir. 2000). Where the
settlement agreement lacks express language of purpose, the court looks beyond
the agreement to other evidence that may shed light on the ‘intent of the payor
as to the purpose in making the payment.’” Id. (quoting Knuckles v. Comm’r, 349
F.2d 610, 613 (10th Cir. 1965)); see also Gadja v. Comm’r, 158 F.3d 802, 804 (5th
Cir. 2005) (noting that under § 104(a)(2) intent of the employer governs
treatment of a severance payment). Ultimately, the character of the payment
hinges on the payor’s dominant reason for making the payment. The evidence
considered by the court may include the amount paid, the evidence adduced at
trial, the underlying judgment, the factual circumstances that led to the
agreement, and any other facts that may reveal the payor’s intent. See, e.g.,

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                            No. 06-60597 & 06-60779

Dotson v. United States, 87 F.3d 682, 687-88 (5th Cir. 1996); Pipitone, 180 F.3d
at 864-65. We heed the wisdom that “when assessing the tax implications of a
settlement agreement, courts should neither engage in speculation nor blind
themselves to the settlement’s realities.” Bagley v. Comm’r, 121 F.3d 393, 395
(8th Cir. 1997). Instead, the court should discern “the claim the parties, in good
faith, intended to settle for.” Dotson, 87 F.3d at 688.
      The language of Paragraph Five does not resolve whether the payments
were made “on account of” Green’s injuries. Paragraph Five simply refers to
“additional damages.” This is in contrast to both of the other paragraphs—
Paragraph Four payments are clearly intended to compensate Green for “loss of
earning capacity, mental anguish and suffering (past) and mental anguish and
suffering (future) and the payments under Paragraph Six are intended to
compensate Green for “all other damages, including punitive, pre-judgment, and
post-judgment interest.”     However, there is no such explanation of what
“additional damages” this Paragraph Five was intended to compensate for.
Green contends that the payments were intended to compensate him for the
injuries sustained in securing payment of the judgment. The Government
responds that the Paragraph Five payments were punitive damages cloaked in
“other damages” language for political reasons.
       Looking beyond the words of the agreement to the payor’s purpose, we
find that it was not clearly erroneous for the trial court to conclude that the
payments made under Paragraph Five were not made to compensate Green for
personal or physical injuries for the following reasons. Green claims that in
refusing to acknowledge that the payments made under Paragraph Five were
intended to compensate Green for personal injuries, the trial court ignored the
evidence and failed to consider the testimony presented at trial. Green argues
that even under the highly deferential “clearly erroneous” standard, he is
entitled to relief because the evidence presented at trial conclusively established

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                            No. 06-60597 & 06-60779

that the money paid under Paragraph Five was intended to compensate Green
for personal injuries received in attempting to collect on the judgment. This
argument is not supported by the record.
      First, an examination of the settlement agreement in conjunction with the
jury verdict in the underlying whistleblower suit supports the Tax Court’s
findings. “Where there has been a judgment in a trial court that preceded the
settlement of the claims, the most persuasive evidence of the payor’s intent in
settling the case is the previous award of that court.” Francisco, 267 F.3d at 320;
see also Robinson, 70 F.3d at 38 (the verdict provides “the best indication of the
worth of the [taxpayer’s] claims). Here, the trial court in the whistleblower
litigation awarded Green $13,775,000 in damages– almost the same amount that
Texas paid to Green under the settlement agreement. Further, the amount of
compensatory damages awarded by the jury in the whistleblower lawsuit for the
loss of earning capacity and past and future mental anguish and suffering,
$3,427,999.97, mirrored exactly the amount of compensatory damages paid
under Paragraph Four of the settlement agreement. The logical import, then,
is that the remainder of the settlement, including the amounts paid under
Paragraph Five, was intended to compensate Green for the remainder of the
judgment– consisting only of punitive damages and interest.
      Second, Green points to the testimony of both Potter and Augustine that
Texas was opposed to paying punitive damages and wanted to minimize the
amount of punitive damages paid. Thus, he argues, the damages paid under
Paragraph Five could not possibly have been punitive damages, but were meant
to compensate Green for the injuries he sustained in his attempts to collect.
However, viewing the testimony presented at the trial as a whole, it appears
that although the Paragraph Five payments were intended to satisfy the
punitive damages portion of the judgment, they were labeled otherwise because
of political considerations. Potter testified that neither he, nor his office, had

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                            No. 06-60597 & 06-60779

undertaken any independent investigation of Green’s injuries and that he lacked
personal knowledge of Green’s injuries resulting from his efforts to collect the
judgment. Potter also testified that Paragraph Five “could have been the same
type of [damages] as paragraph four.”        This testimony undercuts Green’s
assertion that the Paragraph Five payments were intended to compensate for
post-judgment injuries. Further, Potter explained that Texas’s opposition to
paying punitive damages “was pretty much a matter of public policy.” Thus,
given the political climate, along with Potter’s lack of knowledge of Green’s post-
judgment injury, the Tax Court did not err in finding that the Paragraph Five
payments were intended to satisfy a portion of the punitive damages and
interest awarded to Green, but were labeled otherwise.
      Third, Green points to Bullock’s knowledge of his post-judgment injuries
in support of his argument that Paragraph Five was intended to compensate him
for these injuries. The testimony of Green, Fogg, and Augustine established that
Bullock was aware of Green’s hardship and health problems stemming from the
collection efforts. Very likely, it was these compelling facts which led Bullock to
help Green obtain satisfaction of the judgment in the first place. However,
Bullock was not responsible for negotiating the settlement or drafting the
settlement agreement.      Green did not produce any evidence that Bullock
informed Potter about Green’s postjudgment injuries, and in fact, Potter testified
that he was unaware of any postjudgment injuries. Bullock’s knowledge of
Green’s health condition does not satisfy Green’s burden of establishing that
Texas intended the money paid under Paragraph Five to compensate Green for
personal injury or sickness.
      Finally, Augustine testified that his intent was to obtain from Texas full
payment of the punitive damages and interest. Fogg testified that in his
meeting with Bullock, he told Bullock that he expected Green to get a minimum
of what was owed to him by the jury verdict. Both of these statements confirm


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that the overall goal of the settlement negotiations and eventual agreement was
to provide Green with a monetary settlement equal to the judgment entered
against the state.
       We agree with the Tax Court’s conclusion that “the record lacks any
evidentiary basis for concluding that a specific portion of the [Paragraph Five]
annuity was allocable to any personal injury or sickness.” Admittedly, the
language used in Paragraph Five is less than clear. But it is Green who bears
the ultimate burden of proving that the amounts paid under Paragraph Five
were meant to compensate him for personal injuries or sickness. He has not met
that burden.       As such, the payments made under Paragraph Five of the
settlement agreement are not excludable under § 104(a)(2).
       B.      Deductibility of Business Expenses and Punitive Damages Paid to
               Allied
       Green appeals the Tax Court’s determination that the expenses and losses
he incurred in connection with Green Capital and TS Capital are not deductible
under § 162 of the Code as “ordinary and necessary expenses paid or incurred
. . . in carrying on any trade or business.”7 The Commissioner concedes that
Green substantiated the underlying expenses, but argues that they were
deductible only as “ordinary and necessary expenses paid or incurred . . . for the
production or collection of income” under § 212(1) of the Code.
       Section 162 of the Code permits a deduction for all “ordinary and
necessary expenses paid or incurred during the taxable year in carrying on any
trade or business.” 26 U.S.C. § 162. In contrast, deductions are allowed under
§ 212 for “the ordinary and necessary expenses paid or incurred during the


       7
         It is more favorable for a taxpayer to deduct expenses under § 162. Expenses deducted
under § 162(a) generally are subtracted in full from gross income to arrive at adjusted gross
income. However, expenses deducted under § 212 ordinarily are subtracted from gross income
to arrive at taxable income and are subject to certain floor limitations set out in § 67(a) of the
Code. Also, under § 56(b) of the Code, a deduction under § 212 may be limited by application
of the alternative minimum tax.

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                               No. 06-60597 & 06-60779

taxable year . . . for the production or collection of income.” 26 U.S.C. § 212. A
deduction claimed under § 212(1) “must meet the same requirements applicable
to trade or business expenses under § 162, except that the person claiming the
deduction need not be in the trade or business.” Simon v. Comm’r, 830 F.2d 499,
501 (2d Cir. 1987)); Snyder v. United States, 674 F.2d 1359, 1364 (10th Cir. 1982)
(same). The purpose of § 212 is to provide for deductions in “those pecuniarily
motivated or profit seeking activities which are neither the conduct of the
taxpayer’s trade or business on the one hand nor the mere satisfactions of his
needs as a human and those of his family on the other.” Petschek v. United
States, 335 F.2d 734, 735 (2d Cir. 1964).8
       In order to be engaged in carrying on a trade or business, the taxpayer
“must be involved in the activity with continuity and regularity and . . . the
taxpayer’s primary purpose for engaging in the activity must be for income or
profit.” Comm’r v. Groetzinger, 480 U.S. 23, 35 (1987). The concept of trade or
business is a “concept which falls far short of reaching every income or profit
making activity.” Whipple v. Comm’r, 373 U.S. 193, 202 (1963). A sporadic
activity, a hobby, or an amusement does not qualify as a “trade or business.”
Groetzinger, 480 U.S. at 35. The determination of whether Green was engaged
in carrying on a trade or business is a determination of fact that we review for
clear error. See Westbrook v. Comm’r, 68 F.3d 868, 874 (5th Cir. 1995); Jackson
v. Comm’r, 864 F.2d 1521, 1524 (10th Cir. 1989).



       8
         Congress’s purpose in enacting § 212 was to put all income producing activities on
equal footing. United States v. Gilmore, 27 U.S. 39 (1963). Thus, at the time the predecessor
to § 212 was adopted, deductions under § 162 and § 212 had the same effect. Id. However,
beginning in 1986, Congress distinguished between the two, limiting the deductibility of non-
business expenses. The rationale was that some of the § 212 expenses had only a very tenuous
relationship to any income-producing activity and had personal-consumption benefits as well.
See Leah Witcher Jackson, Won the Legal Battle, but at What Tax Cost to Your Client: Tax
Consequences of Contingency Fee Arrangements Leading up to and After Commissioner v.
Banks, 57 Baylor L. Rev. 47, 110-12 (2005).

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                          No. 06-60597 & 06-60779

      The Tax Court found that although Green “continuously and regularly
engaged in the activity of attempting to recover his judgment between 1991 and
1995,” it “could not conclude that [Green] was in a trade or business in the
customary use of those terms.” The Tax Court reasoned that “[a]lthough a trade
or business requires continuous and regular activity, continuity and regularity
do not, standing alone, constitute a trade or business.” The Tax Court’s
conclusions are well-supported by the record in this case. Green’s asserted
purpose in forming Green Capital and TS capital, as noted by the Tax Court
“was to secure the compensation to which he was entitled.” While Green’s
attempt to secure satisfaction of this personal judgment qualifies as an income
seeking activity; it does not qualify as a business or trade. Expenditures may
only be deducted under § 162 “if the facts and the circumstances indicate that
the taxpayer made them primarily in furtherance of a bona fide profit objective
independent of tax consequences.” Copeland v. Comm’r, 290 F.3d 326, 335 (5th
Cir. 2002). Here, the record demonstrates that Green formed the two companies
solely for the purpose of paying expenses associated with the collection of a
judgment that was rendered prior to the establishment of the businesses.
Further, the businesses had no independent purpose beyond the payment of
these legal expenses. Were we to find that the funneling through a business of
Green’s expenses in collecting a personal judgment were sufficient to meet the
requirements of § 162, the distinction between § 162 and § 212 would be
abrogated. The Tax Court did not clearly err in determining that Green’s
expenses and losses from Green Capital and T.S. Capital were not incurred in
carrying on any trade or business. Cf. Alexander v. IRS, 72 F.3d 938 (1st Cir.
1995) (expenses incurred by employee in settling post-termination lawsuit not
deductible as independent business expense because lawsuit proximately
resulted from his employment).



                                      17
                           No. 06-60597 & 06-60779

      Additionally, Green argues that the $365,000 portion of his payment in
satisfaction of Allied’s judgment, constituting exemplary damages, is deductible
under § 162. This judgment was entered against Green for non-payment of
expenses associated with collection of the judgment. Punitive damages may be
deductible under § 162 as a business expense, but only to the extent that such
expense is “ordinary and necessary ” and is incurred in connection with a “trade
or business.” Tax Court found that the punitive damages payment was not
deductible because Green failed to explain the basis of the award against Green
or show that the expense was ordinary or necessary.              Green has not
demonstrated that this conclusion was clearly erroneous. As such, we affirm
that Tax Court’s holding that Green’s punitive damages payment is not
deductible under § 162.
      C.    Accuracy-Related Penalties
      Green appeals the Tax Court’s affirmance of the Commissioner’s
assessment of accuracy-related penalties under § 6662 of the Code on Green’s
income tax returns from 1995 through 1999. The determination of whether
Green acted with reasonable cause and in good faith in making a substantial
understatement of tax liability is a factual issue that we review for clear error.
Srivastava, 220 F.3d at 367; see also Treas. Reg. § 1.6664-4(b)(1) (as amended
2003) (“The determination of whether a taxpayer acted with reasonable cause
and in good faith is made on a case-by-case basis, taking into account all
pertinent facts and circumstances.”)
      Under § 6662 of the Code, a taxpayer may be liable for a penalty of twenty
percent on the portion of underpayment of tax due to “any substantial
understatement of income tax.”       26 U.S.C. § 6662 (b)(2).     A “substantial
understatement” is defined as an understatement of tax liability on a tax return
that exceeds the greater of (1) 10% of the tax required to be shown on the return



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                                No. 06-60597 & 06-60779

for the taxable year; or (2) $5,000. 26 U.S.C. § 6662 (d)(1)(A), (d)(2).9 This
penalty does not apply to any portion of an underpayment if the taxpayer shows
“that there was reasonable cause for such portion and that the taxpayer acted
in good faith with respect to such portion.” 26 U.S.C. § 6664(c)(1); see also
Higbee v. Comm’r, 116 T.C. 438, 488 (T.C. 2001).
       For the reasons discussed above, Green’s failure to pay tax on the
settlement payments and his deduction of the business expenses and losses were
in error. He argues however, that the Tax Court erred in upholding the
penalties because he acted in good faith and with reasonable cause.
           The Tax Court found that Green did not act with reasonable cause and
good faith. It found that Green was negligent in excluding the entire settlement
recovery from his income, while, at the same time, deducting in full the expenses
he incurred to collect the whistleblower judgment. Further, the Tax Court found
that Green’s inclusion of the Paragraph Six payments in 1996, 1997, and 1998
indicated his knowledge that punitive damages and interest were not excluded
under § 104 of the Code. The Tax Court also found that, although Green had
assistance in preparing his return in 1997 and 1998, there was no evidence as
to what Green told the preparer, what the preparer told Green, and whether or
not Green’s reliance on any advice from the preparer was reasonable.
       Based on all of the facts and circumstances, it was not clear error for the
Tax Court to find that Green failed to act with reasonable cause and good faith.




       9
          Section 6662 provides that taxpayers may reduce the amount of an understatement,
and hence the penalty imposed, by that portion of the understatement resulting from a position
taken by the taxpayer for which there was substantial authority or, if the position is disclosed
adequately on the tax return, for which there was a reasonable basis for such treatment. 26
U.S.C. § 6662(d)(2)(B)(i)-(ii). The Tax Court found that Green failed to establish that he was
entitled to the benefit of either of these provisions. On appeal, Green does not appear to argue
that the Tax Court erred in this respect, but to the extent that he does, his argument is
rejected.

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                           No. 06-60597 & 06-60779

We sustain the assessment of penalties for 1996 through 1999 for the substantial
understatement of tax and for 1995 through 1999 for the disallowed deductions.
IV.   CONCLUSION
      For the foregoing reasons, we AFFIRM the Tax Court’s determinations
that: (1) the payments made under Paragraph Five of the settlement were not
excludable under § 104(a)(2) of the Code; (2) Green was entitled to deduct
expenses and losses related to Green Capital and TS Capital under § 212 of the
Code, and not under § 162 of the Code, and that Green was not entitled to deduct
the payment of punitive damages to Allied; and (3) the Tax Court’s affirmance
of the accuracy-related penalties was not in error.




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