                    T.C. Summary Opinion 2006-51



                     UNITED STATES TAX COURT



          JOHN BOTHE AND BARBARA BOTHE, Petitioners v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 6737-04S.             Filed April 12, 2006.



     Stanley Pressment, for petitioners.

     Michelle L. Maniscalco, for respondent.



     CARLUZZO, Special Trial Judge:   This case was heard pursuant

to the provisions of section 7463 of the Internal Revenue Code in

effect at the time the petition was filed.   Unless otherwise

indicated, subsequent section references are to the Internal

Revenue Code in effect for 1999.   Rule references are to the Tax

Court Rules of Practice and Procedure.   The decision to be
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entered is not reviewable by any other court, and this opinion

should not be cited as authority.

     Respondent determined a $25,056 deficiency in petitioners’

1999 Federal income tax.   All adjustments that give rise to the

deficiency have been agreed upon by the parties-–their dispute

involves an item reported on petitioners’ 1999 Federal income tax

return.   John Bothe (petitioner) sued his former employer.

Petitioners included the settlement proceeds from that lawsuit in

the income reported on their 1999 return.    They now take the

position that it was a mistake to have done so.    The issue for

decision is whether those settlement proceeds are excludable from

income pursuant to section 104(a)(2).

Background

     Some of the facts have been stipulated and are so found.

Petitioners are married to each other.    They filed a timely joint

1999 Federal income tax return.    At the time the petition was

filed in this case, they resided in Corfu, New York.

     Years ago, at age 19, petitioner began working at the New

Jersey Sports and Exposition Authority, a.k.a. the Meadowlands

racetrack (the Meadowlands).    In 1979, he became an assistant

race track announcer there.    In 1990, petitioner became the

head race track announcer.    Starting as teenager and continuing
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throughout his employment at the Meadowlands, petitioner suffered

from migraine headaches, a condition known to his supervisors at

the Meadowlands.

     Over the years, petitioner’s migraine headaches have been so

severe that at times he required hospitalization.   Petitioner’s

migraine headaches have caused panic attacks, as well as feelings

of anxiety and depression.    In addition to other health problems,

petitioner’s migraine headaches also caused problems with his

voice.

     Petitioner began betting on horse races as a teenager.

During his employment at the Meadowlands, petitioner “was running

to the window all the time in between races and making bets.”

After petitioner’s gambling habit began to affect his work

performance, he was told by Meadowlands management that he needed

professional help to deal with his gambling problem.    In 1991,

petitioner began treatment for compulsive gambling.    In 1992,

petitioner joined Gamblers Anonymous.

     In February 1998, petitioner lost his voice and had trouble

with his eyesight.   As a result, petitioner missed approximately

a month and a half of work.   The Meadowlands placed petitioner on

paid temporary disability during this time and encouraged him to

seek treatment.    After undergoing treatment from several doctors,

petitioner ultimately returned to work at the Meadowlands.    The
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Meadowlands made special accommodations for petitioner which

included a custom binoculars stand and a larger television

monitor.   According to petitioner, the Meadowlands was “really

being accommodating.”

     In December 1998, the Meadowlands asked petitioner to

participate in a television program to report on various aspects

of the Meadowlands horse races.   In addition to his duties as a

race track announcer, the Meadowlands requested that petitioner

interview horse owners and trainers and handicap the horse races.

Petitioner declined to participate in the television program

because he believed it would jeopardize the ongoing treatment for

his gambling addiction.   Petitioner’s doctors also advised him

against any involvement in handicapping the horse races.

     After petitioner declined to accept the additional job

duties, the Meadowlands informed petitioner that his salary would

be reduced.   At that time, petitioner consulted an attorney.   By

letter dated December 31, 1998, petitioner’s attorney notified

the Meadowlands that petitioner’s “addiction to gambling would be

considered a handicap” and that it is “unlawful for employers to

discriminate against persons on the basis of either a mental or

physical handicap.”   Nevertheless, petitioner’s salary was

reduced as threatened.
                                 - 5 -

     On February 8, 1999, petitioner filed a complaint against

the Meadowlands (the original complaint) in the Superior Court of

New Jersey, Morris County (the lawsuit).      The original complaint

advances two causes of action:    (1) Employment discrimination;

and (2) intentional infliction of emotional distress.      Petitioner

sought the following relief with respect to the employment

discrimination:   (1) Reinstatement of his previously-in-effect

employment conditions; (2) an injunction restraining the

Meadowlands from further violations of the New Jersey Law Against

Discrimination, N.J. Stat. Ann. 10:5-1 through 10:5-49 (West

2002); (3) damages for lost income and medical and fringe

benefits; (4) compensation for injury to petitioner’s

professional stature and loss of public esteem; (5) compensation

for petitioner’s reduced prospects for future employment; (6)

reasonable attorney’s fees and litigation costs; and (7) punitive

damages.   With respect to the count alleging intentional

infliction of emotional distress, petitioner requested

compensatory and punitive damages.       Petitioner remained employed

by the Meadowlands after he filed his complaint.

     During March 1999, petitioner suffered severe migraines and

lost his voice.   Sometime during or shortly before March 1999,

petitioner was placed on paid disability.      On March 23, 1999,
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petitioner filed an amended complaint (the amended complaint) in

the lawsuit and included two executives/employees of the

Meadowlands as co-defendants.   The amended complaint advances

three causes of action:   (1) Employment discrimination; (2)

reprisal against petitioner by the Meadowlands for filing the

lawsuit; and (3) violation of the New Jersey Conscientious

Employee Protection Act, N.J. Stat. Ann. 34:19-1 through 34:19-8

(West 2000), by the two named executives/employees of the

Meadowlands.

     With respect to the first two causes of action, petitioner

sought:   (1) Damages for lost earnings, including medical and

fringe benefits; (2) damages for mental and emotional distress;

(3) compensation for injury to petitioner’s professional stature

and loss of public esteem; (4) compensation for petitioner’s

reduced prospects of future employment; (5) reasonable attorney’s

fees and litigation costs; and (6) punitive damages.   Petitioner

also sought compensatory and punitive damages for mental and

emotional distress with respect to the third cause of action.

According to petitioner, “the whole basis of the lawsuit” was

that he “felt [he] was being discriminated because [he] was going

to Gamblers Anonymous.”

     Ultimately, the lawsuit was settled.   James H. Lockwood

(Mr. Lockwood), the Meadowlands’ associate counsel and longtime
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member of its legal department, participated in the settlement

negotiations.    In order to settle the lawsuit, the Meadowlands

originally proposed that petitioner continue his employment with

the Meadowlands as a per diem employee, the common status of

other race track announcers at the Meadowlands, rather than a

full-time salaried employee.    The Meadowlands further proposed a

5-year contract that would essentially pay petitioner his current

salary but provide no fringe benefits.    In addition, petitioner

would work about 40 fewer nights during the year and not be

required to handicap the horse races.    However, after petitioner

made negative comments about the Meadowlands to the local media,

the Meadowlands withdrew its proposal to allow petitioner to

continue in its employ as a per diem employee.    The Meadowlands

resumed settlement negotiations with petitioner and his counsel

with the sole desire to end petitioner’s employment with the

Meadowlands.    During the settlement negotiations, petitioner made

no request for compensation with respect to any physical injury

or physical sickness.

     On June 30, 1999, petitioner and the Meadowlands entered

into a Settlement Agreement and General Release (the settlement

agreement).    Under the terms of the settlement agreement,

petitioner generally released the Meadowlands from “all actions

or claims * * * arising out of [petitioner’s] employment with
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[the Meadowlands]” in exchange for:     (1) Payments totaling

$225,000; and (2) his resignation as an employee of the

Meadowlands.   The settlement agreement also states that the

Meadowlands and petitioner were entering into the settlement

agreement to avoid the costs of litigation.     In the settlement

agreement, Meadowlands expressly denies any liability with

respect to the claims alleged by petitioner.

     The settlement agreement makes no reference to a physical

injury or physical sickness resulting from the Meadowlands’

actions, nor does the settlement agreement specifically carve out

any portion of the settlement payment as a settlement on account

of personal physical injury or physical sickness.

     Petitioner officially terminated his employment with the

Meadowlands on September 9, 1999.    During 1999, petitioner

received settlement proceeds of $199,073 from the Meadowlands

(the settlement proceeds).

     As previously noted, petitioners filed a timely joint 1999

Federal income tax return.   The income reported on that return

includes the settlement proceeds.    On April 23, 2001, petitioners

submitted a Form 1040X, Amended U.S. Individual Income Tax

Return, for the 1999 taxable year.     On the 1999 amended return

petitioners excluded the settlement proceeds from their gross
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income.1   The 1999 amended return was treated as a claim for

refund and denied by respondent.

Discussion

     Section 61(a) provides generally and broadly that gross

income includes all income from whatever source derived.

Exclusions from gross income must be specifically provided for

and are narrowly construed.   Commissioner v. Schleier, 515 U.S.

323, 328 (1995).

     Section 104(a)(2) excludes from gross income “the amount of

any damages (other than punitive damages) received (whether by

suit or agreement and whether as lump sums or as periodic

payments) on account of personal physical injuries or physical

sickness”.   Section 104(a) further provides that “emotional

distress shall not be treated as a physical injury or physical

sickness” for purposes of section 104(a)(2). “[T]he term

emotional distress includes symptoms (e.g., insomnia, headaches,

stomach disorders) which may result from such emotional

distress.”   H. Conf. Rept. 104-737, at 301 n.56 (1996), 1996-3

C.B. 741, 1041.

     Amounts are excludable from gross income under section

104(a)(2) only if:   (1) The underlying cause of action giving



     1
        On the 1999 amended return, petitioners exclude
settlement proceeds of $199,702 from gross income and not
$199,073. The parties do not explain this difference. However,
this discrepancy is of no significance to our conclusion.
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rise to the recovery is based on tort or tort-type rights, and

(2) the damages are received on account of personal injuries or

sickness.   Commissioner v. Schleier, supra at 336-337.2

     We start our analysis with a focus on whether the settlement

proceeds were received on account of personal physical injuries

or physical sickness.   According to petitioner, they were;

according to respondent, they were not.    For the following

reasons, we agree with respondent.

     The term “damages received”, as used in section 104(a)(2),

means an amount received “through prosecution of a legal suit or

action based upon tort or tort type rights, or through a

settlement agreement entered into in lieu of such prosecution.”

Sec. 1.104-1(c), Income Tax Regs.    When damages are received

pursuant to a settlement agreement, as here, the nature of the

claim that was the actual basis for settlement, as opposed to the

validity of that claim, controls whether the amounts are

excludable under section 104(a)(2).    United States v. Burke, 504

U.S. 229, 237 (1992); Bagley v. Commissioner, 105 T.C. 396, 406


     2
        Subsequent to Commissioner v. Schleier, 515 U.S. 323
(1995), Congress amended sec. 104(a) to provide that amounts are
excludable only if received “on account of personal physical
injuries or physical sickness”. Sec. 104(a)(2) (emphasis added);
Small Business Job Protection Act of 1996, Pub. L. 104-188, sec.
1605, 110 Stat. 1838, effective for amounts received after Aug.
20, 1996. Although the amendment narrows the scope of sec.
104(a)(2), it does not otherwise affect the analysis set forth in
Commissioner v. Schleier, supra. See Goode v. Commissioner, T.C.
Memo. 2006-48; Prasil v. Commissioner, T.C. Memo. 2003-100.
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(1995), affd. 121 F.3d 393 (8th Cir. 1997).     Determining the

nature of the claim is a factual inquiry.3    Robinson v.

Commissioner, 102 T.C. 116, 126 (1994), affd. in part, revd. in

part, and remanded on another issue 70 F.3d 34 (5th Cir. 1995).

“[W]here an amount is paid in settlement of a case, the critical

question is, in lieu of what was the settlement amount paid”.

Bagley v. Commissioner, supra.     An important factor in making

such determinations is the “intent of the payor” in making the

payment.   Knuckles v. Commissioner, 349 F.2d 610, 613 (10th Cir.

1965), affg. T.C. Memo. 1964-33.    If the payor’s intent cannot be

clearly discerned from the settlement agreement, the intent of

the payor must be determined from all the facts and circumstances

of the case, including the complaint filed and details

surrounding the litigation.   Id.; Robinson v. Commissioner, supra

at 127.

     Under the terms of the settlement agreement, petitioner

generally released the Meadowlands from “all actions or claims

* * * arising out of * * *[petitioner’s] employment with * *

*[the Meadowlands]” in exchange for the settlement proceeds and

his resignation as an employee of the Meadowlands.    The

settlement agreement also states that the Meadowlands and



     3
        In   their brief, petitioners take the position that sec.
7491(a) is   applicable, and the burden of proof on this issue
rests with   respondent. To the extent that it does, we find that
respondent   has met that burden.
                              - 12 -

petitioner were entering into the settlement agreement to avoid

the costs of litigation and that the Meadowlands expressly denied

any liability with respect to the claims alleged by petitioner.

     The settlement agreement does not allocate any part of the

settlement payment to a personal physical injury or physical

sickness.   Indeed, the settlement agreement makes no reference to

a physical injury or physical sickness resulting from the

Meadowlands’ actions, nor does the settlement agreement

specifically carve out any portion of the settlement payment as a

settlement on account of personal physical injury or physical

sickness.   Although the settlement agreement provides that any

payment petitioner was to receive pursuant to the settlement “is

in the nature of compensation for any and all claims for alleged

personal injuries (pain and suffering) claimed by * * *

[petitioner]”,   Mr. Lockwood testified that the Meadowlands did

not intend the settlement agreement to compensate petitioner for

any physical injury or physical sickness.

     The amended complaint filed in the lawsuit also fails to

support petitioner’s position here.    The amended complaint states

that “Specifically, the case involves discrimination against a

party afflicted with that species of mental and psychological

handicap commonly referred to as compulsive gambling.”    The

complaint did not seek specific damages with respect to any

physical injury or physical sickness.   Furthermore, petitioner
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testified that “the whole basis of the lawsuit” was that he “felt

[he] was being discriminated because [he] was going to Gamblers

Anonymous.”

     Finally, we note that Mr. Lockwood testified that the

settlement payment was made to compensate petitioner for “lost

time” and so that “Mr. Bothe [would] cease to be employed by [the

Meadowlands] in any capacity”.   Mr. Lockwood further testified

that at no time during the settlement negotiations did petitioner

allege that he had suffered any physical injury or physical

sickness as a result of his employment by the Meadowlands, nor

was it the Meadowlands’ intention to compensate petitioner for

any physical injury or physical sickness.

     Mr. Lockwood’s testimony on these points is corroborated by

a statement in the settlement agreement that provides that, for

income tax purposes, the amount to be paid to petitioner is “in

the nature of compensation”.

     Based upon the foregoing, we conclude that petitioner did

not receive the settlement payment on account of any personal

physical injury or physical sickness as those terms are used in

section 104(a)(2).   Accordingly, we need not address whether the

underlying cause of action giving rise to the settlement was

based upon tort or tort-type rights.    See Commissioner v.

Schleier, 515 U.S. at 337.
                             - 14 -

     We find that the settlement payment is not excludable from

petitioners’ 1999 income under the provisions of section

104(a)(2), and petitioners’ claim for a refund is denied.

     Reviewed and adopted as the report of the Small Tax Case

Division.

     To reflect the foregoing, and to ensure that any agreements

between the parties are properly taken into account,



                                   Petitioners’ claim for refund

                              is denied, and decision will be

                              entered under Rule 155.
