                  T.C. Memo. 2009-156



                UNITED STATES TAX COURT



    JAMES W. AND MATTIE M. JOHNSON, Petitioners v.
     COMMISSIONER OF INTERNAL REVENUE, Respondent



Docket No. 15322-07.              Filed June 29, 2009.



     In 2000 P-H sued a mortgage company over an
attempted foreclosure of his residence. In 2004 P-H
received a $25,000 lump-sum award in settlement of the
lawsuit from which his attorney retained $3,500 in
fees. Ps filed a joint Federal income tax return for
2004 which excluded P-H’s settlement award from gross
income pursuant to I.R.C. sec. 104(a)(2). R determined
a deficiency in Ps’ Federal income tax for 2004 on the
basis that the settlement award was not excludable from
gross income under I.R.C. sec. 104(a)(2). Ps
petitioned this Court for a redetermination of the
deficiency. Additionally, Ps’ amended petition seeks
innocent spouse relief for P-W under I.R.C. sec. 6015.

     Held: P-H’s settlement award is not excludable
from gross income under I.R.C. sec. 104(a)(2) for tax
year 2004 because Ps failed to prove that the
settlement award, or any part thereof, was received on
account of personal physical injuries or physical
sickness.
                                 - 2 -


          Held, further, Ps may deduct attorney’s fees of $3,500
     incurred in 2004 as a miscellaneous itemized deduction under
     I.R.C. sec. 67, subject to the 2-percent floor.

          Held, further, P-W is not entitled to innocent spouse
     relief pursuant to I.R.C. sec. 6015 for tax year 2004.



     James W. Johnson, pro se.

     Erin R. Hines, for respondent.



             MEMORANDUM FINDINGS OF FACT AND OPINION


     GUSTAFSON, Judge:   This case is before the Court on the

petition of James W. and Mattie T. Johnson for a redetermination

of their Federal income tax deficiency for 2004, which the

Internal Revenue Service (IRS) determined to be $3,952.    The

issues to be decided here1 are:    (a) whether the Johnsons are

entitled to exclude from income $25,000 in settlement proceeds

paid to Mr. Johnson in 2004; if not, (b) whether and in what

amount the Johnsons are entitled to deduct attorney’s fees

incurred in connection with that settlement; and (c) whether




     1
      The IRS also determined in the statutory notice of
deficiency that Mrs. Johnson had unreported interest income of
$37. The Johnsons did not dispute this adjustment at trial, and
it is therefore deemed conceded.
                                 - 3 -

Mrs. Johnson is entitled to relief from joint and several

liability under section 6015.2

                          FINDINGS OF FACT

     This case was tried in Washington, D.C., on November 5,

2008.    Mr. Johnson was the sole witness; and Exhibits 1-J (the

Johnsons’ tax return), 2-J (the notice of deficiency), and 3-P (a

draft of the settlement agreement) were entered into evidence.

On the basis of that evidence, we find as follows:

Settlement of Mortgage Dispute

     James W. and Mattie M. Johnson are husband and wife, and

they were married and lived together at all times relevant to

this case.    In 2000 Mr. Johnson had a dispute with a mortgage

company over an attempted foreclosure on the Johnsons’ residence,

which was owned solely by Mr. Johnson.    Mr. Johnson hired an

attorney to file a lawsuit on his behalf, and Mrs. Johnson was

not a party to that suit.    Mr. Johnson did not offer into

evidence the pleadings in that lawsuit, but his understanding of

the nature of the lawsuit is that it was for breach of contract.

The record includes no other information about the nature of the

claims, the damages alleged, or the relief sought in the

complaint.




     2
      Except as otherwise noted, all section references are to
the Internal Revenue Code (26 U.S.C.), and all Rule references
are to the Tax Court Rules of Practice and Procedure.
                                - 4 -

     The dispute ended in 2004 with a settlement agreement, which

included a provision that stated:

     Plaintiff has indicated that it is their [sic] intent
     that the proceeds of the settlement contemplated hereby
     are going to be treated as damages for their pain and
     suffering in connection with the personal injuries they
     have alleged to have suffered as alleged in the Subject
     Litigation. * * * [The defendant mortgage company]
     makes no representation or warranty as to effect of
     this Agreement upon Plaintiff’s liabilities pursuant to
     federal, state or local tax laws or regulations.

The record includes no other information about the defendant

mortgage company’s evaluation of any claim by Mr. Johnson for

“pain and suffering in connection with the personal injuries they

have alleged to have suffered” or the importance of that claim in

the settlement context.    The record includes no evidence that

Mrs. Johnson’s pain and suffering (i.e., from her sickness

discussed below) was pleaded in the lawsuit or pressed in the

settlement negotiations.

Attorney’s Fees

     Under the settlement agreement, the mortgage company paid

Mr. Johnson $25,000 in 2004 by a check payable to him (and not to

Mrs. Johnson).    Mr. Johnson signed over the $25,000 settlement

check to the attorney representing him in the case.    The attorney

retained a portion and wrote Mr. Johnson a check for the balance.
                                - 5 -

We find that the fees retained by the attorney in 2004 amounted

to $3,500.3

Mrs. Johnson’s Connection With the Settlement

     At the time of the settlement in July 2004, Mrs. Johnson

suffered from breast cancer, had recently undergone surgery, and

was very sick.   Mr. Johnson spent most of the settlement proceeds

on expenses that he felt were related to or arose from her

situation or that otherwise benefited her–-medical expenses,

household expenses, and a car that he used to take her to medical

appointments.    Because of Mrs. Johnson’s poor health, Mr. Johnson

avoided discussing financial matters with Mrs. Johnson in 2004

and 2005, including his lawsuit against the mortgage company and

the settlement proceeds therefrom.      Furthermore, Mrs. Johnson is

involved in the family’s financial affairs, has a high school

education, and noticed the purchase of the car.     Mrs. Johnson has

her own bank accounts, and she and Mr. Johnson split the

household bills.



     3
      Mr. Johnson originally testified that the fees were
“approximately $4,000”, but he later admitted, “I don’t remember
the exact amount” and said that the check ultimately delivered to
him was “about 21, 21.5 [thousand], something like that”.
Although he did not offer documentation to prove the amount of
the fees, it is clear from the settlement agreement that no
separate payment was made for attorney’s fees, and that any fees
would have to be recovered from the $25,000 payment.
Mr. Johnson’s testimony about the fact of the attorney’s
retention of fees was credible; but because he failed to document
a precise amount of fees, we find an amount at the lowest end of
the range to which he testified.
                                - 6 -

     The Johnsons filed their joint 2004 tax return in

April 2005.   Mrs. Johnson’s health was a continuing issue in

2005, but Mr. Johnson could not recall (and the record does not

otherwise show) what her condition was when the return was filed.

     On April 2, 2007, the IRS issued to the Johnsons a statutory

notice of deficiency, determining a deficiency in tax for 2004

attributable primarily to the omission of the $25,000 in

settlement proceeds from the gross income reported on their

return.   The Johnsons timely petitioned this Court for a

redetermination of that deficiency on July 5, 2007, at which time

they resided in Washington, D.C.   In an amended petition filed

December 10, 2007, the Johnsons also requested that Mrs. Johnson

be excused from joint and several liability as an innocent spouse

under section 6015.

                               OPINION

     The IRS’s determinations are presumed correct, and Mr. and

Mrs. Johnson, as the petitioners in this case, have the burden of

establishing that the determinations in the notice of deficiency

are erroneous.   See Rule 142(a); Welch v. Helvering, 290 U.S.

111, 115 (1933).   In general, they did not meet that burden.

I.   The Settlement Proceeds

     Section 61(a) provides the following broad definition of the

term “gross income”:   “Except as otherwise provided in this

subtitle, gross income means all income from whatever source
                                   - 7 -

derived”.    Section 61(a) is thus broad in its scope, and

exclusions from gross income must be narrowly construed.

Commissioner v. Schleier, 515 U.S. 323, 328 (1995).

     Section 104(a) provides that gross income does not include:

                 (2) the amount of any damages[4] (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;

     *        *       *        *           *    *       *

     * * * For purposes of paragraph (2), emotional distress
     shall not be treated as a physical injury or physical
     sickness.[5] * * *

Therefore, to be excludable from gross income under section

104(a)(2), a settlement award must be paid to a taxpayer on

account of physical injury or physical sickness, which does not

include emotional distress or symptoms thereof, arising from tort

or tort-like causes of action.      Sec. 1.104-1(c), Income Tax Regs.

     Where damages are received pursuant to a settlement

agreement like Mr. Johnson’s, the nature of the claim that was

the actual basis for settlement controls whether such damages are



     4
      The term “damages received (whether by suit or agreement)”
means an amount received (other than workmen’s compensation)
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.
     5
      “It is intended that the 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.
                                 - 8 -

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

U.S. 229, 237 (1992).    Whether the settlement payment is

excludable from gross income under section 104(a)(2) depends on

the nature and the character of the claims asserted in the

lawsuit.    See Bent v. Commissioner, 87 T.C. 236, 244 (1986),

affd. 835 F.2d 67 (3d Cir. 1987); Church v. Commissioner, 80 T.C.

1104, 1106-1107 (1983); Glynn v. Commissioner, 76 T.C. 116, 119

(1981), affd. without published opinion 676 F.2d 682 (1st Cir.

1982).    The determination of the underlying nature of the claim

is factual.     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); Seay v. Commissioner, 58 T.C. 32, 37

(1972).

     Where there is a settlement agreement, the determination of

the nature of the claim is usually made by reference to the

agreement.    See Knuckles v. Commissioner, 349 F.2d 610, 613 (10th

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

supra at 126.    If the settlement agreement lacks express language

stating the claim that the payment was to settle, the intent of

the payor (here, the mortgage company) is critical to that

determination.     Knuckles v. Commissioner, supra at 613; see also

Agar v. Commissioner, 290 F.2d 283, 284 (2d Cir. 1961), affg. per

curiam T.C. Memo. 1960-21.
                                 - 9 -

     The settlement agreement, on its face, does not list the

claims Mr. Johnson brought against the mortgage company, but the

settlement is intended to settle the claims that were “filed in

[that] action”.   Mr. Johnson did not offer into evidence the

pleadings in that suit against the mortgage company, and the

record includes no other information about the nature of the

claims, the damages alleged, or the relief sought in the

complaint.   Mr. Johnson testified that his understanding of the

nature of the suit is that it was for breach of contract.

     The first requirement for exclusion under section 104(a)(2)

is that the claim underlying the settlement agreement be based on

tort or tort-type rights.     Commissioner v. Schleier, supra.   A

tort is defined 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.’”     United States v. Burke, supra at 234

(quoting Keeton et al., Prosser and Keeton on the Law of Torts 2

(5th ed. 1984)) (emphasis added).    Breach of contract does not

sound in tort, so to the extent that the agreement with the

mortgage company was made to satisfy that contract claim, any

settlement proceeds would not be excludable under section

104(a)(2).   See Metzger v. Commissioner, 88 T.C. 834, 848-850,

858 (1987), affd. without published opinion 845 F.2d 1013 (3d

Cir. 1988); Reisman v. Commissioner, T.C. Memo. 2000-173, affd.

without published opinion 248 F.3d 1151 (6th Cir. 2001).
                                - 10 -

         Mr. Johnson did not allege or present any evidence at trial

to show that there were actual physical injuries that the

mortgage company intended to compensate in its settlement.      And

the only evidence he presented regarding the underlying action

was his assertion that it was for breach of contract.    As a

result, on the basis of the record before us, we cannot find that

Mr. Johnson received any portion of the $25,000 as compensation

for a physical injury.6    For that reason, we find that the

$25,000 is not excludable under section 104(a)(2) from

Mr. Johnson’s gross income for his tax year 2004.7

II. Attorney’s Fees

     When a litigant’s recovery constitutes taxable income, such

income includes the portion of the recovery paid to the

litigant’s attorney.     Commissioner v. Banks, 543 U.S. 426 (2005).

As there is no statute excluding any portion of Mr. Johnson’s



     6
      Although the settlement agreement includes a statement that
Mr. Johnson intended the “proceeds of the settlement contemplated
* * * to be treated as damages for [his] pain and suffering”, we
find no evidence to support that characterization. Moreover, it
is the payor’s intent, not the payee’s, that governs the
character of the settlement payment.
     7
      In his testimony Mr. Johnson stressed that the attorney
representing him in his dispute against the mortgage company had
advised him that the settlement proceeds would not be taxable.
If a penalty were at issue here, then such advice might be
relevant in a “reasonable cause” defense under section 6664(c).
However, the IRS did not determine a penalty against the
Johnsons, and this erroneous advice can have no effect on the
outcome in this case.
                              - 11 -

settlement from his gross income, we find that Mr. Johnson’s

entire settlement constitutes gross income.     Cf. sec. 62(a)(20)

and (21) (allowing an above-the-line deduction from gross income

for attorney’s fees and court costs associated with

discrimination suits and attorney’s fees related to awards to

whistleblowers).   Therefore, even though Mr. Johnson paid his

attorney $3,500 from the proceeds of his settlement, the entire

$25,000 settlement is recognized as gross income to Mr. Johnson

in 2004.   The Johnsons, however, may deduct the attorney’s fees

of $3,500 as miscellaneous expenses under section 67.      See

Commissioner v. Banks, supra at 432.      By definition,

miscellaneous itemized deductions are subject to a 2-percent

floor, meaning the Johnsons can deduct these expenses only to the

extent that they exceed 2 percent of their adjusted gross income

for 2004--i.e., in this instance, to the extent they exceed

approximately $1,400.   See sec. 67(a).    Accordingly, we will

order the parties to recalculate the deficiency amount under

Rule 155 taking into account the payment of $3,500 for attorney’s

fees.

III. Mrs. Johnson’s Claim for Innocent Spouse Relief Under
     Section 6015

     In general, spouses who elect to file a joint Federal income

tax return are jointly and severally liable for the entire amount

of tax reported on the return, as well as for the liability for

any deficiency subsequently determined, even if all of the income
                                - 12 -

giving rise to the tax liability is allocable to only one of

them.     Sec. 6013(d)(3); Butler v. Commissioner, 114 T.C. 276, 282

(2000).    However, section 6015 provides three exceptions from

this joint and several liability for so-called innocent spouses,

and two of those exceptions are potentially applicable here.

Sec. 6015(b), (c),8 (f).    Mrs. Johnson bears the burden of

proving that one of those exceptions applies.     See Rule 142(a);

Alt v. Commissioner, 119 T.C. 306, 311 (2002), affd. 101 Fed.

Appx. 34 (6th Cir. 2004).

     A.      Relief Under Section 6015(b)

     Section 6015(b) provides relief from joint and several

liability for tax (including interest, penalties, and other

amounts) if the requesting spouse satisfies the following five

requirements of section 6015(b)(1):

             (A) a joint return has been made for a taxable
     year;

          (B) on such return there is an understatement of
     tax attributable to erroneous items of 1 individual
     filing the joint return;

          (C) the other individual filing the joint return
     establishes that in signing the return he or she did
     not know, and had no reason to know, that there was
     such understatement;




     8
      Section 6015(c) is inapplicable in this case, because
Mr. and Mrs. Johnson were married and lived together at the time
Mrs. Johnson elected innocent spouse relief under section 6015 by
filing the amended petition on December 10, 2007. See
sec. 6015(c)(3)(A)(i).
                               - 13 -

          (D) taking into account all the facts and
     circumstances, it is inequitable to hold the other
     individual liable for the deficiency in tax for such
     taxable year attributable to such understatement; and

          (E) the other individual * * * [makes a valid
     election for relief] * * *.

Respondent concedes that Mrs. Johnson has satisfied the

requirements under subparagraphs (A) and (E) of section

6015(b)(1).    At issue are the requirements under subparagraphs

(B), (C), and (D).

     Mrs. Johnson satisfies the requirement under

section 6015(b)(1)(B) with respect to the $25,000 of settlement

proceeds paid to Mr. Johnson, because the understatement of tax

resulting from the non-reporting of the settlement proceeds is

properly attributable to Mr. Johnson.9   However, Mrs. Johnson has

failed to meet her burden of proof to show that the requirements

under section 6015(b)(1)(C) and (D) are met.

          1.     Mrs. Johnson’s Knowledge or Reason To Know of the
                 Understatement

     For section 6015(b) to apply, subparagraph (C) requires the

requesting spouse to establish that she did not know or have

reason to know of the understatement with respect to which she

seeks relief.   In deciding whether a spouse “has reason to know”



     9
      However, Mrs. Johnson does not satisfy the requirement
under section 6015(b)(1)(B) with respect to the $37 of unreported
interest income paid to her, because the understatement of tax
resulting from that income is properly attributable to her, not
Mr. Johnson.
                               - 14 -

of an understatement, we undertake a subjective inquiry, and we

recognize several factors that are relevant to our analysis,

including:   (i) the alleged innocent spouse’s level of education;

(ii) the spouse’s involvement in the family’s business and

financial affairs; (iii) the presence of expenditures that appear

lavish or unusual when compared to the family’s past income

levels, income standards, and spending patterns; and (iv) the

culpable spouses’s evasiveness and deceit concerning the couple’s

finances.    Butler v. Commissioner, supra at 284.

     Mrs. Johnson did not testify in support of her claim for

relief under section 6015, but relied instead on the testimony of

her husband.   While Mr. Johnson’s willingness to accept the blame

for the non-reporting of the settlement proceeds shows a

commendable willingness to take responsibility for this error, it

does not suffice to carry Mrs. Johnson’s burden to show her

entitlement to relief from joint and several liability.

     Mrs. Johnson has a high school education and was involved in

her family’s finances.   Although Mr. Johnson avoided discussing

the settlement proceeds with Mrs. Johnson in 2004 and 2005

because of her poor health, the record does not show that Mr.

Johnson deceived Mrs. Johnson or attempted to hide the settlement

proceeds from her.   Moreover, a portion of the settlement

proceeds was used to purchase a car at a time when the family

finances had been problematic, and Mrs. Johnson both used the car
                               - 15 -

and took notice of that conspicuous purchase.    To prove that she

nonetheless did not know or have reason to know of the unreported

settlement proceeds that paid for the car and other expenses, she

should have offered her own testimony (and should have subjected

herself to cross-examination on the point).    In the absence of

such testimony, we infer that it would have been unfavorable to

her.    See Wichita Terminal Elevator Co. v. Commissioner, 6 T.C.

1158, 1165 (1946), affd. 162 F.2d 513 (10th Cir. 1947).    Thus,

Mrs. Johnson failed to establish that she did not know or have

reason to know of the understatement resulting from the non-

reporting of the settlement proceeds.

            2.   Inequity of Holding Mrs. Johnson Jointly and
                 Severally Liable

       For section 6015(b) to apply, subparagraph (D) requires that

in light of all the facts and circumstances, it is inequitable to

hold the requesting spouse jointly and severally liable.      The

most oft-cited material factors to be considered are:

(i) whether there has been a significant benefit to the spouse

claiming relief, and (ii) whether the failure to report the

correct tax liability on the joint return results from

concealment, overreaching, or any other wrongdoing on the part of

the other spouse.    Alt v. Commissioner, supra at 314 (citing

Jonson v. Commissioner, 118 T.C. 106, 119 (2002), affd. 353 F.3d

1181 (10th Cir. 2003)).    The particulars of the Johnsons’

situation do not reflect inequities of this sort.    It is clear
                              - 16 -

that both Mr. and Mrs. Johnson benefited from the settlement

proceeds and from the tax savings that resulted from not

reporting those proceeds as income.    Mr. Johnson spent most of

the settlement proceeds on expenses that benefited Mrs. Johnson,

including her medical expenses, household expenses, and a car

that he used to take her to medical appointments.    It is also

clear that there was no deception or concealment on Mr. Johnson’s

part.

     We also may consider whether the requesting spouse was

deserted, divorced, or separated.   See Alt v. Commissioner, 119

T.C. at 315 (citing Walters v. Commissioner, T.C. Memo.

1998-111).   The Johnsons were married and remain married.   The

two have not separated, and Mrs. Johnson has not been left by her

husband to deal with the tax liability alone.    On the contrary,

Mr. Johnson has testified on behalf of his wife and represented

her in this Court.   Mrs. Johnson continues to benefit from her

husband’s assets and income, in addition to her own.    Therefore,

we hold that it would not be inequitable to hold Mrs. Johnson

liable for the deficiency in tax for 2004.

     Accordingly, we conclude that Mrs. Johnson is not entitled

to relief under section 6015(b).

     B.   Relief Under Section 6015(f)

     The IRS “may relieve” a spouse of joint and several

liability pursuant to section 6015(f) if, “taking into account
                               - 17 -

all the facts and circumstances, it is inequitable to hold the

individual liable for any unpaid tax or any deficiency (or any

portion of either)” and “relief is not available to such

individual under subsection (b) or (c)”.    Considering the facts

and circumstances of this case, we held under

section 6015(b)(1)(D) that it is not inequitable to hold

Mrs. Johnson jointly and severally liable for the deficiency.    We

have previously held that the language of section 6015(f)(1) does

not differ significantly from the language of section

6015(b)(1)(D).    Alt v. Commissioner, supra at 316 (citing Butler

v. Commissioner, supra at 291).    Further, the equitable factors

we considered under section 6015(b)(1)(D) are the same equitable

factors we consider under section 6015(f).     Alt v. Commissioner,

supra at 316.    Therefore, we likewise conclude that Mrs. Johnson

is not entitled to relief under section 6015(f).

     To reflect the foregoing,


                                           Decision will be entered

                                     under Rule 155.
