                  T.C. Memo. 2003-173



                UNITED STATES TAX COURT



    STEPHEN G. AND KAREN P. SHALTZ, Petitioners v.
     COMMISSIONER OF INTERNAL REVENUE, Respondent



Docket No. 6523-02.              Filed June 11, 2003.



     Ps timely filed their joint 1999 Federal income
tax return wherein they failed to report a $30,000
payment P-W received from GM during 1999. That payment
arose from a complaint that P-W had filed against GM
and one of its employees for sexual harassment
primarily in violation of the Elliott-Larsen Civil
Rights Act, Mich. Comp. Law, secs. 37.2101-37.2804
(2001). In her complaint, P-W prayed solely for an
award of “damages for mental anguish, humiliation,
embarrassment, and loss of benefits and other economic
advantages of employment.” Following mediation, GM
settled W’s complaint by paying to P-W $30,000,
inclusive of costs, interest, and attorney fees.

     Held: But for $9,691 conceded by R to be
excludable in this case from gross income, Ps are not
entitled to exclude any of the settlement payment from
their gross income under sec. 104(a)(2), I.R.C. Ps
failed to establish that any of the net settlement
payment was received by P-W on account of a personal
                                 -2-

     physical injury or physical sickness, as required by
     sec. 104(a)(2), I.R.C. Nor have petitioners
     established that they received any portion of the net
     settlement amount for expenses that they paid for
     medical care attributable to emotional distress, so as
     to exclude that portion under the flush language of
     sec. 104(a), I.R.C.



     Robert J. Zinkel, Jr., for petitioners.

     John W. Stevens, for respondent.



                        MEMORANDUM OPINION


     LARO, Judge:   This case is before the Court for decision

without trial.   See Rule 122.   Respondent determined a deficiency

of $12,205 in petitioners’ 1999 Federal income tax and a related

accuracy-related penalty of $2,441 under section 6662(a).

Following concessions by respondent, we are left to decide

whether section 104(a)(2) allows petitioners to exclude from

their gross income a payment that Karen P. Shaltz (petitioner)

received from the settlement of a sexual harassment complaint.

We hold it does not.   Unless otherwise noted, section references

are to the applicable versions of the Internal Revenue Code.

Rule references are to the Tax Court Rules of Practice and

Procedure.
                                 -3-

                              Background

     All facts were stipulated.1    The stipulated facts and the

exhibits submitted therewith are incorporated herein by this

reference.   Petitioners are husband and wife.   They resided in

Munith, Michigan, when their petition was filed.

     Petitioners timely filed a joint 1999 Federal income tax

return.   They did not report on that return that petitioner had

received $30,000 from General Motors, Inc. (GM) during 1999

stemming from a complaint that she had filed in the Michigan

Circuit Court for the County of Wayne against GM and one of its

employees, James Pennington (Pennington).    The complaint alleged

that petitioner’s suit was one “of trespass” and asserted that GM

and Pennington were liable to petitioner for sexual harassment

primarily in violation of the Elliott-Larsen Civil Rights Act,

Mich. Comp. Laws, secs. 37.2101-37.2804 (2001).    The complaint

contained three counts, one against GM and Pennington, and the

other two against GM alone.    With respect to all three counts,

petitioner prayed solely for an award of “damages for mental

anguish, humiliation, embarrassment, and loss of benefits and

other economic advantages of employment.”

     Petitioner’s complaint against GM and Pennington went to

mediation before trial.   Following mediation, GM settled this


     1
       Petitioners attached to their brief an affidavit of their
counsel. We give no consideration to this affidavit. See Rule
143(b).
                                 -4-

complaint by paying to petitioner in 1999 $30,000, inclusive of

costs, interest, and attorney fees.2      Of that amount, $9,691 was

retained by petitioner’s counsel under a contingent fee

arrangement.   Respondent concedes that petitioners’ gross income

does not include this $9,691.    Petitioner also paid in connection

with the litigation $5,964.34 in litigation costs (mainly

deposition expenses).   Petitioner claims also to have paid

$662.73 in medical expenses related to the alleged injuries

underlying the complaint.

                             Discussion

     Respondent’s determinations in the notice of deficiency are

presumed correct, and petitioners must prove those determinations

wrong in order to prevail.    Rule 142(a); Welch v. Helvering,

290 U.S. 111, 115 (1933).    The submission of this case to the

Court under Rule 122 does not change or otherwise lessen

petitioners’ burden of proof.    Rule 122(b); Kitch v.

Commissioner, 104 T.C. 1, 5 (1995), affd. 103 F.3d 104 (10th Cir.

1996).   Whereas in certain cases section 7491(a) shifts the

burden of proof to the Commissioner, we conclude that this is not

one of those cases.   Petitioners have neither alleged that

section 7491 is applicable to this case nor established that they

have complied with the requirements of section 7491(a)(2)(A) and


     2
       But for this general description of the settlement, the
record does not provide any other details as to the terms or
circumstances of the settlement.
                                -5-

(B) to substantiate items, to maintain required records, and to

cooperate fully with reasonable requests of the Commissioner.

See sec. 7491(a)(2).

     Section 61(a) provides that gross income includes all income

from whatever source derived.   Section 61(a) is construed broadly

to reach any accession to wealth.     Exclusions from gross income,

on the other hand, are construed narrowly.     Commissioner v.

Schleier, 515 U.S. 323, 328 (1995); United States v. Burke, 504

U.S. 229, 233 (1992); Commissioner v. Glenshaw Glass Co., 348

U.S. 426, 431 (1955).

     The parties disagree over the applicability of section

104(a)(2) to the net settlement payment of $20,309 ($30,000 less

$9,691).   That section as applicable herein 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”.   In this context, the terms “physical

injury” and “physical sickness” do not include emotional

distress, except to the extent of damages not in excess of the

amount paid for medical care described in section 213(d)(1)(A)

and (B) attributable to emotional distress.    See the flush

language of section 104(a).

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

denotes an amount received “through prosecution of a legal suit
                                -6-

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.     In the absence of bona fide

language in a settlement agreement as to the reason for a

settlement payment, we discern that reason by determining the

intent of the payor in making the payment.     Robinson v.

Commissioner, 102 T.C. 116, 127 (1994), affd. in part and revd.

in part on another issue not relevant herein 70 F.3d 34 (5th Cir.

1995).   We do so on the basis of all the facts and circumstances

of the case, including an analysis of the complaint filed and the

details surrounding the litigation.     Id.

     Petitioners must meet a two-prong test in order for the net

settlement payment to be excluded under section 104(a)(2).    More

specifically, they must prove that:    (1) The underlying cause of

action giving rise to petitioner’s recovery of the payment is

based upon tort or tort type rights and (2) the payment was

received on account of personal physical injuries or physical

sickness.   Commissioner v. Schleier, supra at 328;3 see also sec.


     3
       As relevant herein, the Small Business Job Protection Act
of 1996 (SBJPA), Pub. L. 104-188, sec. 1605, 110 Stat. 1838,
amended sec. 104(a)(2) to narrow the exclusion for amounts
received after Aug. 20, 1996. Whereas the text of the
predecessor section allowed an exclusion for damages received “on
account of personal injuries or sickness”, the SBJPA mandated
that the damages could be excluded from gross income only if they
were received “on account of personal physical injuries or
physical sickness”. (Emphasis added.) The Supreme Court in
Commissioner v. Schleier, 515 U.S. 323 (1995), addressed the
                                                   (continued...)
                                -7-

104(a)(2); sec. 1.104-1(c), Income Tax Regs.   Unless petitioners

prove both of these prongs the net settlement payment is not

excludable from gross income under section 104(a)(2).    E.g.,

Prasil v. Commissioner, T.C. Memo. 2003-100.

     We begin our analysis with the second prong.   Our inquiry as

to this prong is twofold.   First, we need to decide whether

petitioner’s complaint for sexual harassment, mental anguish,

humiliation, embarrassment, and loss of benefits and other

economic advantages of employment constitutes an allegation of

personal physical injuries or physical sickness.    See Horton v.

Commissioner, 100 T.C. 93, 96-98 (1993), affd. 33 F.3d 625 (6th

Cir. 1994).   Second, if we find that it does, we need to decide

what part, if any, of the net settlement amount was paid to

petitioner on account of those personal physical injuries or

physical sickness.

     Petitioner’s complaint prays for an award only as to the

following four damages:   Mental anguish, humiliation,

embarrassment, and loss of benefits and other economic advantages

of employment.   The last category of alleged damages (loss of



     3
      (...continued)
predecessor text and enunciated the referenced two-prong test
without mention of the word “physical”. In that the amendment
made to that text by the SBJPA applies to the instant case, it
logically follows that petitioner’s personal injuries or sickness
must be physical in nature to fall within the exclusion of
section 104(a)(2). See Prasil v. Commissioner, T.C. Memo.
2003-100.
                                -8-

benefits and other economic advantages of employment) is not on

account of personal injuries or sickness.   Commissioner v.

Schleier, supra at 331 (economic injuries are not personal

injuries for purposes of section 104(a)(2)); United States v.

Burke, supra at 239 (same); see also Robinson v. Commissioner,

supra at 126.   Although each of the first three categories of

alleged damages (mental anguish, humiliation, embarrassment)

could be or have been construed to be personal injuries or

sickness, e.g., Commissioner v. Schleier, supra at 329; United

States v. Burke, supra at 235 n.6; see also Greer v. United

States, 207 F.3d 322, 328 (6th Cir. 2000), the question under the

applicable text of section 104(a)(2) is not merely whether those

damages reflected personal injuries or sickness but whether a

personal injury or sickness is physical in nature.4   Under the

facts herein, petitioners’ alleged mental anguish, humiliation,

and embarrassment are not personal physical injuries or physical

sickness within the meaning of section 104(a)(2) but are most

akin to emotional distress.   Sec. 104(a)(2) and the flush

language of sec. 104(a); see H. Conf. Rept. 104-737, at 301 n.56

(1996), 1996-3 C.B. 741, 1041 n.56 (emotional distress, including

symptoms such as insomnia, headaches, and stomach disorders, is



     4
       Petitioners miss this point in that they erroneously apply
in their brief the pre-amendment text of sec. 104(a)(2) and the
Supreme Court’s discussion of that predecessor statute in
Commissioner v. Schleier, supra at 328-329.
                               -9-

not considered a physical injury or physical sickness, except

that an exclusion may be allowed to the amount paid for medical

care attributable to the emotional distress); see also United

States v. Burke, 504 U.S. at 237 (stating that former section

104(a)(2)’s reference to personal injuries “encompasses * * *

nonphysical injuries to the individual, such as those affecting

emotions, reputation, or character”); Greer v. United States,

supra at 328; Garrett v. Commissioner, T.C. Memo. 1994-70.     See

generally Black’s Law Dictionary 542 (7th ed. 1999) (“emotional

distress” denotes “A highly unpleasant mental reaction (such as

anguish, grief, fright, humiliation, or fury) that results from

another person’s conduct; emotional pain and suffering.”).    We

conclude that none of petitioner’s net settlement payment is

attributable to personal physical injuries or physical sickness

and hold that none of that payment may be excluded from

petitioners’ gross income under section 104(a)(2).5   In so doing,

we note that the record does not establish the intent of GM in

making any or all of the settlement payment to petitioner.6


     5
       Petitioners make no claim that any part of the net
settlement amount was received by petitioner as damages for
expenses paid for medical care attributable to emotional
distress. Nor are we able to find that such was the case.
Accordingly, we also conclude that the flush language of sec.
104(a) is inapplicable.
     6
       Petitioners introduced into evidence a letter from the
Social Security Administration showing that petitioner was
eligible for disability payments during 1998. The record is
                                                   (continued...)
                                 -10-

Thus, insofar as petitioners’ sexual harassment complaint was for

personal physical injury or physical sickness, the record before

us would not support a finding that any amount of the $30,000

settlement was received on account of such injury or sickness.

As a result, the entire payment, with the exception of the amount

conceded by respondent, is taxable.     Bland v. Commissioner, T.C.

Memo. 2000-98 (citing Pipitone v. United States, 180 F.3d 859,

865 (7th Cir. 1999)); see also Taggi v. United States, 35 F.3d

93, 96 (2d Cir. 1994); Sherman v. Commissioner, T.C. Memo.

1999-202; Brennan v. Commissioner, T.C. Memo. 1997-317.

     Petitioners argue alternatively that the net settlement

payment is not taxable to them to the extent of the

aforementioned court costs and claimed medical expenses by virtue

of Estate of Clarks v. United States, 202 F.3d 854 (6th Cir.

2000).   We disagree.   We note at the outset that petitioners have

not established that they paid the claimed medical expenses for

emotional distress.     In Estate of Clarks, the Court of Appeals


     6
      (...continued)
silent as to any reason or reasons for petitioner’s disability.
Petitioners also provided a statement of petitioner’s physician
opining that petitioner as of Feb. 5, 1998, suffered from
depression, anxiety, stress, and recurrent past stressors, and
had so suffered from these conditions from March 1995. While the
statement also opined that depression and trauma at work were the
reasons for petitioner’s conditions, the statement does not
mention anything about sexual harassment of petitioner. On the
record before us, we are unable to link petitioner’s disability
and her conditions as reflected in the physician’s statement with
the sexual harassment complaint or, more importantly, to GM’s
settlement of that complaint.
                               -11-

for the Sixth Circuit held that a portion of a judgment awarded

to a taxpayer and paid to the taxpayer’s lawyer under a

contingent fee arrangement was not includable in the taxpayer’s

gross income.   The Court reasoned that the taxpayer’s contingent

fee agreement operated under applicable State (Michigan) law as a

lien on the portion of the judgment to be recovered and

transferred the ownership of that portion to the lawyer.     We do

not read the Court of Appeals’ opinion in Estate of Clarks to

support petitioners’ position as to the court costs and claimed

medical expenses.   We hold against petitioners on this issue.

     We have considered all arguments and have found those

arguments not discussed herein to be irrelevant and/or without

merit.   To reflect the foregoing,



                                           Decision will be entered

                                      under Rule 155.
