                  T.C. Summary Opinion 2004-114



                     UNITED STATES TAX COURT



                   NEDRA BOLDEN, Petitioner v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 194-03S.               Filed August 25, 2004.


     Nedra Bolden, pro se.

     Hieu C. Nguyen, for respondent.



     DEAN, Special Trial Judge:   This case was heard pursuant to

the provisions of section 7463 of the Internal Revenue Code in

effect at the time that the petition was filed.   Unless otherwise

indicated, subsequent section references are to the Internal

Revenue Code in effect for the year in issue, and all Rule

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

The decision to be entered is not reviewable by any other court,

and this opinion should not be cited as authority.
                                -2-

     Respondent determined a deficiency in petitioner's Federal

income tax of $14,441 for 2000 and an accuracy-related penalty of

$2,888 under section 6662(a).   The issue for decision is whether

a $50,000 payment received by petitioner in 2000 is excludable

from gross income under section 104(a)(2).

                            Background

     The stipulation of facts and the exhibits received into

evidence are incorporated herein by reference.    Petitioner

resided in Los Angeles, California, at the time the petition was

filed.

     Petitioner began working for Universal City Studios, Inc.

(Universal), on or about September 1998.   Petitioner filed racial

discrimination charges with the California Department of Fair

Employment and Housing against Universal and various individuals.

The charges alleged a cause of action for racial harassment,

racial discrimination, and retaliation "for her race" and her

complaints about discrimination and harassment.

     Thereafter, on or about December 14, 1999, petitioner filed

a racial discrimination complaint against Universal in the

Superior Court for the County of Los Angeles.

     In an effort to resolve all differences and avoid

litigation, petitioner entered into a "CONFIDENTIAL SETTLEMENT

AGREEMENT AND RELEASE" (settlement agreement) with Universal on

February 8, 2000.   The settlement agreement provided that
                                  -3-

Universal would pay petitioner $50,000 in exchange for her

request for a dismissal with prejudice of all pending claims and

her resignation.    The settlement agreement also provided in

pertinent part:

          2.   The Parties agree to the following * * *:

          *             *        *        *            *

              d. The Parties agree that the Settlement Payment
          represents non-wage damages for injuries arising out
          of Bolden's claims. The Parties further agree that
          the Settlement Payment constitutes non-wage income,
          and shall be subject of an IRS Form 1099 * * *.
          Bolden agrees to hold Universal, and any of its
          current or former officers, agents, and employees
          harmless from, and indemnify them against, any and
          all claims, assessments and/or penalties, and any
          reasonable attorneys' fees incurred in responding
          thereto, made, claimed, sought, or imposed by the
          Internal Revenue Service * * * in regard to any
          amounts due or claimed to be due to such taxing
          authority or agency as a result of Bolden's tax
          treatment of the Settlement Payment. * * *

          *         *        *        *       *     *       *

          16. * * * Bolden also acknowledges that Universal has
     advised her to consult with an attorney, and that she has
     in fact consulted with an attorney, concerning this
     Agreement * * *.

          *        *        *        *     *       *        *

     THE UNDERSIGNED HAVE READ AND UNDERSTAND THE TERMS AND
     CONDITIONS OF THE FOREGOING SETTLEMENT AGREEMENT AND
     RELEASE, AND Bolden SPECIFICALLY ACKNOWLEDGES THAT SHE HAS
     CONSULTED WITH AN ATTORNEY REGARDING THE EXECUTION OF THIS
     AGREEMENT. IN ADDITION, THE PARTIES WARRANT THAT THE
     SETTLEMENT AGREEMENT AND RELEASE CONTAINS THE ENTIRE
     AGREEMENT BETWEEN THE PARTIES HERETO AND NO PROMISE,
     INDUCEMENT OR AGREEMENT NOT EXPRESSLY CONTAINED HEREIN HAS
     BEEN MADE.
                                  -4-

The settlement agreement was signed by petitioner and her

attorney.

     Petitioner filed a tax return for taxable year 2000.     In

that return, petitioner excluded from her gross income the

$50,000 that she received from Universal under the settlement

agreement.   In the notice of deficiency, respondent determined

that petitioner is not entitled to exclude from her gross income

the settlement amount at issue.

                            Discussion

     The Commissioner's deficiency determinations in the notice

of deficiency are presumed correct and, generally, taxpayers bear

the burden of proving that the Commissioner's determinations are

incorrect.   Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115

(1933).   Under certain circumstances, however, section 7491(a)

may shift the burden to the Commissioner.    The issue in this case

is a question of law, and the Court decides the issue without

regard to the burden of proof.    Therefore, section 7491(a) is

inapplicable.

Taxability of Payment Petitioner Received

     As a general rule, gross income includes income from

whatever source derived.   Sec. 61(a).   This definition is to be

construed broadly and was designed by Congress to "exert * * *

'the full measure of its taxing power.'"    Commissioner v.

Glenshaw Glass Co., 348 U.S. 426, 429 (1955) (quoting Helvering
                                 -5-

v. Clifford, 309 U.S. 331, 334 (1940)).   Exceptions to the

general rule are to be construed narrowly.     Commissioner v.

Schleier, 515 U.S. 323, 328 (1995).    "[E]xemptions from taxation

are not to be implied; they must be unambiguously proved."

United States v. Wells Fargo Bank, 485 U.S. 351, 354 (1988).

     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."   (Emphasis added.)

     The regulations define "damages received" as "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.   Damages

received are excludable from gross income only when:    (1) The

underlying cause of action giving rise to recovery is based on

tort or tort type rights, and (2) the damages were received on

account of personal injuries or sickness.     Commissioner v.

Schleier, supra at 337.   The second prong of this test "has since

been extended to apply to the amended version of section 104,

with the corresponding change that the second prong now requires

proof that the personal injuries or sickness for which damages

were received were physical in nature."     Venable v. Commissioner,
                                  -6-

T.C. Memo. 2003-240; see also Shaltz v. Commissioner, T.C. Memo.

2003-173; Henderson v. Commissioner, T.C. Memo. 2003-168, affd.

___ Fed. Appx. ___ (9th Cir., July 16, 2004); Prasil v.

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

      When the amounts are received as part of a settlement

agreement, it is the nature of the claim that was the basis for

the settlement that controls whether such amounts are excludable

under section 104(a)(2).   United States v. Burke, 504 U.S. 229,

237 (1992).   This determination is factual and should be made in

light of the settlement agreement.      Robinson v. Commissioner, 102

T.C. 116, 126 (1994), affd. in part and revd. in part 70 F.3d 34

(5th Cir. 1995).   The critical question to be asked is:     "In lieu

of what was the settlement paid?"       Bagley v. Commissioner, 105

T.C. 396, 406 (1995), affd. 121 F.3d 393 (8th Cir. 1997).      All

relevant facts and circumstances surrounding the drafting of the

settlement agreement should be used to make this determination.

Id.

      "If the settlement agreement lacks express language stating

that the payment was (or was not) made on account of personal

injury, then the most important fact in determining how section

104(a)(2) is to be applied is 'the intent of the payor' as to the

purpose in making the payment."     Metzger v. Commissioner, 88 T.C.

834, 847-848 (1987) (quoting Knuckles v. Commissioner, 349 F.2d
                                 -7-

610, 613 (10th Cir. 1965)), affd. without published opinion 845

F.2d 1013 (3d Cir. 1988).

     The Court notes that the record is nearly devoid of

information regarding the negotiations that led to the settlement

agreement.   However, nothing in the record suggests that the

relationship between petitioner and Universal was anything other

than adversarial.    The settlement was reached while petitioner's

charges against Universal were still pending.   Furthermore, both

sides were represented by counsel.

     The settlement agreement states "that the Settlement Payment

represents non-wage [sic] damages for injuries arising out of

Bolden's claims * * * [and] that the Settlement Payment

constitute[s] non-wage [sic] income, and shall be subject of an

IRS Form 1099".   The settlement agreement says nothing about

physical injuries.   In this situation, the Court must look to

Universal's intent in making the payment.   By referring to the

payment as "nonwage income," Universal demonstrated that it

expected the payment to be included in petitioner's gross income.

     It is clear from other sections of the settlement agreement

that it was not Universal's intention to compensate petitioner

for physical injuries or physical sickness.   As consideration for

the settlement agreement, petitioner was required to request a

dismissal of her claims with prejudice and resign from her

position at Universal.   Only after petitioner had taken the
                                 -8-

prerequisite steps would the settlement payment be sent.    By

requiring petitioner to take these steps, Universal was in fact

buying their release from having to fully litigate petitioner's

discrimination claims.

     While the Court does not dismiss the illnesses that

petitioner experienced during her employment, the evidence

supports the conclusion that the settlement payment was intended

by Universal to be nonwage income and not to compensate

petitioner for any physical injuries or physical sickness.

     Since the Court has found that the settlement proceeds were

not based on personal physical injuries or physical sickness,

there is no need to determine whether "the underlying cause of

action giving rise to the recovery * * * [was] 'based upon tort

or tort type rights.'"     Commissioner v. Schleier, 515 U.S. at 337

(quoting section 1.104-1(c), Income Tax Regs.).    The Court holds

that the $50,000 damage award is not excludable from gross income

under section 104(a)(2).

Penalty Under Section 6662(a)

     The Commissioner has the "burden of production in any court

proceeding with respect to the liability of any individual for

any penalty" under section 6662(a).    Sec. 7491(c); Higbee v.

Commissioner, 116 T.C. 438, 446-447 (2001).    To meet this burden,

the Commissioner must come forward with sufficient evidence

indicating that it is appropriate to impose the penalty.     Higbee
                                  -9-

v. Commissioner, supra at 447.     Once respondent meets his burden

of production, petitioner must come forward with evidence

sufficient to persuade the Court that respondent's determination

is incorrect.    Id.   Petitioner also bears the burden of proof

with regard to issues of reasonable cause, substantial authority,

or similar provisions.     Id. at 446.

     Section 6662(a) imposes a penalty of 20 percent of the

portion of the underpayment which is attributable to, inter alia,

negligence or disregard of rules or regulations.      Sec.

6662(b)(1).    Negligence is the "'lack of due care or failure to

do what a reasonable and ordinarily prudent person would do under

the circumstances.'"     Neely v. Commissioner, 85 T.C. 934, 947

(1985) (quoting Marcello v. Commissioner, 380 F.2d 499, 506 (5th

Cir. 1967)).    The term "disregard" includes any careless,

reckless, or intentional disregard.      Sec. 6662(c).

     No penalty shall be imposed if it is shown that there was

reasonable cause for the underpayment and the taxpayer acted in

good faith with respect to the underpayment.      Sec. 6664(c).   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.      The most

important factor is the extent of the taxpayer's effort to assess

the taxpayer's proper tax liability.      "Circumstances that may

indicate reasonable cause and good faith include an honest
                               -10-

misunderstanding of fact or law that is reasonable in light of

all the facts and circumstances, including the experience,

knowledge and education of the taxpayer."    Sec. 1.6664-4(b)(1),

Income Tax Regs.; see Reynolds v. Commissioner, 296 F.3d 607, 618

(7th Cir. 2002), affg. T.C. Memo. 2000-20.

     Respondent has satisfied his burden of production under

section 7491(c) by establishing that petitioner received the

settlement payment and failed to include it in income.

Petitioner does not dispute receiving the payment.

     The settlement payment represented more than 140 percent of

petitioner's annual income.   A reasonable and ordinarily prudent

person would have sought the advice of a knowledgeable person to

ensure the proper tax treatment of such a large payment.

Additionally, the settlement agreement specifically stated that

Universal considered the payment to be nonwage income and that

they would issue a Form-1099 for the payment.   The settlement

agreement required petitioner to indemnify Universal against any

claims or penalties arising from her tax treatment of the

settlement payment.   During the drafting of the settlement

agreement petitioner was represented by counsel, and she could

have taken that opportunity to determine the proper tax treatment

of the payment.   The Court holds that petitioner is liable for

the accuracy-related penalty under section 6662(a).
                             -11-

    Reviewed and adopted as the report of the Small Tax Case

Division.


                                            Decision will be

                                       entered for respondent.
