                         T.C. Memo. 2002-134



                       UNITED STATES TAX COURT



         SAM ERVIN AND ELLA M. ERVIN, ET AL.,1 Petitioners v.
             COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 22079-97, 22080-97,       Filed May 30, 2002.
                22081-97.



     Thomas P. Ollinger, Jr., for petitioners.

     Charles Pillitteri and Alan Friday, for respondent.



               MEMORANDUM FINDINGS OF FACT AND OPINION


     COLVIN, Judge:    Respondent determined that petitioners are

liable for deficiencies in Federal income tax for 1994 as

follows:


     1
        The following cases were consolidated for trial,
briefing, and opinion: Alfred Hudson, docket No. 22080-97; and
Hawthorne Echols and Vivian H. Echols, docket No. 22081-97.
                                - 2 -

             Petitioners                     Deficiency

         Sam and Ella M. Ervin                $97,982
         Alfred Hudson                         97,440
         Hawthorne and Vivian H. Echols        95,597

     In February 1994, United Insurance Company of America

(United) made payments to petitioners Ella M. Ervin (Ervin),

Alfred Hudson (Hudson), and Vivian H. Echols (Echols) to settle a

lawsuit relating to the purchase of health insurance from United

by Ervin, Hudson, and Echols.    Ervin, Hudson, and Echols are

siblings.    After concessions,2 the sole issue for decision is

whether petitioners may exclude those payments from gross income

under section 104(a)(2) as damages for personal injuries or

sickness.    We hold that they may not.

     Section references are to the Internal Revenue Code as

amended and in effect for the year in issue, and Rule references

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

to petitioners are to Ervin, Hudson, and Echols.




     2
        Respondent conceded that petitioners may deduct their
attorney’s fees and related legal expenses from their gross
settlement proceeds to derive the taxable amounts of the
settlement proceeds.
                                 - 3 -

                           FINDINGS OF FACT

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

A.   Petitioners

     1.      Ella M. Ervin and Sam Ervin

     Ervin and her husband, Sam Ervin, resided in Mobile,

Alabama, when they filed their petition.

     Lee Padgett (Padgett) was United’s agent who sold a health

insurance policy to Ervin for her daughter.     Ervin told Padgett

that Ervin’s daughter had lupus.     Padgett told Ervin that her

daughter’s condition would not preclude coverage.     United later

denied medical claims that Ervin filed for her daughter on the

grounds that her daughter had lupus before Ervin bought the

insurance.    Ervin and her husband filed a joint Federal income

tax return for 1994.

     2.    Alfred Hudson

     Hudson, a truck driver, resided in Eight Mile, Alabama, when

he filed his petition.     He bought hospitalization insurance from

United through Padgett.     He had surgery and incurred medical

bills totaling about $6,000.     United did not pay any of those

bills.    Hudson subsequently filed for bankruptcy protection.

Hudson did not file a 1994 Federal income tax return.

     3.      Hawthorne Echols and Vivian H. Echols

     Echols and Hawthorne Echols were married and resided in

Mobile, Alabama, when they filed their petition.     She bought life

insurance and medical insurance from United through Padgett
                                - 4 -

because Padgett told her that it would cover the medical costs

that she would incur in having a child.     However, United did not

pay those costs.    Echols and her husband filed a joint Federal

income tax return for 1994.

B.   The Lawsuits

     In August 1993, Ervin, Hudson, and Echols (the plaintiffs)

each filed a lawsuit in the Circuit Court of Mobile County,

Alabama, against United and Padgett.     Each complaint related to

medical, hospitalization, or life insurance policies purchased by

the plaintiffs from United through Padgett.

     The plaintiffs sought an unspecified amount for punitive and

compensatory damages.    They alleged:   (1) United overcharged them

for the insurance coverage; (2) Padgett forged their names to

additional insurance applications; (3) United did not pay the

plaintiffs’ insurance claims; and (4) Padgett and United

wrongfully conspired against them.      The plaintiffs did not claim

that United or its agents caused them to have any personal

injuries or sickness.

C.   The Settlements

     Petitioners were represented by counsel during the

settlement negotiations.    United was represented by Kirk Cordell

Shaw (Shaw).   On February 10, 1994, petitioners each settled

their cases with United for $333,333.33.     Clisby Jarrard

(Jarrard), a United vice president, approved the settlements.

The settlement agreements are substantially similar.     They state
                              - 5 -

in pertinent part:

          I fully understand that when I sign this Receipt
     and Release I will have surrendered and released all
     rights and claims which I now have, both known and
     unknown, against * * * United * * *; including, but not
     limited to, claims for past, present, and future
     damages, indemnity, costs, attorneys fees, interest of
     all types, and damages of every other kind by whatever
     named called.

           *      *      *      *       *      *      *

          For the same consideration recited herein above, I
     and my attorneys * * * agree that every aspect of this
     settlement shall remain confidential in every respect
     * * *.

          For the same consideration recited herein above, I
     and my attorneys * * * agree that they will surrender
     every document of every type that has been produced to
     them or their clients by United * * * in any case
     * * *.

          For the same consideration recited herein,
     attorneys * * * hereby warrant that they have not
     heretofore and will not in the future transmit or
     convey in any manner the documents described in the
     preceding paragraphs to any third parties of any type.
     * * * Said attorneys further warrant that they have not
     and will not in the future refer current or former
     policyholders of United * * * to any third parties for
     possible prosecution of any purported claims.

     The last paragraph of the settlement agreements states:

          I hereby acknowledge that all settlement amounts
     received are for damages that are compensatory in
     nature and that no payment was or will ever be paid to
     me for alleged punitive damages arising out of any
     claims which I asserted or could have asserted in this
     matter.

     In February 1994, petitioners gave their attorneys all of

their documents related to their claims against United.   All of

those documents were then shredded.   Petitioners and their
                                - 6 -

attorneys signed the settlement agreements.      Later in February

1994, Ervin and Hudson each received net settlement proceeds of

$166,573.10, and Echols received net settlement proceeds of

$166,556.60.    Ervin and Echols did not report the settlement

proceeds on their 1994 Federal income tax returns, and Hudson did

not file a 1994 return.

     Respondent determined that Ervin and Hudson had unreported

income of $333,333, and Echols had unreported income of $332,991

in 1994.

                               OPINION

A.   Contentions of the Parties and Background

     Petitioners contend that the amounts that they received from

United in 1994 are excludable from gross income as compensation

for personal injuries or sickness under section 104(a)(2).3

Petitioners contend that they suffered personal injuries due to

United’s conduct and that the settlement amounts were intended to

compensate them for those injuries.      Respondent contends that


     3
         Sec. 104(a)(2) provides:

          SEC. 104(a). In General.--Except in the case of
     amounts attributable to (and not in excess of)
     deductions allowed under section 213 (relating to
     medical, etc., expenses) for any prior taxable year,
     gross income does not include--

            *       *      *        *      *      *      *

                (2) the amount of any damages received
           (whether by suit or agreement and whether as
           lump sums or as periodic payments) on account
           of personal injuries or sickness; * * *
                                 - 7 -

petitioners may not exclude the United payments from income under

section 104(a)(2) because petitioners have not shown that the

United payments were on account of personal injuries or sickness.

Petitioners bear the burden of proving that they may exclude the

United payments from income under section 104(a)(2).4    Rule

142(a)(1).    We agree with respondent for reasons discussed next.

     Gross income does not include the amount of any damages

received (whether by suit or agreement and whether as lump sums

or as periodic payments) on account of personal injuries or

sickness.    Sec. 104(a)(2).   Damages on account of personal

injuries include payments intended to compensate for pain and

suffering, lost wages recovered by an individual who cannot work

due to personal injuries, medical expenses, and other

consequential damages.    Commissioner v. Schleier, 515 U.S. 323,

329 (1995).

     To decide whether payments were for personal injuries or

sickness, courts have considered, inter alia, the following:

(1) The underlying complaint and the nature of the claims; (2)

the settlement negotiations and settlement agreement; and (3) the

intent of the payor.    See United States v. Burke, 504 U.S. 229,

239 (1992); Thompson v. Commissioner, 866 F.2d 709, 711 (4th Cir.

1989), affg. 89 T.C. 632 (1987); Knuckles v. Commissioner, 349


     4
        Sec. 7491 applies to court proceedings arising in
connection with examinations commencing after July 22, 1998.
Respondent issued the notices of deficiency in 1997. Thus,
petitioners bear the burden of proof. Rule 142(a)(1).
                                 - 8 -

F.2d 610, 612-613 (10th Cir. 1965), affg. T.C. Memo. 1964-33;

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

curiam T.C. Memo. 1960-21; Bagley v. Commissioner, 105 T.C. 396,

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

B.   Underlying Complaints and Nature of the Claim

     Petitioners contend that the underlying complaints and

nature of their claims were for relief from personal injuries.

We disagree.

     In the complaints, petitioners sought an unspecified amount

of punitive and compensatory damages, but they requested no

relief for personal injuries or sickness.    Petitioners’ four

causes of action related to petitioners’ purchase of the United

insurance policies and United’s denial of petitioners’ claims for

benefits under those policies.    Petitioners’ claims are in the

nature of breach of contract, see Gray v. Reynolds, 553 So. 2d

79, 82 (Ala. 1989) (breach of contract occurs when a party to a

contract fails to do a particular thing that he or she promised

to do); Seybold v. Magnolia Land Co., 376 So. 2d 1083, 1085 (Ala.

1979) (same); 17A Am. Jur. 2d, Contracts, sec. 441 (1991), not in

terms which indicate that they sought relief for personal

injuries or sickness.   Neither petitioners’ complaints nor the

nature of their claims support their contention that United’s

payments to them were on account of personal injuries or

sickness.
                                 - 9 -

C.   Settlement Negotiations and Settlement Agreements

     Petitioners contend that the settlement included payments

for emotional distress, and that Shaw considered emotional

distress in drafting the agreements for United.    They point out

that the settlement agreements included a release of “damages of

every other kind by whatever name called”.    Petitioners contend

that this language shows that United paid them on account of

emotional distress.   We disagree.   Jarrard and Shaw represented

United at the settlement conference.     Jarrard testified that the

parties did not discuss emotional distress during the settlement

discussions.   Shaw testified that he did not remember considering

emotional distress in settling petitioners’ cases.    There is no

evidence that the parties discussed personal injuries or sickness

in their settlement negotiations.

     Petitioners contend that the settlement agreements establish

that United paid them on account of personal injuries or

sickness.   We disagree; the settlement agreements do not refer to

personal injuries or sickness.

     Petitioners contend that the last paragraph of the

settlement agreements shows that United paid them on account of

personal injuries or sickness because it states that the payments

were compensatory in nature.   We disagree.   Generally,

“compensatory damages” are the same as “actual damages” and

encompass all types of damages other than punitive damages.

Fountain-Lowrey Entrs, Inc. v. Williams, 424 So. 2d 581, 585

(Ala. 1982); Skipper v. S. Cent. Bell Tel. Co., 334 So. 2d 863,
                               - 10 -

866 (Ala. 1976); 22 Am. Jur. 2d, Damages, sec. 23 (1988); 25

C.J.S., Damages, sec. 2 (1966).   A plaintiff may be awarded

compensatory damages for claims of breach of contract,

conversion, conspiracy, or fraudulent inducement.   See, e.g.,

Estate of Henderson v. Henderson, 804 So. 2d 191, 192 (Ala.

2001); Old Republic Ins. Co. v. Lanier, 790 So. 2d 922, 927 (Ala.

2000); Williams v. Williams, 786 So. 2d 477, 479 (Ala. 2000).

Those claims do not necessarily include claims on account of

personal injuries or sickness, and did not do so here.   Thus, use

of the term “compensatory damages” does not prove that the United

payments to petitioners were on account of personal injuries or

sickness.

     Thus, neither the settlement negotiations nor the settlement

agreement proves that United intended to compensate Ervin,

Hudson, or Echols for personal injuries or sickness.

D.   United’s Intent

     Shaw and Jarrard represented United at the settlement

conference and testified about the settlement agreements.

Petitioners contend that their testimony about United’s intent is

inadmissible parol evidence because the reference in the last

paragraph of the settlement agreement to compensatory damages is

unambiguous and dispositive.   We disagree because, as discussed

in paragraph C, above, the term “compensatory damages” in the

last paragraph is not synonymous with “on account of personal

injuries or sickness”.   However, even if we did not consider the

testimony of Jarrard and Shaw, our analysis would be unchanged
                                - 11 -

because there is no evidence that United intended to compensate

petitioners for personal injuries or sickness.

E.   Petitioners’ Injuries

     Petitioners testified that they suffered sleep loss, damaged

credit, and anxiety from United’s failure to pay their insurance

claims.    However, this does not establish that United intended to

pay damages on account of petitioners’ personal injuries or

sickness.

     Petitioners contend that Hudson’s loss of credit is a

personal injury for purposes of section 104(a)(2) similar to the

injury to the taxpayer’s business reputation in Threlkeld v.

Commissioner, 87 T.C. 1294 (1986), affd. 848 F.2d 81 (6th Cir.

1988).    We disagree.   Regardless of the treatment of injury to

business reputation by courts in other cases, there is no

evidence that Hudson made that a part of his claim against United

or that United intended any part of the settlement to compensate

him for damages to his business reputation.

F.   Conclusion

     We conclude that the United payments to petitioners in 1994

were not on account of personal injuries or sickness.     Thus,
                             - 12 -

pursuant to respondent’s concession (see n.2 above), Ervin,

Hudson, and Echols must include in income in 1994 the United

payments less attorney’s fees and related legal expenses.

     To reflect the foregoing,

                                             Decisions will be

                                        entered under Rule 155.
