                        T.C. Memo. 2003-320



                      UNITED STATES TAX COURT



        DAMIAN GERARD AND LEIGH H. GERARD, Petitioners v.
           COMMISSIONER OF INTERNAL REVENUE, Respondent

   PETER W. HOBLER AND KATHERINE A. HOBLER, Petitioners v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket Nos. 344-01, 346-01.        Filed November 20, 2003.



     Richard D. Lageson and Brenda L. Talent, for petitioners.

     Michael W. Bitner and Steven W. LaBounty, for respondent.



              MEMORANDUM FINDINGS OF FACT AND OPINION


     THORNTON, Judge:   In these consolidated cases, respondent

determined deficiencies in petitioners’ 1994 Federal income taxes

as follows:
                               - 2 -

     Petitioners                                Deficiency

     Peter and Katherine Hobler                 $188,518
     Damian and Leigh Gerard                     100,704


     In the course of a family shareholder dispute, Bill Maritz,

who was chairman and chief executive officer of Maritz Inc.,

retaliated against his in-laws Katherine Hobler (Katherine) and

Damian Gerard (Damian) by terminating their professional

relationships with the corporation.    Katherine and Damian

asserted claims with respect to these actions.     To settle these

claims Maritz Inc. paid $500,000 to Katherine and $250,000 to

Damian.   After concessions, the issue for decision is what

amounts, if any, of these settlement payments are excludable from

petitioners’ gross incomes pursuant to section 104(a)(2) as

compensation for personal injuries.1

                         FINDINGS OF FACT

     The parties have stipulated some facts, which we incorporate

herein, along with associated exhibits.     When they petitioned

this Court, petitioners Peter and Katherine Hobler resided in

Jackson, Wyoming; petitioners Damian and Leigh Gerard resided in

St. Louis, Missouri.




     1
       Unless otherwise indicated, all section references are to
the Internal Revenue Code for the year at issue; all Rule
references are to the Tax Court Rules of Practice and Procedure.
                                 - 3 -

A.   Corporate and Family Background

     Maritz Inc. provides sales motivation programs and travel

services.     Its corporate headquarters are in Fenton, Missouri.

     At all relevant times, Bill Maritz was chairman and chief

executive officer of Maritz Inc.     Before the stock redemptions

described below, Bill Maritz and his children (collectively, the

Maritz family) owned half the voting shares of Maritz Inc.      The

other half was owned by Bill Maritz’s sister, Jean Hobler (Jean),

along with her husband, Wells Hobler, and their children, Peter,

Christopher, and Leigh (collectively, the Hobler family).      In

1987, Damian married Leigh.     In 1990, Katherine married Peter.2

B.       Katherine’s History with Maritz Inc.

         In 1984, before marrying Peter, Katherine began working for

Maritz Inc. as an internal auditor.      Highly motivated and well

regarded within the company, she received consistently favorable

reviews and advanced rapidly.     By June 1993, she had risen to the

position of Vice President, Director, Corporate Accounting of

Maritz Travel Co., a subsidiary of Maritz Inc., and was receiving

an annual salary of $56,700.     At all relevant times while

employed at Maritz Inc., Katherine was an at-will employee; i.e.,

she had no employment contract.




     2
       At no time did Katherine or Damian own any voting shares
of Maritz Inc. in their individual capacities.
                                 - 4 -

C.   Damian’s Business History

     In 1992, Damian began employment with First Capitol Printing

Arts, Inc. (First Capitol), a print shop that produces short-run,

two-color prints.   By June 1993, he had acquired one-third of the

First Capitol stock and was sales manager.      By July 1994, he had

become president of First Capitol.       In September 1994, he became

sole owner of First Capitol.

     Before the soon-to-be-described events of June 1993, Damian

would visit Maritz Inc. each day and “walk the halls”, soliciting

jobs to bid on.   Typically, he would bid on one to three Maritz

Inc. jobs per week.   First Capitol had no written contract to

provide services to Maritz Inc.; Damian got work from Maritz Inc.

only if he had the low bid.    In the first half of 1993, Damian

successfully solicited about $10,000 of business from Maritz

Inc., representing less than 2 percent of First Capitol’s 1993

gross receipts.

D.   Shareholder Dispute

     In 1992, a dispute arose between Bill Maritz and his sister

Jean regarding the family business.      Negotiations commenced for

Maritz Inc. to redeem the Hobler family voting shares.      The

parties sharply disagreed on the redemption price.      On June 25,

1993, Kenneth Suelthaus (Suelthaus), the attorney representing

the Hobler family, met with Millard Backerman (Backerman), the

attorney representing Maritz Inc.    Suelthaus presented a
                              - 5 -

preliminary independent appraisal of the Hobler family’s Maritz

Inc. voting shares and stated that the Hobler family was going to

“play hardball” by “asserting their rights” as voting

shareholders and electing their own nominees to the Maritz Inc.

board of directors.

     Learning of these developments, Bill Maritz was vexed.    In a

June 28, 1993, letter to his brother-in-law Wells Hobler, he

stated:

     Based on the news of your family’s disruptive and
     greedy plans which were passed on to Millard
     [Backerman] by Ken [Suelthaus] * * *, I no longer think
     of you and Jean and your family as friends of Maritz
     Inc. or of me and my family or of Maritz management,
     Maritz people or of the Maritz Board of Directors.

              *       *   *     *     *     *     *

     Since Ken Suelthaus emphasized to Millard that all
     members of your family are fully in support of the
     actions you are planning, please inform Kathy
     [Katherine] Hobler that her employment at Maritz will
     be terminated, and please tell Damian Gerard that he
     will no longer be welcome to call on Maritz Inc.

     In a June 29, 1993, letter to the Maritz Inc. board of

directors and members of the Maritz family, Bill Maritz stated

that he was going to respond to the “new, tough approach of the

Hoblers * * * in an even stronger manner” by terminating

Katherine’s employment and First Capitol’s vendor relationship

with Maritz Inc.

     On June 30, 1993, at a special meeting of Maritz Inc. vice

presidents and corporate officers, Bill Maritz declared that the
                               - 6 -

Hobler family was the “enemy out to destroy” Maritz Inc. and that

consequently Katherine’s employment would be terminated and

Damian would no longer be in good standing to call on Maritz Inc.

Katherine’s supervisor then summoned her to his office and

informed her that Maritz Inc. was terminating her employment

because of the shareholder dispute.    About the same time, Damian

received a message from Maritz Inc. that the vendor/customer

relationship between Maritz Inc. and First Capitol was terminated

and that all work in progress should be returned.

E.   Assertion of Katherine’s and Damian’s Claims

     Katherine and Damian immediately retained Suelthaus to

represent them in asserting claims against Maritz Inc.   On or

about June 30, 1993, during a meeting focused primarily on the

redemption of the Hobler family shares, Suelthaus discussed with

Backerman the recent events concerning Katherine and Damian.

Suelthaus asserted claims for severance benefits on Katherine’s

behalf and for tortious interference with a business relationship

on Damian’s behalf.   He stated that these claims would need to be

resolved before any agreement regarding the redemption could

ultimately be reached.

F.   Proposed Corporate Resolutions

     In a July 1, 1993, letter to the Maritz Inc. board of

directors, Jean Hobler protested the actions taken by Bill Maritz
                               - 7 -

against her daughter-in-law Katherine and her son-in-law Damian.

She stated:

     I am shocked that Bill’s response to a business
     situation is to inflict pain on my children. Does a
     chief executive officer have authority, and is it
     proper corporate policy, to exact retribution against
     shareholders with whom he disagrees? The Board of
     Directors will have to deal with the issues raised by
     these actions.

     At a July 12, 1993, annual shareholders meeting, the Hobler

family elected three members of their choosing, including Ralph

Lobdell, to the 7-member Maritz Inc. board of directors.   That

same day, at a meeting of the Maritz Inc. board of directors,

Ralph Lobdell introduced three resolutions.   One resolution

called for reinstating Katherine in her former position with the

corporation and for compensating her for lost wages and benefits,

as well as “for any emotional and/or physical damages she may

have suffered” as a result of her termination, in amounts to be

determined by a committee of independent directors.   Another

resolution called for reinstating First Capitol as a supplier to

Maritz Inc. and for compensating First Capitol for “lost profits

on the cancelled orders * * * and any other damages (if any) it

may have suffered”.   The other resolution called for a committee

to review the termination of the vendor/customer relationship

between First Capitol and Maritz Inc., which it characterized as

First Capitol’s “largest customer”, as well as the termination of
                                - 8 -

Katherine’s employment with Maritz Inc.    The board rejected each

resolution by a four-to-three vote.

G.   Personal Effects on Katherine and Damian

     Katherine’s termination from Maritz Inc. resulted in

dramatic changes in her personality.    She went from being a

positive, energetic, decisive person to someone who, for months

after her termination, could not sleep, get out of bed, eat, or

make even small decisions.    She also suffered embarrassment from

the reporting of her termination in the newspaper and local

business journal.

     Similarly, the termination of Damian’s professional

relationship with Maritz Inc. caused him shock and embarrassment

and adversely affected his relationships with his business

partners and customers.

H.   Continued Negotiations

     Throughout the remainder of 1993 and into the beginning of

1994, the redemption negotiations continued.    In one meeting in

the fall of 1993, Peter Hobler, the designated representative of

the Hobler family, described emotional damages to Katherine and

Damian resulting from Bill Maritz’s actions, and Suelthaus

asserted tort claims for emotional damage on Katherine’s and

Damian’s behalf.
                                - 9 -

I.    Tentative Global Agreement

      On March 2, 1994, the parties reached a tentative global

agreement on the redemption price of the Hobler family shares and

on the settlement of Katherine’s and Damian’s claims.   Pursuant

to this tentative agreement, which was contingent on approval by

the Maritz Inc. board of directors, Maritz Inc. would pay

$750,000 for the release of Katherine’s and Damian’s collective

claims.    Subsequently, Katherine and Damian agreed that Katherine

would receive $500,000 and Damian would receive $250,000.

J.   Suelthaus Letters Asserting Claims

     Backerman later told Suelthaus that, notwithstanding the

tentative settlement agreement, Maritz Inc. could not resolve

Katherine’s and Damian’s claims until Suelthaus asserted them in

writing.   Consequently, in a May 17, 1994, letter to Henry

Stolar, the General Counsel and Senior Vice President of Maritz

Inc., Suelthaus asserted claims on Katherine’s behalf as follows:

     On or about June 30, 1993, Ms. Hobler [Katherine] was
     terminated from her position as an officer of Maritz
     Travel Company, without reasonable prior notice,
     entirely without cause, and with the intent to injure
     her.

          Ms. Hobler was injured by the actions of Maritz
     Inc. and we believe that she is entitled to
     compensatory damages for wrongful termination of
     employment, defamation, infliction of emotional
     distress, emotional pain, suffering, inconvenience,
     mental anguish, loss of enjoyment of life, and other
     applicable claims arising out of and/or related to the
     above event. It is our intention to prepare a petition
     to be filed in a court of competent jurisdiction to
     seek legal redress for the personal damages suffered by
                             - 10 -

     Ms. Hobler as a result of the outrageous conduct of
     Maritz Inc. through its duly authorized agent.

     In a May 18, 1994, letter to Henry Stolar, Suelthaus

asserted claims on Damian’s behalf as follows:

     On or about June 30, 1993, Maritz Inc. terminated its
     vendor/customer and other relationships with Mr. Gerard
     [Damian] and his employer, First Capitol Printing Arts,
     Inc., without reasonable prior notice and entirely
     without cause, and with the intent to injure Mr.
     Gerard.

          Mr. Gerard was injured by the actions of Maritz
     Inc. and we believe that he is entitled to compensatory
     damages for intentional interference with his
     employment relationship, defamation, infliction of
     emotional distress, emotional pain, suffering,
     inconvenience, mental anguish, loss of enjoyment of
     life, and other applicable claims arising out of and/or
     related to the above event. It is our intention to
     prepare a petition to be filed in a court of competent
     jurisdiction to seek legal redress for the personal
     damages sustained by Mr. Gerard as a result of the
     outrageous conduct of Maritz Inc. through its duly
     authorized agent.

K.   Final Settlement Agreement

     On June 8, 1994, a settlement agreement, subject to the

approval of the Maritz Inc. board of directors, was signed by

Bill Maritz in his capacity as chairman and chief executive

officer of Maritz Inc. and in his individual capacity, and by

other members of the Maritz and Hobler families, including
                              - 11 -

Katherine and Damian.   Pursuant to the settlement agreement, the

parties agreed that Maritz Inc. would redeem the Hobler family

voting shares for about $65 million and would settle any and all

claims of Katherine and Damian (including any claims arising from

the termination of the vendor/customer relationship between

Maritz Inc. and Katherine, Damian, or First Capitol) for

$750,000, to be paid “to the Persons and in the amounts set forth

on Schedule III”.3   Schedule III to the settlement agreement


     3
       Sec. 11.03 of the settlement agreement (wherein Maritz
Inc. is referred to as Maritz) provides in relevant part:

          Upon receipt of the sum of $750,000 to be paid by
     Maritz * * * to the Persons and in the amounts set
     forth on Schedule III hereto * * *, and for other good
     and valuable consideration the receipt of which hereby
     is acknowledged, the Sellers, Jean Maritz Hobler, Wells
     A. Hobler, Katherine A. Hobler, Leigh Hobler Gerard and
     Damian Gerard (the “Releasing Parties”) and each of
     them, hereby release and forever discharge each member
     of the William E. Maritz Family, Maritz * * * and each
     past, present and future officer, director,
     shareholder, employee and agent of Maritz (collectively
     the “Released Parties”) from any and all manner of
     claims, demands, damages, losses, expenses, causes of
     action, debts, liabilities, controversies, judgments
     and suits of every kind and nature whatsoever,
     foreseen, unforeseen or unforeseeable, known or
     unknown, resulting or to result, now known or which may
     hereafter be discovered, which the Releasing Parties
     and each of them, now or in the future may have or hold
     or at any time heretofore had or held against the
     Released Parties, or any of them, resulting from or
     arising out of or in connection with or based on any
     facts, causes, matters or things existing from the
     beginning of the world, to the time of consummation of
     the Initial Closing, including by way of enumeration
     and not in limitation hereof, all causes, matters or
     things arising out of or in connection with (a)
                                                    (continued...)
                              - 12 -

describes the payments to be made pursuant to this provision as

follows:

     (a)   To Katherine A. Hobler, for personal damages as
           described in correspondence dated May 17, 1994,
           from Sellers’ Attorney [Suelthaus] to the General
           Counsel of Maritz, the sum of $500,000.00.

     (b)   To Damian Gerard, for personal damages as
           described in correspondence dated May 18, 1994,
           from Sellers’ Attorney [Suelthaus] to the General
           Counsel of Maritz, the sum of $250,000.00.

     Section 3.04 of the settlement agreement provides that the

“Sellers shall cause” First Capitol to execute a mutual release

with Maritz Inc.   As executed on June 9, 1994, and signed by

Damian in his capacity as president of First Capitol, the mutual

release provided that First Capitol and Maritz Inc. agreed to

release all claims against each other, including all claims “in

connection with the termination of any and all vendor/customer

and other relationships between the Maritz Released Parties, or

any of them, and First Capitol.”

     On June 9, 1994, the Maritz Inc. board of directors

considered, authorized, and approved the settlement agreement

signed on the previous day.



     3
      (...continued)
     Katherine A. Hobler’s employment with (and termination
     of such employment by) Maritz and (b) the termination
     of any and all vendor/customer and other relationships
     between Maritz and Damian Gerard and any entity with
     which he was, is, or hereafter may be, affiliated
     (including without limitation First Capitol Printing
     Arts, Inc.) * * *.
                                - 13 -

L.   “Tax Consistency” Letter

     A letter dated June 8, 1994, addressed to Peter Hobler and

signed by David Fleisher, the chief financial officer of Maritz

Inc., states that “It is understood” by Maritz Inc. that the

settlement payments to Katherine and Damian “are, and for income

tax purposes shall be treated as, payments in settlement of

claims for personal damages” and therefore “do not require

reporting on Form 1099 or any other applicable information

reporting form.”

M.   Settlement Payments, Tax Reporting, and Examination

     On July 7, 1994, Katherine and Damian received checks from

Maritz Inc. in amounts of $500,000 and $250,000, respectively.

Maritz Inc. issued no Form 1099 to Katherine or Damian.

Petitioners did not report the settlement payments on their

respective 1994 joint Federal income tax returns.

     On June 5, 1998, respondent commenced examination of

petitioners’ 1994 Federal income tax returns.   On October 6,

2000, by separate notices of deficiency, respondent determined

that the settlement payments were includable in petitioners’

respective taxable incomes for 1994.
                               - 14 -

                               OPINION

      Petitioners argue that the amounts that Katherine and Damian

received pursuant to the settlement agreement with Maritz Inc.

were entirely on account of personal injuries within the meaning

of section 104(a)(2) and so are excludable from income.

Petitioners bear the burden of proof.    See Rule 142(a).4

I.   General Principles

      Except as otherwise provided in subtitle A of the Internal

Revenue Code, gross income means income from all sources.    Sec.

61(a).    This statutory provision is construed broadly, unlike

statutory exclusions from income, which are construed narrowly.

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

      Section 104(a)(2) excludes from gross income “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”.    This provision excludes from gross income

only amounts that are received both:     (1) Through prosecution or

settlement of an action based upon tort or tort type rights; and

(2) on account of personal injuries or sickness.     Commissioner v.

Schleier, supra at 333; Bagley v. Commissioner, 105 T.C. 396, 416



      4
       Respondent’s examination of petitioners’ 1994 returns
commenced before July 22, 1998. Consequently, sec. 7491(a),
which in some circumstances may place the burden of proof on the
Commissioner, has no application here. See Internal Revenue
Service Restructuring and Reform Act of 1998, Pub. L. 105-206,
sec. 3001(c), 112 Stat. 727.
                              - 15 -

(1995), affd. 121 F.3d 393 (8th Cir. 1997).   For the taxable year

at issue, personal injuries include both physical and nonphysical

injuries.   See Commissioner v. Schleier, supra at 329 n.4.5

      If amounts are received pursuant to a settlement agreement,

the nature of the claim that was the actual basis for settlement

(and not the validity of the claim) governs whether such amounts

are excludable from gross income under section 104(a)(2).      See

United States v. Burke, 504 U.S. 229, 237 (1992); Mayberry v.

United States, 151 F.3d 855, 858 (8th Cir. 1998); Seay v.

Commissioner, 58 T.C. 32, 37 (1972).   “[T]he critical question

is, in lieu of what was the settlement amount paid”?    Bagley v.

Commissioner, supra at 406.   This determination is factual.     Id.

II.   Were the Underlying Causes of Action Based on Tort or Tort
      Type Rights?

      To satisfy the first Schleier requirement, the taxpayer must

prove the existence of a claim based upon tort or tort type

rights.   See Commissioner v. Schleier, supra at 337.   For this

purpose, claims must be bona fide but need not be valid or

sustainable.   See Mayberry v. United States, supra at 859 n.3;

Taggi v. United States, 35 F.3d 93, 96 (2d Cir. 1994); Robinson


      5
       The Small Business Job Protection Act of 1996 (SBJPA),
Pub. L. 104-188, sec. 1605, 110 Stat. 1838, amended sec.
104(a)(2) by limiting the exclusion from gross income to, inter
alia, damages received “on account of personal physical injuries
or physical sickness.” This amendment, however, does not apply
to amounts received before Aug. 20, 1996. See SBJPA sec.
1605(d)(1), 110 Stat. 1839. Therefore, the SBJPA amendment is
inapplicable to the instant case.
                             - 16 -

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

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

State law controls whether the nature of the claim is a tort or

tort type right; Federal law controls the Federal tax

consequences pertaining to such interests and rights.   See

Helvering v. Stuart, 317 U.S. 154, 162 (1942); Threlkeld v.

Commissioner, 87 T.C. 1294, 1305-1306 (1986), affd. 848 F.2d 81

(6th Cir. 1988).

     As reflected in the May 1994 Suelthaus letters, which are

cross-referenced in Schedule III of the settlement agreement,

which in turn is cross-referenced in section 11.03 of the

settlement agreement, Katherine and Damian asserted that their

professional relationships with Maritz Inc. were each terminated

with “intent to injure” and sought compensatory damages with

respect to a variety of claims.   These letters assert, in

identical language, certain common claims on Katherine’s and

Damian’s behalf; namely, claims for compensatory damages for

“defamation, infliction of emotional distress, emotional pain,

suffering, inconvenience, mental anguish, loss of enjoyment of

life, and other applicable claims”.   The May 17, 1994, Suelthaus

letter asserts on Katherine’s behalf an additional claim for

“wrongful termination of employment”.   The May 18, 1994,

Suelthaus letter asserts on Damian’s behalf an additional claim

of “intentional interference with his employment relationship”.
                              - 17 -

     Respondent acknowledges on reply brief that the amounts

Katherine and Damian received from Maritz Inc. were “paid for the

‘personal damages’ stated in Suelthaus’ May 1994 letters to Henry

Stolar”.   Respondent further concedes that “Missouri recognizes

‘intentional infliction of emotional distress’ as a personal

injury/tort-like cause of action.”     Respondent does not dispute

that Katherine’s and Damian’s other common claims asserted in the

Suelthaus letters (i.e., the claims for defamation, infliction of

emotional distress, emotional pain, suffering, inconvenience,

mental anguish, and loss of enjoyment of life) are also based on

personal injury torts.

     We also find that Katherine’s claim for wrongful discharge

from employment constituted a bona fide tort claim.    Katherine

was an at-will employee; i.e., she had no employment contract.

Historically, under Missouri law, an employer could generally

discharge an at-will employee with or without cause.    See Johnson

v. McDonnell Douglas Corp., 745 S.W.2d 661, 662 (Mo. 1988).     A

number of Missouri appellate decisions, however, have recognized

that an at-will employee may have a “cause of action in tort for

damages for wrongful discharge”, where the discharge is in

violation of public policy.   Boyle v. Vista Eyewear, Inc., 700

S.W.2d 859, 878 (Mo. Ct. App. 1985); see also Lynch v. Blanke

Baer & Bowey Krimko, Inc., 901 S.W.2d 147, 150 (Mo. Ct. App.
                                  - 18 -

1995).6      We need not decide whether Katherine would have been

able to sustain a claim for wrongful discharge, since it is the

nature of the claim and not its validity that matters for present

purposes.       See, e.g., Mayberry v. United States, supra at 859

n.3.       We conclude that Katherine asserted a bona fide tort claim

for wrongful discharge and that Maritz Inc. recognized it as

such.7

       Similarly, Damian’s claim for interference with his

employment relationship falls within a larger category of claims

for tortious interference with a business relationship.      Such

tort claims are recognized under Missouri law.      See Salomon v.

Crown Life Ins. Co., 536 F.2d 1233, 1238 (8th Cir. 1976);

Fischer, Spuhl, Herzwurm & Associates, Inc. v. Forrest T. Jones &

Co., 586 S.W.2d 310, 315 (Mo. 1979).

       In sum, we conclude that the first element of Schleier is

met with respect to the various claims asserted on Katherine’s




       6
       Noting that it had neither “expressly defined nor adopted
the exception”, the Missouri Supreme Court in Luethans v. Wash.
Univ., 894 S.W.2d 169, 171 n.2 (Mo. 1995), stated that for
purposes of that opinion “we assume that the public policy
exception to the at-will employment doctrine exists.”
       7
       Millard Backerman, the attorney who represented Maritz
Inc. in the settlement negotiations, testified that he believed
that he made inquiries at his law firm during the negotiations as
to whether an at-will employee could have a cause of action for
wrongful discharge in Missouri and was told “there is that
possibility on some kind of a specialized tort action.”
                                - 19 -

and Damian’s behalf in the 1994 Suelthaus letters as incorporated

by cross-reference in the settlement agreement.

III.   Were the Payments Received on Account of Personal Injuries
       or Sickness?

       To satisfy the second element of the Schleier test, the

taxpayer must show that the payments were received on account of

personal injuries or sickness.     See sec. 104(a)(2); Commissioner

v. Schleier, 515 U.S. at 337.     For this purpose, each element of

a tort settlement must be examined to determine whether there is

a direct causal link between the tort and a personal injury.

Commissioner v. Schleier, supra at 330.

       A.   The Allocation of the Settlement Proceeds Between
            Katherine and Damian

       Respondent contends that because Maritz Inc. initially

agreed to pay a lump sum of $750,000 to discharge both

Katherine’s and Damian’s claims, and the Hobler family later

decided upon the allocation between Katherine and Damian, it is

impossible “to attribute the necessary ‘direct causal link’

between this lump sum and the alleged personal injuries

suffered”.     We disagree.

       The tentative agreement to provide a lump-sum amount to be

divided between Katherine and Damian was contingent upon approval

by the Maritz Inc. board of directors.     Before the agreement was

approved, Backerman insisted on Suelthaus’ asserting Katherine’s

and Damian’s respective claims in writing, which he did.     The
                              - 20 -

final settlement agreement, as approved by the Maritz Inc. board

of directors, expressly provided for $500,000 to be paid to

Katherine and $250,000 to be paid to Damian in settlement of

their respective claims as asserted in the Suelthaus letters.    On

these facts, the manner in which the allocation between Katherine

and Damian was reached is not determinative of the existence or

absence of a causal link between the payments to each and

personal injuries suffered by each.

     B.   The Effect of the Characterization of the Settlement
          Proceeds as Being for “Personal Damages”

     Petitioners contend that the settlement agreement expressly

allocates the settlement payments to Katherine’s and Damian’s

claims for personal injuries, noting that Schedule III of the

settlement agreement refers to the settlement payments to

Katherine and Damian as being for “personal damages”, as does the

May 1994 Suelthaus letters and the so-called tax consistency

letter.   We disagree with petitioners’ contention.

     In the first instance, we are unconvinced that Maritz Inc.

would have understood the term “personal damages” as used in

these various documents to be synonymous with tort type personal

injuries.   We believe a more reliable indicator of Maritz Inc.’s

intent is found in section 11.03 of the settlement agreement,

which expressly indicates that the payments to Katherine and

Damian would discharge “all manner of claims” that might arise
                             - 21 -

from the termination of their professional relationships with

Maritz Inc.8

     Even if we were to assume, however, for sake of argument,

that by using the term “personal damages” the parties to the

settlement agreement meant to expressly allocate the settlement

proceeds exclusively to tort type personal injuries, we still

would not find such an allocation dispositive here, for the

reasons described below.

     An express allocation in a settlement agreement will

generally be followed if the parties have entered into the

agreement “in an adversarial context at arm’s length and in good

faith”; such an express allocation is not necessarily

determinative, however, “if other facts indicate that the payment

was intended by the parties to be for a different purpose.”

Bagley v. Commissioner, 105 T.C. at 406.   Absent an express

allocation in the settlement agreement, the most important

consideration is the payor’s intent in making the payment.

Metzger v. Commissioner, 88 T.C. 834, 847-848 (1987), affd.

without published opinion 845 F.2d 1013 (3d Cir. 1988).


     8
       Sec. 11.03 of the settlement agreement provides that “Upon
receipt of the sum of $750,000 to be paid by Maritz * * * to the
Persons and in the amounts set forth on Schedule III hereto”, the
parties will release and discharge “all manner of claims * * * in
connection with or based on any facts, causes, matters or things
existing from the beginning of the world”, including “all causes,
matters or things arising out of or in connection with” the
termination of Katherine’s and Damian’s professional
relationships with Maritz Inc.
                                 - 22 -

      In key respects the circumstances here are similar to those

in LeFleur v. Commissioner, T.C. Memo. 1997-312.      In LeFleur, the

taxpayer received a lump-sum settlement payment that covered both

tortlike personal damages and other damages.     The settlement

agreement allocated 80 percent of the proceeds to tortlike

personal damages.     Id.   The evidence indicated that although the

underlying litigation was adversarial, by the time the settlement

agreement was reached, the parties were no longer adversaries.

Id.   Because the payor was unconcerned with the allocation of the

settlement proceeds as between tortlike personal injuries and

other injuries, the taxpayer “in effect was able to unilaterally

allocate the proceeds” in an attempt to maximize tax advantages

for themselves.     Id.   Consequently, this Court refused to

“blindly accept the parties’ allocation of settlement proceeds

where * * * the allocation is patently inconsistent with the

realities of the underlying claims”.      Id.; see also Bagley v.

Commissioner, supra at 406-410; Robinson v. Commissioner, 102

T.C. at 128-134; Burditt v. Commissioner, T.C. Memo. 1999-117;

Hess v. Commissioner, T.C. Memo. 1998-240 (“the characterization

of the payment in a settlement agreement (or other executed

document) * * * is not always dispositive, for example, when the

record proves the characterization inconsistent with the

realities of the settlement”).
                                - 23 -

     In the instant case, as in LeFleur v. Commissioner, supra,

the evidence does not suggest that the parties had any

adversarial interests in characterizing the settlement payments

as being for “personal damages”.     On the basis of all the

evidence, it appears that the “personal damages” characterization

occurred after the parties had reached agreement in principle on

the settlement.     Clearly, petitioners had tax motivations for

characterizing the payments as being for personal injuries.     The

evidence strongly suggests that Maritz Inc. was unconcerned with

how the payments were allocated, so long as all potential claims

were discharged.9

     In sum, we are unconvinced that the mere use of the term

“personal damages” in various documents, as described above,

establishes that Maritz Inc. intended the settlement payments to

discharge exclusively claims for personal injuries or sickness.

Consequently, we look to all the evidence to determine the nature

of the underlying claims for which the payments were made and the

intent of Maritz Inc. in making the payments.




     9
       Millard Backerman testified that he thought “the lion’s
share” of the tax consistency letter was drafted by Katherine’s
and Damian’s attorney, Kenneth Suelthaus. Petitioners seek to
counter this testimony with testimony by David Fleisher, former
chief financial officer of Maritz Inc., that the tax consistency
letter was “drafted by our lawyers”. We find Backerman’s
testimony more credible in this regard, particularly in light of
the fact that Backerman was Maritz Inc.’s attorney in the
settlement negotiations.
                                - 24 -

     C.     The Underlying Claims

            1.   Katherine’s and Damian’s Claims for Personal
                 Injuries

     On the basis of all the evidence, we believe that Bill

Maritz’s actions caused Katherine and Damian to suffer personal

injuries.    In particular, Katherine’s termination from Maritz

Inc. caused her acute emotional distress and resulted in dramatic

changes in her personality.    The termination of Damian’s

professional relationship with Maritz Inc. also caused him

emotional distress and damaged his professional reputation.      Such

claims were asserted on Katherine’s and Damian’s behalf in the

settlement negotiations with Maritz Inc.      We believe that Maritz

Inc. took these claims seriously and intended the settlement

payments at least in part to discharge such claims.      Accordingly,

we find that the settlement payments were received at least in

part through settlement of tort-based claims on account of

personal injuries or sickness.      To that extent, the settlement

payments are excludable from income pursuant to section 104(a)(2)

as amounts received based upon tort rights and on account of

personal injuries.    See, e.g., United States v. Burke, 504 U.S.

at 235-236 & n.6, 239 (recognizing that section 104(a)(2) covers

damages for injuries affecting “emotions, reputation, or

character” and “traditional harms associated with personal

injury” include “pain and suffering, emotional distress, [and]

harm to reputation”); Threlkeld v. Commissioner, 87 T.C. at 1308
                               - 25 -

(holding that compensatory damages received for malicious

prosecution, including compensation for injuries to professional

reputation, were excludable under section 104(a)(2)); Gross v.

Commissioner, T.C. Memo. 2000-342 (holding that lump-sum

settlement payment covering claim for defamation was excludable

under section 104(a)(2)); Burditt v. Commissioner, supra (holding

that settlement proceeds paid to settle a claim for mental

anguish were excludable under section 104(a)(2)); Noel v.

Commissioner, T.C. Memo. 1997-113 (holding that settlement

proceeds attributable to a claim for tortious interference with

contractual rights and prospective business advantages were

excludable under section 104(a)(2)).

     For the reasons described below, however, we are unpersuaded

that Katherine and Damian received the settlement payments

exclusively on account of personal injuries or sickness.

           2.   Katherine’s Claims for Economic Injuries

     On or about June 30, 1993, immediately after Maritz Inc.

terminated Katherine’s employment, Suelthaus met with Backerman

and asserted a claim for severance benefits on Katherine’s

behalf.   About 2 weeks later, the Hobler family, through one of

their newly elected Maritz Inc. board members, introduced a

resolution to reinstate Katherine in her former position and to

compensate her for lost wages and benefits, as well as “for any

emotional and/or physical damages she may have suffered” as a
                              - 26 -

result of her termination.   Clearly, then, at least initially,

claims were asserted on Katherine’s behalf for economic injuries,

as well as for emotional and physical damages.   There is no

suggestion in the record that Maritz Inc. ever received any

affirmative indication that Katherine had abandoned her

previously asserted claims for economic injuries.   Particularly

in light of the assertion on Katherine’s behalf, in the May 1994

Suelthaus letter, of a claim for wrongful discharge from

employment, we are convinced that Maritz Inc. intended the

settlement payment to Katherine to discharge her previously

asserted and never-withdrawn claims for economic injuries, as

well as her claims for personal injuries.

          3.   Damian’s and First Capitol’s Claims for Economic
               Injuries

     At the meeting between Suelthaus and Backerman on or about

June 30, 1993, Suelthaus asserted a claim on Damian’s behalf for

tortious interference with a business relationship.   About 2

weeks later, the Hobler family, through one of their newly

elected Maritz Inc. board members, introduced a resolution to

reinstate First Capitol as a supplier to Maritz Inc. and to

compensate it for “lost profits on the cancelled orders * * * and

any other damages (if any) it may have suffered”.   No resolution

was introduced to compensate Damian for any separate injuries he

may have suffered, personal or otherwise.   We believe at that

early juncture in the negotiations, the claims asserted on behalf
                               - 27 -

of Damian individually were, and would have been perceived by

Maritz Inc. as being, part and parcel of the claims for economic

injuries asserted on behalf of First Capitol, of which Damian was

a significant owner.

     The record contains no suggestion that Maritz Inc. ever

received any affirmative indication that Damian or First Capitol

had abandoned their previously asserted claims for such economic

injuries.   To the contrary, section 11.03 of the settlement

agreement expressly states that the settlement payment to Damian

was in discharge of any claims arising from the “termination of

any and all vendor/customer and other relationships between

Maritz and Damian Gerard and * * * First Capitol Printing Arts,

Inc.”   Section 3.04 of the settlement agreement required First

Capitol, for no apparent consideration beyond the $250,000

settlement payment to Damian, to execute a release of any claims

against Maritz Inc.    On June 9, 1994, Damian executed such a

release in his capacity of president of First Capitol.    We

believe these circumstances show that the $250,000 payment to

Damian was intended to discharge economic injury claims

previously asserted on behalf of First Capitol as well as related

economic injuries and personal injuries asserted by Damian in his

individual capacity.
                                - 28 -

          4.    Allocation of the Settlement Payments

     As just discussed, we are convinced that the settlement

payments to Katherine and Damian were on account of both personal

injuries and economic injuries.10    The record does not suggest

that Maritz Inc. was ever presented with empirical evidence as to

the extent of either Katherine’s or Damian’s personal or economic

injuries.11    The record is clear, however, that Maritz Inc. took

seriously the various claims that Suelthaus asserted on

Katherine’s and Damian’s behalf, believed that Katherine and

Damian would litigate these claims if they were not settled, and

made the settlement payments to discharge all such claims, for

personal and economic injuries alike.12    In these circumstances,


     10
       On the basis of all the evidence, we do not believe that
any part of the payments to Katherine and Damian was in
redemption of Maritz Inc. stock. The redemption agreement was
only for Maritz Inc. voting stock. Katherine owned only
nonvoting stock. Damian owned no Maritz Inc. stock in his
individual capacity. In his testimony, Backerman made clear that
Maritz Inc. viewed the payments it made to discharge Katherine’s
and Damian’s claims as being separate from the payments it made
to redeem the Hobler voting stock.
     11
       We note that before her termination, Katherine was
earning a $56,700 salary as a corporate officer of Maritz Inc.
and that Damian did $10,000 worth of business with the
corporation over a 6-month period. The record does not suggest,
however, any direct correlation between these figures and the
amounts of the settlement payments.
     12
       Backerman testified that Maritz Inc. took seriously the
claims asserted by Suelthaus on Katherine’s and Damian’s behalf.
He testified that “Maritz Inc., should not have, and did not,
come to a resolution of the stock redemption issue without also
clearing up these asserted claims, such as they were, and it
                                                   (continued...)
                             - 29 -

we use our best judgment to allocate the settlement payments.

See Stocks v. Commissioner, 98 T.C. 1, 14 (1992); Burditt v.

Commissioner, T.C. Memo. 1999-117; Goeden v. Commissioner, T.C.

Memo. 1998-18; Noel v. Commissioner, T.C. Memo. 1997-113; see

also Cohan v. Commissioner, 39 F.2d 540, 544 (2d Cir. 1930);

Eisler v. Commissioner, 59 T.C. 634, 640-641 (1973).   On the

basis of the whole record, and bearing against petitioners, who

have the burden of proof, we conclude that neither personal

injury claims nor economic injury claims predominated in the

calculus of Maritz Inc.’s reasons for making the settlement

payments, but rather that both types of claims weighed equally,

without distinction between Katherine’s and Damian’s claims.

Accordingly, we conclude and hold that one-half of Katherine’s

and Damian’s respective settlement payments are excludable from

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




     12
      (...continued)
would not have made sense for the company to be paying many
millions of dollars to the Hoblers [for redemption of their
stock] that they could use to pursue claims in court.” He
testified that Maritz Inc. “certainly” felt there was a
possibility that Katherine and Damian would proceed to litigation
unless their claims were settled. He testified that Katherine
and Damian “were making demands, and in the overall it was just
time to get this matter behind us.” He testified that Maritz
Inc. “did settle those claims and they would not have settled
those claims if they thought they were totally worthless.” We
regard Backerman’s testimony as especially creditable given that
he was the attorney who negotiated the redemption agreement and
settlement payments on behalf of Maritz Inc. We also note that
he was called as respondent’s witness.
                             - 30 -

     We have considered all arguments the parties have raised.

Arguments not addressed herein we have concluded are irrelevant

or without merit.

     To reflect the foregoing and the parties’ concessions,



                                        Decisions will be

                                   entered under Rule 155.
