                  T.C. Summary Opinion 2005-17



                     UNITED STATES TAX COURT



          ASHIT VALIA AND SMITA VALIA, Petitioners v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 6756-03S.              Filed February 16, 2005.


     Ashit Valia and Smita Valia, pro se.

     Hieu C. Nguyen, for respondent.



     PANUTHOS, Chief Special Trial Judge:    This case was heard

pursuant to the provisions of section 7463 of the Internal

Revenue Code in effect at the time the petition was filed.    The

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

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

     Respondent determined a deficiency of $25,276 in

petitioners’ Federal income tax for the 2001 taxable year.     The

issue for decision is whether petitioners are entitled to exclude

$62,500 of settlement proceeds, including $25,000 of attorney’s

fees from their gross income for the 2001 taxable year.1

Background

     Some of the facts have been stipulated, and they are so

found.   The stipulation of facts and the attached exhibits are

incorporated herein by this reference.   At the time of their

petition, petitioners resided in California.

     Petitioner Smita Valia (petitioner) was an employee of Smith

Barney, Inc. (Smith Barney) in its Southfield, Michigan, office

until her resignation in September 1993.   In a letter dated

November 18, 1999, Stowell & Friedman, Ltd., a law firm in

Chicago, Illinois, informed petitioner that she was a member of a

class to whom Smith Barney would make a settlement offer in

Martens v. Smith Barney, Inc., 181 F.R.D. 243 (S.D.N.Y. 1998).

     On February 5, 2001, petitioner entered into a “Release of

Claims” (release), which provided in relevant part:

          1. Smita Valia (“Claimant”), in consideration of
     a payment of $100,000.00 payable as follows: 1) the
     payment of $37,500.00 to Claimant (less applicable
     payroll withholding taxes); 2) the payment to Claimant


     1
        The parties stipulated that, if the attorney’s fees are
includable in income, then petitioners are entitled to deduct the
amount of such attorney’s fees as an itemized deduction for the
2001 taxable year.
                                 - 3 -

     of $37,500.00 (for which an IRS “Form 1099” will be
     issued); and, 3) the payment of attorneys’ fees and
     costs in the amount of $25,000.00 to Stowell & Friedman
     (for which an IRS “Form 1099” will be issued to both
     Claimant and Stowell & Friedman), hereby releases and
     forever discharges Salomon Smith Barney Inc. (“Smith
     Barney”), TravelersGroup, Inc., and Citigroup Inc., and
     each of their past, current and future parents,
     subsidiaries and affiliated companies and each of their
     past, current and future officers, directors, and
     employees, from any and all claims and demands
     whatsoever, known or unknown, in law or equity, by
     contract, tort or pursuant to statute, regulation or
     ordinance, which she now has or ever had or may have
     from the beginning of time until the date she executes
     this Release, including, but without limitation, any
     claims raised in the Dispute Resolution Process (“DRP”)
     provided for in the settlement of the above-captioned
     lawsuit, and expressly including any and all claims and
     demands regarding, arising out of, or relating to
     Claimant’s employment with Smith Barney and, if
     applicable, the termination thereof.

          2. This Release includes claims and demands
     regarding, arising out of, or relating to any form of
     employment discrimination, including, but not limited
     to, sex or gender discrimination, sexual harassment,
     sexual preference discrimination, race, national
     origin, or religious discrimination, age or disability
     discrimination and any and all other forms of
     employment discrimination prohibited by the 1866 Civil
     Rights Act, 42 U.S.C. §1981 [sic], Title VII of the
     Civil Rights Act of 1964, as amended, 42 U.S.C. § 2000e
     et. sec., [sic] the Civil Rights Act of 1991, the Equal
     Pay Act, the Age Discrimination in Employment Act, 29
     U.S.C. §621 [sic], the Americans with Disabilities Act,
     the Family and Medical Leave Act of 1993, or any other
     Federal, state or local statute, regulation or
     ordinance prohibiting employment discrimination.

Petitioner was a resident of California when she executed the

release.   Petitioners’ legal fees were based on a contingency-fee

agreement with their attorney.
                               - 4 -

     Of the $100,000 settlement proceeds, Smith Barney sent

Stowell & Friedman, Ltd. a check in the amount of $25,000, which

was characterized as payment of attorney’s fees and costs.

Smith Barney also sent, and petitioners received, $60,056.25 of

the remaining settlement proceeds.2    Consistent with the release,

Smith Barney issued petitioners a Form W-2, Wage and Tax

Statement, for $37,500 and a Form 1099-MISC, Miscellaneous

Income, for $62,500.

     Petitioners reported $37,500 of the settlement proceeds on

their 2001 tax return, an amount corresponding with that reported

on the Form W-2.   Petitioners did not report any of the remaining

$62,500 in settlement proceeds.   Petitioners contend that they

are entitled to exclude the $62,500 reported on the Form 1099-

MISC from their gross income for the 2001 taxable year because

such amount was for sickness and injuries suffered by petitioner

from exposure to second-hand cigarette smoke at Smith Barney.

Discussion

     Neither of the parties has addressed the applicability of

section 7491(a) regarding the burden of proof.    Petitioners have

not established that they satisfied the requirements of section

7491(a); thus the burden of proof remains with petitioners.


     2
        Of the remaining $75,000 not sent to petitioners’
attorney, $37,500 was treated as wages subject to withholding
taxes for Michigan State income tax of $1,575, Federal income tax
$10,500, Social Security tax of $2,325, and Medicare tax of
$543.75.
                                 - 5 -

     The release indicates that the unreported settlement

proceeds of $62,500 consisted of two components:    (1) $37,500

“for which an IRS ‘Form 1099’ will be issued” and (2) $25,000 for

attorney’s fees and costs.    Language in a settlement agreement

can offer some probative evidence on how a settlement payment

should properly be characterized for purposes of section

104(a)(2).    See, e.g., Bent v. Commissioner, 87 T.C. 236, 246

(1986), affd. 835 F.2d 67 (3d Cir. 1987).    That characterization

is important in deciding whether the payment may be excluded from

a taxpayer’s gross income.

     In general, a taxpayer’s gross income broadly encompasses

all income from whatever source derived.    Sec. 61(a).   It does

not include “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”.    Sec. 104(a)(2).   As

such, settlement proceeds on account of nonphysical injuries,

such as gender discrimination, may not be excluded under section

104(a)(2).

     The underlying litigation upon which the parties rely was

reported as Martens v. Smith Barney, Inc., supra.     The complaint

in that case raised allegations of gender discrimination.     See

id. at 250.    There was no claim of personal physical injury or

sickness.     Similarly, the release focuses on claims and demands
                                - 6 -

regarding gender discrimination and not upon a claim of personal

physical injury or sickness.    Consequently, petitioners cannot

avail themselves of section 104(a)(2) to exclude $37,500 of the

unreported settlement proceeds.

     Petitioners nevertheless claim that the settlement proceeds

relate to injuries suffered by petitioner from exposure to

second-hand cigarette smoke at Smith Barney.    Petitioners claim

that the release did not cover such injuries because Smith Barney

“wanted to protect [itself]”.    Petitioners have not offered, nor

can they point to, any evidence in the record that supports such

characterization of the settlement payment.3

     The remaining $25,000 not reported by petitioners is

characterized as attorney’s fees and costs.    To the extent there

was previously any doubt as to the includability in income of

attorney’s fees received as part of a contingent-fee agreement,

the U.S. Supreme Court recently resolved the question.    In

Commissioner v. Banks, 543 U.S. __, 125 S. Ct. 826 (2005), the

Supreme Court held that in general when a plaintiff’s recovery of

a money judgment or settlement constitutes income, the portion of

a money judgment or settlement paid to the plaintiff’s attorney

under a contingent-fee agreement is income to the plaintiff under

the Internal Revenue Code.   Accordingly, the $25,000 attorney’s



     3
        It is somewhat illogical to suggest that the release
would not include all claims made by petitioner.
                              - 7 -

fees are includable as income to petitioners, and as a result of

the parties stipulation, is also deductible as an itemized

deduction.4

     Reviewed and adopted as the report of the Small Tax Case

Division.

     To reflect the foregoing and the parties’ stipulation

regarding the deductibility of attorney’s fees,

                                           Decision will be entered

                                      under Rule 155.




     4
        The Supreme Court in Commissioner v. Banks, 543 U.S. __,
125 S. Ct. 826 (2005), noted that the American Jobs Creation Act
of 2004, Pub. L. 108-357, sec. 703, 118 Stat. 1546, amending the
I.R.C. by adding sec. 62(a)(19) was not effective at the time of
the transaction. Since the Act is not retroactive, the Supreme
Court did not consider it. Likewise, we need not consider
whether it might apply to the facts of this case.
