                         T.C. Memo. 2010-9



                      UNITED STATES TAX COURT



                JULIE LEIGH DOMENY, Petitioner v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 6975-08.1             Filed January 13, 2010.



     Brett L. Gibbs and Barbara N. Morrison, for petitioner.

     Matthew A. Williams, for respondent.



                        MEMORANDUM OPINION


     GERBER, Judge:   Respondent determined a $9,543 deficiency in

petitioner’s Federal income tax for 2005 and a $1,909 accuracy-



     1
      This case was originally docketed as “small tax case” in
accord with petitioner’s designation. At trial petitioner moved
without objection from respondent that this case be removed from
the small tax case category. The Court granted petitioner’s
motion, and the docket number has been changed accordingly.
                                - 2 -

related penalty under section 6662(a).    The parties have resolved

all issues other than whether $16,933 petitioner received from

her employer was excludable from gross income under section

104(a)(2).2

     Unless otherwise indicated, all section references are to

the Internal Revenue Code in effect for 2005, the taxable year in

issue, and all Rule references are to the Tax Court Rules of

Practice and Procedure.

                             Background

     Petitioner resided in California at the time her petition

was filed.    After completing high school petitioner obtained a

degree in visual merchandising, cost, and design.    She worked in

theater and visual merchandising for approximately 20 years in

the San Francisco area.    Following those positions, petitioner

became involved in professional fundraising for nonprofit

organizations.    After approximately 2½ years as a professional

fundraiser petitioner was employed by the Pacific Autism Center

for Education (PACE) in 2000.

     During 1996 before her employment with PACE petitioner was

diagnosed with multiple sclerosis (MS).    At the onset of her MS



     2
      Petitioner conceded that she failed to report a $799 State
income tax refund and $59 of interest income. Petitioner also
conceded that she failed to report $7,050 of wage compensation
for 2005. Respondent conceded that petitioner acted in good
faith and with reasonable cause and that she is not liable for
any penalty under sec. 6662(a).
                               - 3 -

she experienced numbness from the waist down.     The numbness

receded to her feet, leaving them numb.     She also experienced

fatigue, lightheadedness, vertigo, and sometimes a burning

sensation behind her eyes.   Petitioner found the prescribed

treatment (which did not ameliorate the symptoms of her

condition) more profoundly troublesome than her symptoms, so she

chose to “manage” her symptoms without medication.     She left her

position as a professional fundraiser before being hired by PACE,

because she was seeking a job situation were she would not have

to spend as much time on her feet.

     Petitioner’s duties with PACE included community

development, fund raising, and writing grants.     Petitioner

enjoyed her work with PACE, and she was motivated by the children

and parents who were involved with PACE’s autism program.       The

fact that petitioner was ill with MS motivated her involvement

with the cause of autism and the underlying fundraising

activities.

     After a while PACE appointed a new executive director who

was to be petitioner’s supervisor.     The new executive director

did not want petitioner to socialize or be involved with parents

of autistic children, although she was required to somehow

approach them for fundraising purposes.     Petitioner had a

strained relationship with her supervisor, who restricted her

duties.   By 2004 these concerns and conditions in petitioner’s
                               - 4 -

workplace caused her MS symptoms to flare up.    In November 2004

it came to petitioner’s attention that the director was

embezzling funds from PACE’s students’ personal accounts.

Petitioner went to PACE’s board members with this information,

and she was told that they would take care of the situation.

Petitioner felt tension concerning her supervisor’s alleged

embezzlement.   In particular she was upset that PACE sent her out

to raise funds from parents, knowing that funds were being

embezzled by her supervisor.   Petitioner advised her superiors on

several occasions of her unhealthful work environment, including

her stress from the embezzlement and PACE’s failure to take any

action.   The series of events involving the embezzlement and

resulting severance of the residential director caused petitioner

much distress, and during that time her MS symptoms intensified.

     Petitioner’s symptoms continued to worsen, and on March 7,

2005, she left work.   On the next day she visited her primary

care physician, Dr. Chris E. Chung.    At that time Dr. Chung

determined that petitioner was too ill, because of her MS

symptoms, to return to work and that she should not return to

work until after March 21, 2005.   Petitioner’s March 7, 2005,

symptoms from MS included:   Vertigo, shooting pain in both legs,

difficulty walking due to numbness in both feet, a burning

sensation behind her eyes, and extreme fatigue.    On or about

March 8, 2005, petitioner notified PACE by facsimile of Dr.
                               - 5 -

Chung’s diagnosis and of the doctor’s instructions that she not

return to work until after March 21, 2005.    After sending the

facsimile on March 8, 2005, petitioner received a telephone call

from PACE’s executive director, who notified her that her

employment would be terminated effective March 15, 2005.     After

that telephone conversation petitioner’s physical MS symptoms

were “spiking”, including shooting pain up her legs, fatigue,

burning eyes, spinning head, vertigo, and lightheadedness.

During the taxable year 2005 petitioner was employed by PACE from

January 1 through March 15.

     Because of these circumstances, petitioner contacted a

lawyer to seek redress from PACE.   She explained the

circumstances of her employment, illness, and dismissal to the

lawyer, who agreed that she had a cause of action, and petitioner

retained the lawyer to pursue PACE.    Petitioner’s lawyer

negotiated with PACE lawyers, and a settlement was reached.    The

settlement agreement was entitled “Severance Agreement and

Release of Claims” (the agreement).    In the agreement petitioner

released the following list of numerous possible causes of action

or rights:

     (a)   any and all rights and claims relating to or in
           any manner arising from the * * * [petitioner’s]
           employment or the termination of her employment;

     (b)   any and all rights and claims arising under the
           California Fair Employment and Housing Act * * *;
                                - 6 -

     (c)    any and all claims arising under the Civil Rights
            Act of 1964 * * *;

     (d)    any and all rights and claims arising under the
            Americans with Disabilities Act;

     (e)    any and all rights and claims arising [sic] the Age
            Discrimination in Employment Act of 1967 * * *;

     (f)    any and all rights and claims arising under the
            Family and Medical Leave Act or the California
            Family Rights Act;

     (g)    any and all claims for violation of the Fair Labor
            Standards Act, the California Labor Code, or the
            California Wage Orders; and

     (h)    any and all claims for breach of contract, breach
            of the covenant of good faith and fair dealing,
            invasion of privacy, infliction of emotional
            distress, defamation and misrepresentation.

     Under the agreement $33,308 was the total amount PACE agreed

to pay.    Of the $33,308, $8,187.50 was compensation due to

petitioner, which PACE agreed to send directly to petitioner’s

attorney.    Petitioner reported the $8,187.50 on her 2005 Federal

income tax return as wage compensation.    Another $8,187.50 was

sent directly to petitioner’s attorney, and petitioner was not

issued a Form 1099-MISC, Miscellaneous Income, or Form W-2, Wage

and Tax Statement, by PACE for that amount.    PACE paid the

remaining $16,933 to petitioner without withholding

deductions and issued a Form 1099-MISC reflecting that the amount

was “Nonemployee compensation”.

     Petitioner did not attend the negotiations between her

lawyer and PACE’s lawyer.    At the time petitioner received her
                                 - 7 -

$16,933 settlement it was her understanding that it was to

compensate her for physical injuries that occurred in a hostile

work environment which PACE allowed to exist over an extended

time.   Petitioner’s intense MS symptoms, which occurred during

her PACE employment, prevented her from working until sometime in

2006.

                              Discussion

     The sole question to be considered is whether the $16,933

settlement amount petitioner received is excludable from her

gross income under section 104(a)(2).        More specifically, the

parties disagree about whether petitioner received the settlement

for her physical condition.    Section 104(a) provides in pertinent

part:

     SEC. 104(a). * * * gross income does not include–-

                   *     *      *        *      *     *     *

               (2) 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;

                   *     *      *        *      *     *     *

     * * * For purposes of paragraph (2), emotional distress
     shall not be treated as physical injury or physical
     sickness. The preceding sentence shall not apply to an
     amount of damages not in excess of the amount paid for
     medical care (described in subparagraph (A) or (B) of
     section 213(d)(1)) attributable to emotional distress.
                              - 8 -

     To prevail, petitioner must show3 that her claim against

PACE was based on tort or tort type rights and that the damages

were received on account of physical4 injuries or sickness.

Commissioner v. Schleier, 515 U.S. 323, 337 (1995); see also

Commissioner v. Banks, 543 U.S. 426 (2005).   The agreement,

pursuant to which the $16,933 was paid, contains a list of

numerous possible causes of action or rights that petitioner was

releasing in exchange for the payment.   In all respects, the

settlement agreement is ambiguous5 regarding any specific reason

for the payment.   Respondent relies on that ambiguity as showing

that PACE had no specific intent when making the settlement

payment.   When a settlement agreement lacks express language

stating the specific purpose of the settlement payment, the most

important factor for courts to consider is the intent of the

payor.   See Kurowski v. Commissioner, 917 F.2d 1033, 1036 (7th

Cir. 1990), affg. T.C. Memo. 1989-149.   Accordingly, we must




     3
      Petitioner acknowledges on brief that she bears the burden
of going forward with evidence and the ultimate burden of proof.
No question concerning the shifting of the burden under sec. 7491
was raised by either party.
     4
      The requirement that to be excludable the compensation must
be for “physical injuries or physical sickness” was added to sec.
104 by the Small Business Job Protection Act of 1996, Pub. L.
104-188, sec. 1605, 110 Stat. 1838.
     5
      During trial respondent conceded that petitioner is in no
way limited from showing the specific intent for the payment
because of the ambiguity of the settlement agreement.
                              - 9 -

decide the reason or intent for the payment.   This is a purely

factual inquiry.

     There can be no doubt that petitioner’s claim against PACE

was based on tort or tort type rights.   The parties do not dwell

on this requirement.   The focus of the parties’ arguments is on

the second requirement of the Schleier test, that the damages be

received on account of physical injury or sickness.    It has been

held that the second test “can only be satisfied if there is ‘a

direct causal link’ between the damages and the personal

injuries sustained.”   Banaitis v. Commissioner, 340 F.3d 1074,

1080 (9th Cir. 2003) (quoting Fabry v. Commissioner, 223 F.3d

1261, 1270 (11th Cir. 2000), revg. 111 T.C. 305 (1998)), affg.

in part and revg. in part T.C. Memo. 2002-5, revd. on other

grounds sub nom. Commissioner v. Banks, supra.

     When damages are paid in connection with a settlement

agreement we first look to the underlying agreement to determine

whether it expressly states that the damages compensate for

“personal physical injuries or physical sickness” under sec.

104(a)(2).   See Pipitone v. United States, 180 F.3d 859, 863

(7th Cir. 1999).   If the agreement is ambiguous or lacks express

language specifying the purpose of the compensation, courts then

proceed to examine the intent of the payor.    Id. at 864;

Kurowski v. Commissioner, supra at 1036; Knuckles v.

Commissioner, 349 F.2d 610, 613 (10th Cir. 1965), affg. T.C.
                               - 10 -

Memo. 1964-33.    The payor’s intent can be “based on all the

facts and circumstances of the case, including the complaint

that was filed and the details surrounding the litigation.”

See, e.g., Allum v. Commissioner, T.C. Memo. 2005-177, affd. 231

Fed. Appx. 550 (9th Cir. 2007).6

     Petitioner’s exposure to a hostile and stressful work

environment exacerbated her MS symptoms to a point where she was

unable to work.   This fact was confirmed by her doctor, who

prescribed 2 weeks off.   Petitioner notified her employer of her

condition and faxed to her employer her doctor’s diagnosis

together with his instructions that she take time off from work

because of illness.   A short time later the executive director

advised petitioner by telephone that her employment would be

terminated effective March 15, 2009.

     Petitioner obtained the services of an attorney and

explained (in greater detail) the circumstances of her

employment, illness, and termination from employment.    The

attorney met with petitioner’s employer’s attorney and worked

out a settlement of petitioner’s claim against her employer.

The agreement contained a blanket release from any and all




     6
      Petitioner’s failure to bring suit or make formal
allegations against PACE “is not necessarily detrimental to * * *
[her] efforts to establish the existence of an underlying tort-
type cause of action.” Pipitone v. United States, 180 F.3d 859,
863 (7th Cir. 1999).
                              - 11 -

claims that petitioner might have had, but had no specific or

express statement of the payor’s intent.

     An inference can be drawn, however, from the terms of the

settlement agreement.   The manner in which PACE agreed to pay out

the settlement compensation reveals some recognition of

petitioner’s claim and condition.   The $33,308 settlement was

segregated into three separate and distinct payments.    One amount

($8,187.50) was reflected as employee compensation due to

petitioner which PACE agreed to pay directly to petitioner’s

attorney.   Petitioner reported that $8,187.50 on her 2005 Federal

income tax return as wage compensation.    Another $8,187.50 was

sent directly to petitioner’s attorney, and no Form 1099-MISC or

Form W-2 was issued to petitioner by PACE for that amount.    The

remaining $16,933 was paid by PACE to petitioner, and the payment

was not reduced by withholding.   PACE issued a Form 1099-MISC

reflecting that the $16,933 was “Nonemployee compensation”.

     The differing tax and reporting treatments used for the

three payments show that PACE was aware that at least part of

petitioner’s recovery may not have been subject to tax; i.e., was

due to physical illness.   Coupled with that inference is the fact

that petitioner advised PACE of her illness before her employment

was terminated and the likelihood that her attorney represented

petitioner’s circumstances to PACE in the course of the

settlement negotiations.   Petitioner made no other claim.   We
                              - 12 -

find that PACE intended to compensate petitioner for her acute

physical illness caused by her hostile and stressful work

environment.

     In summary, petitioner has shown that her work environment

exacerbated her existing physical illness.7   Petitioner’s

condition and her MS flareup caused by her working conditions was

intense and long lasting.   Petitioner was physically unable to

work until sometime in 2006, more than 1 year following her

termination.   She has shown that the only reason for the $16,933

payment was to compensate her for her physical injuries.

     To reflect the foregoing and to account for concessions of

the parties,

                                         Decision will be entered

                                    under Rule 155.




     7
      It is of no consequence that petitioner had the MS
condition before the flareup caused by her hostile work
environment.
