                         T.C. Memo. 1997-412



                       UNITED STATES TAX COURT



            DARRELL D. AND JANE E. MORAN, Petitioners v.
            COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 5374-96.                  Filed September 17, 1997.



     Darrell D. and Jane E. Moran,    pro sese.

     James Gehres, for respondent.



               MEMORANDUM FINDINGS OF FACT AND OPINION

     GERBER, Judge:    Respondent, by means of a notice mailed

February 16, 1996, determined an $11,701 income tax deficiency

for petitioners’ 1994 taxable year.    The sole issue for our

consideration is whether the amount of $37,840 received by

Darrell D. Moran1 (petitioner) as the result of the termination


     1
         Jane E. Moran is a petitioner solely because she filed a
                                                     (continued...)
                                - 2 -


of his employment relationship with Holnam, Inc., is excludable

under section 104(a)(2)2 as damages received on account of

personal injury or sickness.3

                          FINDINGS OF FACT

     Petitioners resided in Cheyenne, Wyoming, at the time their

petition was filed.    In 1975, petitioner, who had obtained a

college degree in engineering, began employment with Ideal Cement

Industries.   Holnam, Inc. (Holnam), became the successor to Ideal

Cement Industries.    In 1985, petitioner was selected to go to

Montana to manage a plant that had not performed well.      By 1990,

the plant’s performance had improved.    As of 1993, petitioner had

been promoted to regional sales manager for Montana, and his

office was located in Bozeman, Montana.      During 1993, Holnam

announced a reorganization of the sales portion of its

organization, and petitioner's position was to be eliminated.

Although the Bozeman office was to remain open and a position

higher than petitioner’s was to continue, the higher level

position in Bozeman was offered to a Holnam employee from


     1
      (...continued)
joint return with Darrell D. Moran, who will be referred to as
petitioner in this opinion.
     2
        Unless otherwise indicated, all section references are to
the Internal Revenue Code in effect for the period under
consideration, and all Rule references are to this Court’s Rules
of Practice and Procedure.
     3
       Two other adjustments were set forth in the notice of
deficiency, both of which were computational and dependent on the
outcome of the question of excludability of the $37,840 amount.
                                - 3 -


Seattle, Washington.   From petitioner’s point of view, the higher

level position in Bozeman was petitioner’s old position with a

new title.   Petitioner was offered the alternative of a position

in Seattle or a sales position in Montana, and the acceptance of

either position would require the relocation of petitioner’s

family.   The positions offered to petitioner would not have been

considered promotions.

     Petitioner had little warning preceding these events, and he

was profoundly affected by them.   When petitioner was advised

that he was not going to be offered the new position in Bozeman,

he asked for an explanation, but no explanation was provided,

further upsetting petitioner.   Petitioner had heard that other

employees had been offered "attractive buy-outs".

     Petitioner sought severance pay from Holnam under its policy

and procedure manual, but he was refused on the grounds that

severance pay was only available for involuntary separations.

Thereafter, petitioner was offered a choice between a severance

package or continuing in a particular job position, but he could

not come to terms with company representatives.   Petitioner would

have been satisfied with a reasonable severance package, but the

company representatives did not provide what he regarded as

reasonable alternatives.   Subsequently, petitioner hired Michael

J. San Souci, an attorney, to seek redress from Holnam.   Attorney

San Souci sent a nine-page letter, dated October 29, 1993, to

Alex Pappas, vice president of Holnam's Human Resource
                               - 4 -


Department.   Attorney San Souci explained that he had been hired

to review Holnam’s proposed separation agreement with petitioner,

and he also pointed out that petitioner and his wife had suffered

due to Holnam’s actions.   After setting forth the background,

beginning on page five of the letter, attorney San Souci outlined

the "Potential Liability Issues", which fell into the following

four categories:   Holnam’s conduct toward petitioner may be

deemed (1) the "cause-in-fact" for a constructive discharge;

(2) a breach of express or implied promises of Holnam not to

reprimand, discipline, or discharge him, absent good or just

cause based on the parties’ long-term employment relationship;

(3) a breach of a covenant of good faith and fair dealing based

on Holnam’s supervisors’ treatment of petitioner; and (4) a

violation of section 703(a)(1), title VII of the Civil Rights Act

of 1964 due to discrimination with respect to petitioner

(petitioner is part Native American).   Attorney San Souci’s

letter concluded with settlement proposals covering severance pay

and compensation; accrued unpaid vacation pay, bonuses, and

expenses; continuation and conversion of medical, dental, life,

and disability insurance; 401(k) savings plan, pension, and stock

purchase plans; favorable future recommendations and recovery of

legal fees.

     A settlement agreement was reached between petitioner and

Holnam on November 15, 1993, under which petitioner was to

receive $5,336 per month for 4 months beginning after his
                                - 5 -


resignation from Holnam and a $24,500 lump-sum payment on

March 14, 1994.    In addition, Holnam agreed to provide petitioner

with medical and dental coverage through March 30, 1994.    In

exchange, petitioner agreed, among other things, to release

Holnam from the following pertinent claims:    (1) Any claim that

petitioner was wrongfully forced to resign; (2) all claims for

breach of employment agreement; (3) any claim under "Wrongful

Discharge For Employment Act, Sec. 39-2-901 et seq."; (4) any

claim for discrimination under title VII of the Civil Rights Act

of 1964 or the Montana Human Rights Act; (5) all claims for

improper separation that could have been brought under any local,

State, or Federal administrative agency jurisdiction; (6) all

claims for mental and/or physical injury, damages to or loss of

personal reputation, libel, slander, or defamation of character,

intentional infliction of emotional stress, or violation of civil

or constitutional rights; (7) any claim concerning interference

with any contractual relationship; and (8) any claim for salary,

fringe benefits, costs, expenses or attorney's fees.

     Petitioner received $37,840 under the settlement agreement

during the taxable year 1994, which Holnam reflected as wages or

income to petitioner in the 1994, Form W-2 that Holnam supplied

to petitioner.    Holnam withheld income and employment tax from

the amount paid under the settlement agreement.    Petitioner, on

line 21 of page 1 of his Form 1040 (U.S. Individual Income Tax

Return), deducted $37,714, and in a schedule attached to the
                               - 6 -


return explained that the amount was "excludable under Rev. Rul.

93-88 and code section 104(a)(2) as compensatory damages received

through settlement agreement in lieu of prosecution based upon

tort type rights and racial discrimination claims for disparate

treatment under Title VII."   Respondent disallowed the $37,714

deduction claimed by petitioner.

                              OPINION

     Except as otherwise provided, gross income includes income

from all sources.   Sec. 61(a); Commissioner v. Glenshaw Glass

Co., 348 U.S. 426 (1955).   Section 61(a), concerning inclusion of

income, has been broadly construed, and statutory exclusions from

income have been narrowly construed.    Commissioner v. Schleier,

515 U.S. 323, 327-328 (1995); Kovacs v. Commissioner, 100 T.C.

124, 128 (1993), affd. without published opinion 25 F.3d 1048

(6th Cir. 1994).

     Under section 104(a)(2), 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”.    Section 1.104-1(c), Income Tax

Regs., in pertinent part, provides that

     The term "damages received (whether by suit or
     agreement)" means an amount received * * * 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.

     Thus, an amount may be excluded from gross income only when

it was received both:   (1) Through prosecution or settlement of
                                - 7 -


an action based upon tort or tort type rights; and (2) on account

of personal injuries or sickness.       Commissioner v. Schleier,

supra; Wesson v. United States, 48 F.3d 894, 901-902 (5th Cir.

1995); Bagley v. Commissioner, 105 T.C. 396, 416 (1995), affd. __

F.3d __ (8th Cir., Aug. 6, 1997).

      When damages are received pursuant to a settlement

agreement, the nature of the claim that was the actual basis for

settlement controls whether such damages are excludable under

section 104(a)(2).    United States v. Burke, 504 U.S. 229, 237

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

1989), affg. 89 T.C. 632 (1987); Robinson v. Commissioner, 102

T.C. 116, 126 (1994), affd. in part, revd. in part and remanded

70 F.3d 34 (5th Cir. 1995).   "[T]he critical question is, in lieu

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

supra at 406.

      Determination of the nature of the claim is factual.      Id.;

Stocks v. Commissioner, 98 T.C. 1, 11 (1992).      The first

requirement is the existence of a claim based upon tort or tort

type rights.    Commissioner v. Schleier, supra at 337.    The claim

must be bona fide, but not necessarily valid; i.e., sustainable.

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

v. Commissioner, supra at 126; Stocks v. Commissioner, supra at

10.

      Petitioner here was a long-term employee (almost 20 years)

of a business enterprise.   During that employment, he progressed
                                 - 8 -


through a series of more responsible positions from sales

representative to sales manager in Bozeman, Montana.    A

restructuring of the company caused the elimination of the layer

of management where petitioner’s position was situated, and he

was offered positions in the layer below the one eliminated.

Both of the positions offered would have been in locations other

than the one in which petitioner and his family had settled.      The

position in the surviving layer of the company, just above the

one that was eliminated, which was located in Bozeman, Montana,

was offered to a person other than petitioner.

     Initially, petitioner applied for severance pay, but was

turned down because the company’s policy was to only permit

severance pay for employees who were “involuntarily separated”

due to a "reduction in force".     After he was turned down for

severance pay, petitioner engaged an attorney who approached the

company with various claims that he thought petitioner could

assert against the company due to his circumstances.    Those

claims generally included various breaches of contractual type

rights, wrongful discharge, and violation of civil rights.      The

parties’ settlement agreement does not delineate or allocate the

amounts which are attributable to the various claims made by

petitioner.   Although no specific amount is allocated to any

particular claim, petitioner released the company from possible

claims sounding in both contract and tort, including

discrimination under title VII of the Civil Rights Act of 1964 or
                                - 9 -


the Montana Human Rights Act and all claims for mental and/or

physical injury, damages to or loss of personal reputation,

libel, slander, or defamation of character, intentional

infliction of distress or violation of civil or constitutional

rights.   It is accordingly difficult to differentiate the actual

basis for settlement.   Similarly, we are unable to discern from

the method of payment whether any portion was designated or

intended to be allocable to any one of petitioner’s claims.



     The settlement agreement between petitioner and the company

does not specifically indicate that the four monthly payments or

the lump-sum payment received by petitioner were paid to settle a

potential personal injury claim against the employer/company.

Where a settlement agreement lacks express language stating what

the settlement amount was paid to settle, then the most important

factor is the intent of the payor.      Knuckles v. Commissioner, 349

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

v. Commissioner, 80 T.C. 1104, 1107 (1983).

     In that regard the evidence in this case does not present a

predicate for finding that petitioner’s former employer made an

identifiable portion of the payments to settle a claim in tort or

on account of a personal injury.   The payments here appear to be

more in the nature of taxable severance pay rather than a payment

for personal injury.    Petitioner was profoundly affected by the

actions of the company, but there has been no showing of any
                              - 10 -


specific tort or personal injury.    Although petitioner is part

Native American, there is no indication that he was discriminated

against or that damages were paid under the settlement due to

that fact.   Other than the distress caused by the unsettling

circumstances surrounding the company’s restructuring and the

elimination of petitioner’s position, there is no indication of a

personal injury.   Nor is there a sufficient basis in the record

for allocating any portion of the settlement to such an injury.

     The settlement agreement indicates that petitioner "wishes

to voluntarily terminate his employment with HOLNAM    * * * [and

that] HOLNAM is willing to offer * * * [petitioner] certain

compensation and benefits as assistance, some of which * * *

[petitioner] would not be entitled to receive except by reason of

this Separation Agreement and Release."    Further, the agreement

designates the payments in question as "severance pay" and the

company treated them as such, withholding income and employment

tax from the payments made to petitioner.

     Under these circumstances, the payments received by

petitioner are not excludable from his gross income under section

104(a)(2).

     To reflect the foregoing,

                                      Decision will be entered

                                 for respondent.
