                         T.C. Memo. 2000-131



                       UNITED STATES TAX COURT



    MADELINE A. COBLENZ AND WILLIAM J. MASON, Petitioners v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 22383-97.                Filed April 11, 2000.



     William A. Roberts, for petitioners.

     Wanda M. Cohen and Russell S. Shieldes (specially

recognized), for respondent.



             MEMORANDUM FINDINGS OF FACT AND OPINION

     VASQUEZ, Judge:    For 1995, respondent determined a

deficiency of $88,497 in and an accuracy-related penalty of

$17,699 on petitioners’ Federal income tax.      The issues for
                               - 2 -

decision are (1) whether $266,6861 received by William J. Mason

(hereinafter, petitioner) in connection with a settlement of a

lawsuit should be excluded from gross income pursuant to section

104(a)(2); and (2) whether petitioners are liable for an

accuracy-related penalty pursuant to section 6662(a).2

                         FINDINGS OF FACT

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

The stipulation of facts and the attached exhibits are

incorporated herein by this reference.   At the time they filed

their petition, petitioners resided in Houston, Texas.

     From 1977 to 1985, petitioner was a manager of various movie

theaters.   Towards the end of that period, petitioner met an

individual involved in radio broadcasting.   After this encounter,

petitioner became interested in purchasing and upgrading a radio

station.




     1
        The record reflects that this amount comprises settlement
proceeds of $550,000 net of attorney’s fees and litigation
expenses. In the notice of deficiency, respondent’s
determination did not include in income the entire $550,000, only
the $266,686. At the end of the trial, pursuant to Rule 41(b),
respondent orally moved to amend the pleadings to conform to the
evidence (i.e., treating the settlement proceeds of $550,000 as
income and the attorney’s fees and litigation expenses as
miscellaneous itemized deductions) and increase the deficiency.
We denied respondent’s motion.
     2
        All 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.
                               - 3 -

Acquisition of Radio Station

     In late 1987, petitioner located a radio station in

Beaumont, Texas, struggling financially and in bankruptcy.

Petitioner developed a business plan for acquiring, upgrading,

and profitably operating the radio station (the venture).

     In December 1988, petitioner met Mark W. White, Jr. (Mr.

White), a former Texas Governor, and discussed the venture.

After their meeting, petitioner negotiated favorable contracts

and organized Modern World Media, Inc. (Modern World) with Mr.

White, to acquire the radio station.3   In the beginning of 1990,

using his many contacts, Mr. White obtained bank financing for

the venture from First City, Texas-Houston, N.A. (First City

Bank).   As a condition for the financing, First City Bank

required a letter of credit to secure $5.5 million in bank loans.

     Mr. White introduced petitioner to various wealthy Texas

business people.   Through these introductions, Mr. White and

petitioner convinced H. Ross Perot (Mr. Perot) to commit a $2.5

million letter of credit for the venture through one of Mr.

Perot’s companies, Gnat Robot Corp.

     During 1990, First City Bank advanced funds in an amount

less than $5.5 million.   With the funds that Mr. White and

petitioner received from First City Bank, they acquired the radio


     3
        Because Mr. White was seeking the Democratic nomination
for the Texas governorship, Mr. White did not initially take an
equity interest in Modern World.
                                - 4 -

station and made some minor improvements.   Because of the

incomplete funding, the radio station did not begin operating

profitably or generating cash-flows as projected by petitioner’s

business plan.

Lawsuit by Gnat Robot Corp. and Mr. Perot

     By the end of 1990, Mr. Perot became concerned about his

investment in the venture.   Gnat Robot Corp. subsequently

requested Modern World to find someone else to provide a letter

of credit.   In early 1991, Gnat Robot Corp. and Mr. Perot

instituted a lawsuit against First City Bank, Modern World, Mr.

White, Linda Gale White (Mrs. White),4 and petitioner

(collectively, defendants) to enjoin First City Bank from drawing

upon the letter of credit and to award Gnat Robot Corp. and Mr.

Perot a 100-percent equity interest in Modern World (Gnat

lawsuit).    After Gnat Robot Corp. and Mr. Perot failed to obtain

an injunction, First City Bank drew upon the letter of credit.

Gnat Robot Corp. and Mr. Perot continued pursuing the Gnat

lawsuit to recover the $2.5 million and to obtain the 100-percent

equity interest in Modern World.   After a jury trial, the

defendants were ordered jointly and severally to pay Gnat Robot

Corp. and Mr. Perot $2.5 million plus interest.   Mr. White, Mrs.

White, and petitioner were ordered to relinquish their equity


     4
        Mrs. White, Mr. White’s spouse, was a part owner of
Modern World and participated in the agreement with Gnat Robot
Corp. with regard to the letter of credit.
                                - 5 -

interest in Modern World to Gnat Robot Corp.    Before the judgment

was entered against Modern World, Mr. and Mrs. White caused

Modern World to seek bankruptcy protection.

     During late 1991 and early 1992, several Texas newspapers

reported the Gnat lawsuit.   The newspaper headlines and

underlying stories mostly described the Gnat lawsuit as a legal

fight between Mr. White and Mr. Perot.    Some of the articles,

however, made references to petitioner.    After the Gnat lawsuit,

petitioner unsuccessfully attempted to raise venture capital to

acquire other radio stations.

First City Bank Receivership

     During 1992, the Federal Deposit Insurance Corporation (the

FDIC) took control of First City Bank for reasons unrelated to

the venture and established a receivership to liquidate its

assets and pay off its debts.   An entity, First City Liquidating

Trust Loans, L.P. (FCLT), was created to receive any assets

remaining after all debts had been paid and to distribute those

assets to a corporation that had obtained the rights to those

assets (purchasing corporation).   The FDIC set aside $20 million

of First City Bank’s assets to create a reserve for claims

against and litigation expenses incurred for First City Bank.

Any funds remaining after the resolution of all claims against

First City Bank were to be transferred to FCLT.
                                 - 6 -



Petitioner’s Administrative Claim Against the FDIC

       On February 8, 1993, petitioner filed an administrative

claim with the FDIC, as the receiver for First City Bank, in the

amount of $3 million.     On July 13, 1993, petitioner amended his

claim to $2.5 million plus interest.     On January 26, 1994,

petitioner’s claim was denied by the FDIC for failure to provide

sufficient information to support a provable claim.

Petitioner’s Complaints Filed in U.S. District Court

       Petitioner retained the services of Leonard Simon (Mr.

Simon), a commercial litigator and bankruptcy attorney, who

evaluated several potential causes of action against the FDIC as

receiver for First City Bank.     On March 28, 1994, petitioner

filed a complaint against the FDIC alleging four causes of

action:    (1) Count I:   Breach Of Warranty, (2) Count II:   Texas

Deceptive Trade Practices - Consumer Protection Act, (3) Count

III:    Tortious Interference, and (4) Count IV:   Conspiracy.    On

August 18, 1994, petitioner filed an amended complaint alleging

an additional cause of action entitled Count V:     Breach Of The

Duty Of Care Owed By A Pledgee Of Stock.     We refer generally to

petitioner’s complaint and amended complaint as petitioner’s

lawsuit.

       Petitioner’s amended complaint contained a section entitled

“The Facts” which recited relevant facts serving as the basis of
                               - 7 -

petitioner’s lawsuit.   Petitioner alleged in “The Facts” that

“First City [Bank] wrongfully demanded, and received, payment of

$2,500,000, under * * * [Gnat Robot Corp.’s] letter of credit,

and thereby triggered a sequence of events that deprived * * *

[petitioner] of his ownership rights in * * * [Modern World] but

left him indebted to third parties based on guarantees directly

related to those ownership rights that were lost”.

     On the basis of “The Facts”, in Count I, petitioner alleged

that when First City Bank demanded payment on the letter of

credit, it warranted to all interested parties that $2.5 million

was due and payable by Modern World.     Petitioner further alleged

that the $2.5 million was not due and payable and that therefore

First City Bank’s improper demand caused petitioner to lose his

equity interest in Modern World.   As to Count II, he alleged that

First City Bank violated certain provisions of the “Texas

Deceptive Trade Practices - Consumer Protection Act”, that First

City Bank breached its warranty made to petitioner, and that

First City Bank “engaged in an unconscionable course of action”.

In Count III, petitioner contended that First City Bank’s

interference with petitioner’s contractual relationship with Gnat

Robot Corp. caused damages to petitioner, including the loss of

his equity rights in Modern World.     In Count IV, petitioner

alleged that First City Bank and Mr. White entered into a

conspiracy to place Modern World in bankruptcy proceedings from
                                - 8 -

which Modern World did not financially recover.    Finally, in

Count V, petitioner alleged that First City Bank “breached the

duty of ordinary care that a creditor in possession of property

securing a debt owes to the pledgor of such property”.    As a

result of First City Bank’s breach, petitioner alleged that he

lost the Modern World stock which he had pledged to First City

Bank.    Petitioner sought actual and consequential damages, as

well as attorney’s fees, on account of these alleged causes of

action.5

     In his original and amended complaints, petitioner did not

allege that First City Bank’s actions damaged his business

reputation.    Although Mr. Simon retained an appraiser to value

petitioner’s equity interest in Modern World, he did not hire an

expert to value any harm to petitioner’s business reputation.

Initial Offer of Settlement, Mediation, and Documents Filed With
the U.S. District Court

     On October 18, 1994, Mr. Simon made an initial offer of

settlement to the FDIC.    Mr. Simon proposed that in settlement of

petitioner’s claims, the FDIC provide petitioner with a $750,000

payment or a $2 million loan for the purchase of another radio

station.    The FDIC rejected Mr. Simon’s offer.

     In June of 1995, Mr. Simon contacted Pat Cantrell, a tax

attorney, C.P.A., and former IRS revenue agent and Appeals


     5
        With regard to some counts, petitioner sought incidental,
enhanced, and punitive damages.
                               - 9 -

officer (tax adviser), for advice regarding whether settlement

proceeds in petitioner’s lawsuit would be considered nontaxable

income under the tax laws.

     The litigation eventually proceeded to mediation.    On July

20, 1995, Mr. Simon, petitioner, and representatives for the FDIC

met before a mediator.   Larry A. Thomas served as the lead

attorney for the FDIC (the FDIC attorney).   The mediation proved

unsuccessful.

     Before and after the mediation, the FDIC and petitioner

filed various motions and documents with the U.S. District Court.

On July 19, 1995, the FDIC filed a motion for summary judgment

with regard to petitioner’s amended complaint.6    On July 25,

1995, petitioner filed a supplement to his amended complaint

alleging that First City Bank participated in Mr. White’s alleged

breach of his fiduciary duties to petitioner.     Petitioner alleged

that his damages included the value of his Modern World stock at

the time of First City Bank’s wrongful conduct.7    In motions to

dismiss and for summary judgment, the FDIC vigorously contested

both petitioner’s claim that First City Bank caused him to lose


     6
        The U.S. District Court granted the FDIC’s motion for
summary judgment with regard to Count II.
     7
        The other damages alleged by petitioner consisted of any
amounts the U.S. District Court might award First City Bank on
its counterclaim against him. Based on this description of
petitioner’s damages, petitioner sought actual, punitive, or
enhanced damages, court costs, and attorney’s fees in the
supplement to his amended complaint.
                               - 10 -

his equity interest in Modern World and petitioner’s valuation of

the equity interest.   On August 1, 1995, petitioner moved for

summary judgment with regard to certain causes of action in his

lawsuit (cross motion for summary judgment).   In that cross

motion for summary judgment, petitioner alleged that his damages

amounted to the value of his stock awarded to Gnat Robot Corp.

Final Settlement Discussions

     After mediation failed, Mr. Simon and petitioner decided to

negotiate with Bob Brown (Mr. Brown), who was in charge of FCLT.

On August 29, 1995, prepared to make a detailed presentation

regarding petitioner’s claims, Mr. Simon and petitioner met

briefly with Mr. Brown.   Before the meeting, the FDIC had

approved Mr. Brown’s involvement in the settlement discussions.

At the meeting, Mr. Brown only asked Mr. Simon and petitioner for

a settlement figure.   There were no discussions about the alleged

causes of action in petitioner’s lawsuit.   The meeting lasted

only 10 to 15 minutes, and they agreed that the FDIC, subject to

its approval, would pay $550,000 to settle petitioner’s claims

(settlement offer).

FDIC Approval of the Settlement Offer

     Mr. Brown, thereafter, notified the FDIC attorney of the

settlement offer.   On August 30, 1995, the FDIC attorney wrote a

legal memorandum to an FDIC officer summarizing the facts

involved in petitioner’s lawsuit, analyzing each of petitioner’s
                                - 11 -

remaining causes of action, and recommending the approval of the

settlement offer.   In a section entitled “AMOUNT OF CLAIM”, the

FDIC attorney stated that petitioner alleged that “he has been

damaged in the amount of the value of his stock in the radio

station asset”.   In a section entitled “CURRENT STATUS AND

ESTIMATES”, the FDIC attorney stated that “this is a complicated

case involving many complex legal issues which could cause

difficulty for a jury and, therefore, create uncertainty as to

the outcome.   It is clear that Mason plans to make an emotional

argument to the jury claiming he was the innocent party and * * *

[First City Bank] destroyed his dream of owning a radio station.”

The FDIC attorney, however, did not specifically address a harm

to business reputation claim.

     On August 31, 1995, the FDIC approved the settlement offer.

Sometime after the FDIC approved the settlement, the FDIC

attorney coordinated the drafting of a Mutual Settlement and

Indemnification Agreement (settlement agreement).   Before the

drafting of the settlement agreement, the FDIC attorney was not

aware of any claim by petitioner that First City Bank had harmed

his business reputation.   On September 8, 1995, the FDIC prepared

a check in the amount of $550,000, payable to petitioner.

Drafting of the Settlement Agreement

     The draft of the settlement agreement dated September 10,

1995, contained an introductory paragraph listing the parties
                                - 12 -

subject to the settlement agreement and its effective date, a

“Recitals” section outlining relevant facts, and a

“Consideration” section providing the benefits and obligations of

each party.    In the Consideration section, petitioner’s attorneys

included a statement that the settlement proceeds were in

satisfaction of petitioner’s claims for personal injuries,

“within the meaning of title 26, section 104, of the United

States Code”, resulting from the alleged tortious conduct by

First City Bank (the section 104 sentence).8

         The FDIC attorney was surprised by the inclusion of the

section 104 sentence.     After reading section 104, the FDIC

attorney concluded that only settlement proceeds on account of

physical injuries were excluded from gross income.     Therefore, he

requested that the section 104 sentence be removed.

     By September 12, 1995, the parties9 produced a final draft

of the settlement agreement (final settlement agreement).       In the

final settlement agreement, the section 104 sentence was removed.

The Recitals section stated, among other things, that “Mason then

commenced an action * * *, alleging various tort claims based on



     8
        Around this period in September 1995, Mr. Cantrell
provided Mr. Simon an opinion that the settlement proceeds were
nontaxable.
     9
        Although FCLT, the purchasing corporation, and Madeline
Coblenz (petitioner’s wife) were not named parties in
petitioner’s lawsuit, the settlement agreement referred to them,
in addition to the FDIC and petitioner.
                              - 13 -

the alleged misconduct of * * * [First City Bank] and alleging

actual and consequential damages in an unspecified amount”.

Petitioner’s attorneys requested that the language “Mason

believes that * * * [First City Bank’s] conduct damaged his

business reputation” (business reputation sentence) be included

in the Recitals section of the final settlement agreement.

Because the FDIC attorney did not find petitioner’s belief

relevant, he permitted the inclusion of the business reputation

sentence in the final settlement agreement.

     In the Consideration section of the final settlement

agreement, the parties released each other from any claims that

each had against the other.   With regard to the scope of the

settlement agreement, however, the parties stated that the

“release is limited to those claims, demands, rights and causes

of action with respect to acts, omissions, transactions,

practices, conduct, facts or circumstances arising from (1) the

subject matter of the Recitals, (2) the subject matter of the

Mason Lawsuit, (3) the Mason Note and (4) the Mason Guaranty”

(scope provision).   The scope provision similarly appeared in the

September 10, 1995, draft of the final settlement agreement.

     The parties did not allocate the $550,000 petitioner

received from the FDIC (settlement proceeds) to any specific

claim by petitioner.   After attorney’s fees and litigation

expenses, petitioner received a net amount of $266,686.
                              - 14 -


                              OPINION

I.    Evidentiary Issue

      Petitioners reserved relevance objections to Exhibits 42-R

through 57-R.   The exhibits consist of court documents related to

motions to dismiss and for summary judgment filed by the FDIC and

petitioner in petitioner’s lawsuit.     Rule 401 of the Federal

Rules of Evidence defines relevant evidence as “evidence having

any tendency to make the existence of any fact that is of

consequence to the determination of the action more probable or

less probable than it would be without the evidence”.     In order

to be deemed relevant, proffered evidence need not prove an

ultimate fact in issue; it must only tend to make the existence

of any fact more or less probable.     Upon reviewing the exhibits

to which petitioners’ relevance objections are outstanding, we

find those exhibits relevant within the meaning of rule 401, and

thus petitioners’ objections are overruled and the exhibits are

hereby made a part of this record.

II.   Section 104(a)(2) Exclusion From Gross Income

      Under section 61(a), Congress has provided that gross income

includes all income from whatever source derived unless otherwise

excluded by the Internal Revenue Code.     See Commissioner v.

Glenshaw Glass Co., 348 U.S. 426, 429-430 (1955).     Pursuant to

section 104(a)(2), gross income does not include “the amount of

any damages received (whether by suit or agreement and whether as
                               - 15 -

lump sums or as periodic payments) on account of personal

injuries or sickness”.

     The Secretary has interpreted “damages received” to mean

amounts 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”.    Sec. 1.104-

1(c), Income Tax Regs.   Therefore, to exclude damages from gross

income pursuant to section 104(a)(2), the taxpayer must prove (1)

the underlying cause of action is based upon tort or tort type

rights; and (2) the damages received were on account of personal

injuries or sickness.    See Commissioner v. Schleier, 515 U.S.

323, 337 (1995).   The term “personal injuries” has been

interpreted as including nonphysical injuries such as those

affecting emotions, reputation, or character.10   See United

States v. Burke, 504 U.S. 229, 235 n.6 (1992).    This Court has in

certain circumstances concluded that damages received on account

of harm to business reputation were received on account of

personal injuries.   See, e.g., Threlkeld v. Commissioner, 87 T.C.

1294, 1308 (1986), affd. 848 F.2d 81 (6th Cir. 1988).

     In evaluating whether amounts received pursuant to a



     10
        Congress amended sec. 104(a)(2) in The Small Business
Job Protection Act of 1996, Pub. L. 104-188, sec. 1605(a), 110
Stat. 1755, 1838, by limiting the exclusion, inter alia, to
“personal physical injuries or physical sickness”. The amendment
does not apply to the year before us and has no bearing on the
instant case.
                              - 16 -

settlement agreement are excludable under section 104(a)(2), we

look to the written terms of the settlement agreement to

determine the origin and allocation of the settlement proceeds.

See Metzger v. Commissioner, 88 T.C. 834 (1987), affd. without

published opinion 845 F.2d 1013 (3d Cir. 1988); Jacobs v.

Commissioner, T.C. Memo. 2000-59.     If the language in the

settlement agreement is unclear about the claim subject to

settlement or if the settlement agreement does not provide for

any allocations, we must look to “‘the intent of the payor’ as to

the purpose in making the payment.”     Metzger v. Commissioner,

supra at 847-848; see also Robinson v. Commissioner, 102 T.C.

116, 127 (1994), affd. in part, revd. in part and remanded on

another issue 70 F.3d 34 (5th Cir. 1995).    We analyze the nature

of the claim that was the basis for settlement, not the validity

of the claim.   See United States v. Burke, supra at 237; Fabry v.

Commissioner, 111 T.C. 305 (1998).     We ask ourselves “in lieu of

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

105 T.C. 396, 406 (1995), affd. 121 F.3d 393 (8th Cir. 1997).

This involves a factual inquiry.    See Fabry v. Commissioner,

supra.

     In the instant case, the litigants disagree as to the nature

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

agreement.   Petitioners contend that petitioner alleged various

causes of actions in his lawsuit against the FDIC which are
                               - 17 -

considered torts under Texas law, that petitioner incurred harm

to his business reputation as a result of the alleged torts

committed by First City Bank, that the harm to his business

reputation was a personal injury, and that petitioner’s lawsuit

was settled on account of that personal injury.    Respondent

disagrees and asserts that petitioner’s lawsuit was settled on

account of petitioner’s loss of the Modern World stock, an

economic injury.   We first discuss whether the settlement

proceeds were received on account of a harm to business

reputation claim and on account of personal injuries or sickness.

     The parties executed a settlement agreement to settle

petitioner’s lawsuit.    Within the scope provision of the final

settlement agreement, the parties recited that the subject matter

of the Recitals and petitioner’s lawsuit served as the basis for

the settlement.    By reference to the Recitals section in the

final settlement agreement and petitioner’s amended complaint

against the FDIC, the final settlement agreement covers both a

claim of harm to business reputation and a loss of the Modern

World stock, respectively.    Because the final settlement

agreement does not provide an allocation with regard to those

claims, we look beyond the final settlement agreement to

determine the intent of the payor in paying the settlement

proceeds.

     In reaching a settlement with the FDIC, petitioner and his
                              - 18 -

attorneys underwent various steps:     (1) Filing an administrative

claim, (2) filing a complaint in U.S. District Court, (3)

participating in mediation, (4) filing various court papers, (5)

pursuing settlement discussions, and (6) drafting a settlement

agreement.   We evaluate each step to determine whether the

settlement proceeds paid by the FDIC were on account of

petitioner’s claim of harm to business reputation.

     Petitioner filed an administrative claim with the FDIC which

was subsequently dismissed.   The record does not contain the

administrative complaint filed by petitioner with the FDIC.      As

to the types of damages alleged by petitioner in the

administrative complaint, an FDIC internal memorandum suggests

that petitioner sought $2.5 million plus interest for the loss of

his Modern World stock.

     In his original and amended complaints in the U.S. District

Court, petitioner never alleged that his business reputation was

harmed.   Instead, as to Counts I, III, and V in the amended

complaint, petitioner claimed that First City Bank’s actions

caused him to lose his equity interest in Modern World.    The

remaining counts did not specify any damage resulting from harm

to business reputation.   Petitioners argue that as to all counts

in petitioner’s amended complaint, petitioner sought actual and

consequential damages which included harm to business reputation.

The language of the original and amended complaints and the
                                - 19 -

overall record do not support petitioner’s argument.      See

discussion infra.

     The FDIC and petitioner proceeded to mediation after the

filing of petitioner’s lawsuit.    At trial in the present case,

petitioner testified that his dream of owning a radio station was

discussed during the mediation.    However, neither petitioner nor

Mr. Simon testified that a claim of harm to business reputation

was discussed during the mediation.      At trial in the present

case, the FDIC attorney could not remember the claims made by

petitioner during the mediation, but he did document petitioner’s

claims in a memorandum drafted after the mediation.      Nowhere in

that memorandum did the FDIC attorney discuss that petitioner

alleged that his business reputation was harmed.     On the

contrary, the memorandum concentrated on petitioner’s allegations

regarding his lost equity interest in Modern World and the

valuation of that ownership interest.

     In documents filed with regard to motions to dismiss and for

summary judgment, the FDIC never contested or addressed a harm to

business reputation argument.    In fact, petitioner filed a cross

motion for summary judgment in which he alleged that First City

Bank’s wrongful conduct caused him to lose his Modern World

stock.

     During the final settlement discussions with Mr. Brown,

there were no discussions about petitioners’ alleged causes of
                               - 20 -

action.    The record reveals that the FDIC was first made aware of

petitioner’s harm to business reputation claim upon receipt of

the September 10, 1995, draft of the settlement agreement.    By

that time, the FDIC had approved the settlement offer and

prepared a check for petitioner.   The FDIC attorney subsequently

requested that the section 104 sentence be removed, and he only

allowed the inclusion of the business reputation sentence because

he did not view petitioner’s belief as relevant.

     Although we look to the FDIC’s intent in settling

petitioner’s lawsuit, we note that Mr. Simon testified that he

understood petitioner’s story as “a loss of his business”.    He

further testified that his initial legal theories “were all

primarily tort related theories that dealt with the actions of

First City [Bank] that resulted in a loss of petitioner’s ability

to ultimately own, operate, and reap the benefits of this radio

station [referring to Modern World]”.   Mr. Simon hired an

appraiser to make a valuation of the radio station and to compute

the value of petitioner’s equity ownership.   Further, Mr. Simon

testified that after the mediation, he and his associates

reevaluated the case, and “[they] tried to just refocus on the

point that Bill Mason had been damaged, that his reputation had

been damaged, and that his life-long dream of owning a radio

station had been foreclosed by the activities of First City

[Bank]”.   During the final settlement discussions, however, in
                               - 21 -

Mr. Simon’s and petitioner’s meeting with Mr. Brown, there were

no discussions regarding petitioner’s alleged causes of action.

       On the basis of the entire record, we conclude that the FDIC

did not provide the settlement proceeds to petitioner on account

of a harm to business reputation claim.11   The record, instead,

favors respondent’s argument that the FDIC settled petitioner’s

lawsuit on account of his allegations that First City Bank’s

actions led to the loss of his Modern World stock.    Because we

decide against petitioners with regard to whether the settlement

proceeds were received on account of harm to business reputation,

we conclude that the settlement proceeds were not received on

account of personal injuries or sickness.    Accordingly, we need

not address whether the underlying causes of action were based

upon tort or tort type rights.    Therefore, we sustain

respondent’s determination.

III.    Section 6662(a) Accuracy-Related Penalty

       Pursuant to section 6662(a), for the year in issue,

respondent determined an accuracy-related penalty of 20 percent

on the amount of the underpayment attributable to a substantial

understatement of tax.    In the alternative, respondent determined

the accuracy-related penalty on the amount of the underpayment


       11
        Petitioners argue that FCLT was the real payor of the
settlement proceeds. While we disagree, we note that Mr. Simon
and petitioner did not discuss petitioner’s claims with Mr. Brown
and that petitioners have failed to provide any credible evidence
that Mr. Brown was aware of a harm to business reputation claim.
                              - 22 -

due to negligence or disregard of rules or regulations.

Respondent's determinations are presumed to be correct, and

petitioners bear the burden of proving that the accuracy-related

penalty does not apply.   See Rule 142(a).

     A substantial understatement of tax is defined as an

understatement of tax that exceeds the greater of 10 percent of

the tax required to be shown on the tax return or $5,000.     See

sec. 6662(d)(1)(A).   The understatement is reduced to the extent

that the taxpayer has (1) adequately disclosed his or her

position or (2) has substantial authority for the tax treatment

of the item.   See sec. 6662(d)(2)(B).   Section 6662(c) defines

“negligence” as any failure to make a reasonable attempt to

comply with the provisions of the Internal Revenue Code, and

“disregard” means any careless, reckless, or intentional

disregard.

     Whether applied because of a substantial understatement of

tax or negligence or disregard of the rules or regulations, the

accuracy-related penalty is not imposed with respect to any

portion of the understatement as to which the taxpayer acted with

reasonable cause and in good-faith.    See sec. 6664(c)(1).   The

decision as to whether the taxpayer acted with reasonable cause

and in good-faith depends upon all the pertinent facts and

circumstances.   See sec. 1.6664-4(b)(1), Income Tax Regs.

Relevant factors include the taxpayer's efforts to assess his
                               - 23 -

proper tax liability, including the taxpayer’s reasonable and

good-faith reliance on the advice of a professional such as an

accountant.   See id.   Further, an honest misunderstanding of fact

or law that is reasonable in light of the experience, knowledge,

and education of the taxpayer may indicate reasonable cause and

good-faith.   See Remy v. Commissioner, T.C. Memo. 1997-72.

     Petitioners’ tax adviser testified at trial that he reviewed

the pleadings in petitioner’s lawsuit, the final settlement

agreement, and the applicable tax law and discussed petitioner’s

lawsuit with Mr. Simon and petitioner before recommending to

petitioners that the settlement proceeds were excludable under

section 104(a)(2).   The tax adviser made the recommendation

around the time of the final settlement agreement and the filing

of petitioners’ 1995 tax return.   After reviewing the entire

record, we find petitioners' reliance on their tax adviser

reasonable and in good-faith, and we conclude that the accuracy-

related penalty should not be imposed in this case.

     In reaching our holdings herein, we have considered all

arguments made, and to the extent not mentioned above, we find

them to be irrelevant or without merit.
                        - 24 -

To reflect the foregoing,

                                 Decision will be entered for

                            respondent with respect to the

                            deficiency and for petitioners with

                            respect to the accuracy-related

                            penalty.
