                  T.C. Summary Opinion 2004-28



                      UNITED STATES TAX COURT



          WALLY O. AND KATE A. OYELOLA, Petitioners v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 6599-02S.              Filed March 12, 2004.


     Wally O. and Kate A. Oyelola, pro sese.

     Frank W. Louis, for respondent.



     WHERRY, 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.1   The decision to be entered

is not reviewable by any other court, and this opinion should not

be cited as authority.


     1
       Unless otherwise indicated, section references are to
sections of the Internal Revenue Code in effect for the years in
issue, and Rule references are to the Tax Court Rules of Practice
and Procedure.
                               - 2 -

     Respondent determined Federal income tax deficiencies for

petitioners’ 1997 and 1998 taxable years in the amounts of $898

and $30,008, respectively.   Respondent also determined an

accuracy-related penalty in accordance with section 6662(a) of

$3,793 for 1998.   After concessions by petitioners, the sole

issue for decision is whether a $30,000 payment received by

petitioner Wally O. Oyelola (also known as Oluwole Oyelola and

hereinafter Mr. Oyelola) is excludable from gross income under

section 104(a).

                             Background

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

The stipulations of the parties, with accompanying exhibits, are

incorporated herein by this reference.    At the time the petition

was filed in this case, petitioners resided in Tolland,

Connecticut.

     Mr. Oyelola began working for Connecticut Mutual Life

Insurance Company in December of 1989.    On May 13, 1996, Mr.

Oyelola filed a racial discrimination complaint against

Connecticut Mutual Life Insurance Company with the Connecticut

Commission on Human Rights and Opportunities.    This complaint was

amended on August 5, 1996, but was ultimately dismissed because

it was not filed within 180 days of the alleged unlawful

employment practices.
                               - 3 -

     Thereafter, on February 11, 1998, Mr. Oyelola brought an

action against Massachusetts Mutual Life Insurance Company2 and

various individuals in the U.S. District Court for the District

of Connecticut.   The complaint in this action, brought under

Title VII of the Civil Rights Act of 1964, alleged a history of

discrimination based on race, color, ancestry, and national

origin.

     The District Court action was resolved by a General Release,

Confidential Separation Agreement, Waiver and Covenant Not To Sue

(settlement agreement) executed by Mr. Oyelola and a

representative for Massachusetts Mutual Life Insurance Company

and the individual defendants on August 20 and 27, 1998,

respectively.   The stated purpose of the settlement agreement was

“to resolve any and all differences that may now exist, or may

arise in the future as a result of any act that has heretofore

occurred, under state or federal law regarding employment with

and separation from the Company”.   The document then provided in

Paragraph 4 for the following settlement terms:

     a.   The Company will pay to Mr. Oyelola the amount of
     Thirty Thousand Dollars ($30,000.00) (Payment 1).
     Payment 1 is payable to Mr. Oyelola based on his claim
     that he is entitled to compensation for emotional
     distress.



     2
         Massachusetts Mutual Life Insurance Company and
Connecticut Mutual Life Insurance Company merged in 1996, and Mr.
Oyelola’s employment apparently continued with the merged entity
under the Massachusetts Mutual Life Insurance Company name.
                         - 4 -

b.   The Company will pay to Mr. Oyelola the amount of
Ninety Thousand Dollars ($90,000.00), minus appropriate
withholdings and deductions (Payment 2). Payment 2 is
payable to Mr. Oyelola as compensation for
Mr. Oyelola’s claims of lost wages.

c.   The Company will pay to Mr. Oyelola the amount of
Sixty Thousand Dollars ($60,000.00) for any and all
attorney’s fees, costs and claims incurred by
Mr. Oyelola (Payment 3). Payment 3 is payable to
Mr. Oyelola’s counsel of record, Nitor V. Egbarin, Esq.

d.   The Company will pay to Mr. Oyelola the sum of
Seven Thousand Eight Hundred Twenty Four Dollars
($7,824.00), which is an amount equivalent to the cost
of 12 months of continued COBRA benefits, including
both medical and dental coverage (Payment 4). Payment
4 is payable to Mr. Oyelola.

e.   The Company will provide Mr. Oyelola with three
(3) months of outplacement services at Lee Hecht
Harrison or an equivalent placement agency of the
Company’s choice.

f.   Mr. Oyelola agrees that he has not relied on the
Defendants for information or advice regarding the
taxability of any monies paid to him. Mr. Oyelola
further agrees that the Company will issue the
appropriate Internal Revenue Service Forms 1099 with
respect to the monies paid to him pursuant to Paragraph
4 above. * * * The Defendants represent no position
regarding the question of tax liability in relation to
any settlement payment made to Mr. Oyelola or his
attorney and encourage Mr. Oyelola to rely on his own
Accountant or Tax Attorney for advice.

g.   In the event of a tax assessment against the
Company by any federal, state or local taxing authority
as a result of not making deductions or withholding
from the monies paid to Mr. Oyelola under this
Paragraph 4, Mr. Oyelola shall pay the employee’s share
of that assessment. Mr. Oyelola agrees that if he
declines to pay his portion of any such assessment he
will indemnify and hold the Company harmless for the
amount equal to the employee’s portion of the tax
assessment, as well as for any and all interest or
penalties the Company may be required to pay to the
                                 - 5 -

      Internal Revenue Service or other taxing authority, and
      reasonable attorney’s fees incurred.

Mr. Oyelola further agreed, in paragraphs 7 and 9 of the

settlement document, that his separation of employment from the

Company3 would be effective upon his execution of the settlement

agreement and that he would withdraw and obtain dismissal with

prejudice of any charges filed with any court or administrative

agency against the Company and related individuals.

      Petitioners filed joint Forms 1040, U.S. Individual Income

Tax Return, for 1997 and 1998.    On their 1998 return, petitioners

did not report as income the $30,000 settlement payment

designated as compensation for emotional distress.    On January 3,

2002, respondent issued to petitioners the notice of deficiency

underlying the instant proceeding, in which respondent

determined, inter alia, that the $30,000 payment was taxable to

petitioners.

                            Discussion

I.   Burden of Proof

      In general, the Commissioner’s determinations are presumed

correct, and the taxpayer bears the burden of proving otherwise.

Rule 142(a).   Section 7491, effective for court proceedings that

arise in connection with examinations commencing after July 22,


      3
       Hereinafter, for convenience, we adopt the terminology of
the settlement agreement and refer to Massachusetts Mutual Life
Insurance Company as the Company.
                                 - 6 -

1998, however, may operate in specified circumstances to place

the burden on the Commissioner.    Internal Revenue Restructuring &

Reform Act of 1998, Pub. L. 105-206, sec. 3001(c), 112 Stat. 727.

With respect to factual issues and subject to enumerated

limitations, section 7491(a) may shift the burden of proof to the

Commissioner in instances where the taxpayer has introduced

credible evidence.    Concerning penalties and additions to tax,

section 7491(c) places the burden of production on the

Commissioner.

      Although the record in this case is not explicit as to when

the underlying examination began, it is clear that, at least with

respect to 1998, section 7491 would be applicable.    In any event,

respondent conceded at trial that section 7491 likely applied to

this matter.    Nonetheless, the Court finds it unnecessary to

decide whether the burden should be shifted under section

7491(a).    The record in this case is not evenly weighted and

enables us to render a decision on the merits based upon a

preponderance of the evidence, without regard to burden of proof.

II.   Section 104(a) Exclusion

      A.   General Rules

      As a general rule, the Internal Revenue Code imposes a

Federal tax on the taxable income of every individual.    Sec. 1.

Section 61(a) specifies that “Except as otherwise provided”,

gross income for purposes of calculating such taxable income
                                - 7 -

means “all income from whatever source derived”.    The boundary of

this definition is broad, typically reaching any accretions to

wealth.   Commissioner v. Schleier, 515 U.S. 323, 327 (1995);

Commissioner v. Glenshaw Glass Co., 348 U.S. 426, 429-431 (1955).

     Section 104, in contrast, provides otherwise by authorizing

an exclusion with respect to compensation for injuries or

sickness.    Such exclusions from gross income are construed

narrowly.    Commissioner v. Schleier, supra at 328; United States

v. Burke, 504 U.S. 229, 248 (1992) (Souter, J., concurring in

judgment).    As amended on August 20, 1996, by the Small Business

Job Protection Act of 1996 (SBJPA), Pub. L. 104-188, sec. 1605,

110 Stat. 1838, and as applicable to this case, section 104 reads

in pertinent part as follows:

     SEC. 104.   COMPENSATION FOR INJURIES OR SICKNESS.

          (a) In General.--Except in the case of amounts
     attributable to (and not in excess of) deductions
     allowed under section 213 (relating to medical, etc.,
     expenses) for any prior taxable year, 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 a physical injury or physical
     sickness. The preceding sentence shall not apply to an
                               - 8 -

     amount of damages not in excess of the amount paid for
     medical care * * * attributable to emotional distress.

Legislative history accompanying passage of the SBJPA

additionally clarifies that “the term emotional distress includes

symptoms (e.g., insomnia, headaches, stomach disorders) which may

result from such emotional distress.”   H. Conf. Rept. 104-737, at

301 n.56 (1996), 1996-3 C.B. 741, 1041.

     Regulations promulgated under section 104 further define

“damages received (whether by suit or agreement)” as “an amount

received (other than workmen’s compensation) 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.

     Prior to the SBJPA, section 104 authorized exclusion of

damages received on account of “personal injuries or sickness”,

which embraced “nonphysical injuries to the individual, such as

those affecting emotions, reputation, or character”.    United

States v. Burke, supra at 235 n.6; see also Commissioner v.

Schleier, supra at 329-331.   Interpreting that regime, the U.S.

Supreme Court in Commissioner v. Schleier, supra at 336-337,

established a two-pronged test for ascertaining a taxpayer’s

eligibility for the section 104(a)(2) exclusion.    As stated by

the Supreme Court:   “First, the taxpayer must demonstrate that

the underlying cause of action giving rise to the recovery is

‘based upon tort or tort type rights’; and second, the taxpayer
                                 - 9 -

must show that the damages were received ‘on account of personal

injuries or sickness.’”     Id. at 337.     This test has since been

extended to apply to the amended version of section 104, with the

corresponding change that the second prong now requires proof

that the personal injuries or sickness for which the damages were

received were physical in nature.     See, e.g., Venable v.

Commissioner, T.C. Memo. 2003-240, and cases cited therein.

     B.    Analysis

            1.   Tort or Tort Type Rights

     As indicated above, the first requirement for the section

104(a)(2) exclusion is that the claim underlying the funds

received must be based on tort or tort type rights.        Commissioner

v. Schleier, supra at 337.     A “tort” is defined as a “‘civil

wrong, other than breach of contract, for which the court will

provide a remedy in the form of an action for damages.’”        United

States v. Burke, supra at 234 (quoting Prosser and Keeton on the

Law of Torts 2 (1984)).

     Where amounts are received pursuant to a settlement

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

the settlement controls excludability.        Stocks v. Commissioner,

98 T.C. 1, 10 (1992); Metzger v. Commissioner, 88 T.C. 834, 847

(1987), affd. without published opinion 845 F.2d 1013 (3d Cir.

1988).    The claim must be bona fide, but it need not be

sustainable or valid.     Taggi v. United States, 35 F.3d 93, 96 (2d
                               - 10 -

Cir. 1994); Stocks v. Commissioner, supra at 10; Metzger v.

Commissioner, supra at 847.    The claim additionally need not have

been asserted prior to the settlement, but lack of knowledge of

the claim on the part of the payor may indicate a lack of intent

to settle such a claim.   Gajda v. Commissioner, T.C. Memo. 1997-

345, affd. 158 F.3d 802 (5th Cir. 1998); Brennan v. Commissioner,

T.C. Memo. 1997-317.

     The parties here have not addressed whether the claim or

claims underlying the settlement sound in tort.   Rather, they

have focused on whether the $30,000 payment was received on

account of physical injury.    This emphasis may in large part be

due to the fact that the complaint filed in the District Court

action, which provided a principal impetus for the settlement at

issue, is not in the record.   Hence, while the parties stipulated

generally that the complaint alleged a history of discrimination

“based on Title VII of the Civil Rights Act of 1964, as amended”,

it is not possible to ascertain from the evidence what particular

claims Mr. Oyelola may have asserted or whether he advanced a

multiplicity of legal theories.4   In these circumstances, and


     4
       We note that the Supreme Court in United States v. Burke,
504 U.S. 229, 241 (1992), held that a claim premised on Title VII
of the Civil Rights Act of 1964, prior to its amendment in 1991,
was not based on tort or tort type rights. The Supreme Court
also ruled in Landgraf v. USI Film Prods., 511 U.S. 244, 282, 286
(1994), that the 1991 amendments to Title VII did not apply to
conduct occurring before Nov. 21, 1991. As will be detailed more
fully infra in text, petitioners place significant reliance on an
                                                   (continued...)
                              - 11 -

because a ruling on the physical injury question will be

sufficient to resolve the instant case, we shall follow the lead

of the parties and restrict our analysis to the second prong of

the test for exclusion under section 104(a)(2).

          2.   On Account of Personal Physical Injuries

     As previously discussed, section 104(a)(2) sanctions

exclusion of payments received “on account of personal physical

injuries or physical sickness”.   This phraseology reflects that

excludability depends not only on the nature of the injuries but

also on the purpose of the payment.    Accordingly, in the context

of settlement payments, “the critical question is, 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 is a factual inquiry involving consideration of all facts

and circumstances surrounding the settlement.     Id.

     The Court has summarized the role in this calculus of

payment allocations set forth in a settlement agreement:

          Where there is an express allocation contained in
     the agreement between the parties, it will generally be
     followed in determining the allocation if the agreement
     is entered into by the parties in an adversarial
     context at arm’s length and in good faith. However, an
     express allocation set forth in the settlement is not
     necessarily determinative if other facts indicate that
     the payment was intended by the parties to be for a
     different purpose. [Id.; citation omitted.]


     4
      (...continued)
incident taking place in March of 1991 to support their request
for exclusion under sec. 104(a)(2).
                              - 12 -

Stated conversely, “If the settlement agreement lacks express

language stating that the payment was (or was not) made on

account of personal injury, then the most important fact in

determining how section 104(a)(2) is to be applied is ‘the intent

of the payor’ as to the purpose in making the payment.”     Metzger

v. Commissioner, supra at 847-848 (quoting Knuckles v.

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

Memo. 1964-33).

     Here, the settlement agreement explicitly designated the

disputed $30,000 amount as “compensation for emotional distress”.

Section 104(a) states unequivocally that “emotional distress

shall not be treated as a physical injury or physical sickness”,

except for amounts actually paid for medical care attributable to

the emotional distress.   Essentially, then, our query is whether

the circumstances of this case afford any justification for a

departure from the result otherwise directed by the face of the

settlement document.

     At the outset, we note that the record is nearly devoid of

information regarding the negotiations that led to the settlement

agreement.   However, nothing suggests that the context was other

than adversarial and arm’s length.     The settlement was reached

during the pendency of a filed legal action, and both sides were
                              - 13 -

apparently represented by counsel.5    Additionally, the agreement

was very specific as to the allocation of each portion of the

monetary award.   Out of a total of $187,824, only $30,000 was

designated for personal injuries, and that amount was explicitly

for emotional distress.   This then would not seem to be a

situation where one party’s tax considerations were allowed to

take precedence over the actual nature and significance of the

various underlying claims.

     Petitioners nonetheless argue on brief as follows:

     The petitioners stated and provided evidence to the
     Court that payments [sic?] of $30,000.00 was as a
     result of physical damage to the lips, sustained as a
     result of years of racial and national origin
     harassment in the course of his employment at the
     Connecticut Mutual Life Insurance Company. Medical
     papers were also presented from Rockville General
     Hospital and the Institute of Living Medical Group,
     P.C., substantiating the period, which pre-date the
     emotional distress treatment.

     The petitioners asked the Court to disallow the
     $30,000.00 as taxable, given that emotional distress
     cited in the “General Release, Confidential Separation
     Agreement, Waiver and Covenant Not To Sue”, resulted
     from physical injury to the lips. More so, the
     complaint of the physical injury, to the CHRO, pre-
     dates the payment of this $30,000.00, and pre date
     [sic] treatment of the distress.

     In summary, we would like the court to see that, it was
     the physical injury which was sustained at first, that
     causes severe head ache, delusion, coupled with
     sustained racial discrimination that led to my


     5
       Petitioners state in their trial memorandum that the
attorney who represented Mr. Oyelola in the civil rights action
has been disbarred from the practice of law in Connecticut and
cannot be located.
                              - 14 -

     emotional distress; hence, the treatments at the mental
     hospital: The Institute of Living.

     Petitioners therefore appear primarily to contend that,

notwithstanding the language of the settlement agreement, the

$30,000 amount was in fact paid on account of a physical injury.

That injury was allegedly sustained to Mr. Oyelola’s lips, as a

result of sleep walking brought on by the emotional distress

ensuing from the claimed discrimination.   Alternatively,

petitioners seem to suggest that the lip injury, not the

discrimination itself, was the root cause of the emotional

distress.   In making these arguments, petitioners emphasize that

the lip injury was communicated to the Connecticut Commission on

Human Rights and Opportunities in conjunction with Mr. Oyelola’s

1996 complaint.

     At trial, petitioners introduced into evidence a copy of a

supplemental affidavit filed by Mr. Oyelola with the Connecticut

Commission on Human Rights and Opportunities.   The 30-page

document contains a single paragraph discussing physical injury,

specifically a March 14, 1991, incident involving harm to Mr.

Oyelola’s lips:

     8.   My manager’s constant remarks wore me down. I
     lost a lost of sleep, and I hardly ate properly. In
     1990 [sic], during the course of this treatment, I had
     a heart failure one night and collapsed. When I
     regained consciousness, I was in a pool of blood. My
     two upper teeth pierced through my lower lip. I was
     rushed to Rockville/Vernon Hospital emergency room (see
     attached hospital records as Exhibit A). I
                               - 15 -

     subsequently went to Enfield Special Clinic for
     stitches on my lip.

     Petitioners testified to similar effect at trial, although

the “heart failure” could not be corroborated, and introduced the

referenced hospital records as an exhibit.    The records show that

petitioner was treated on March 14, 1991, at Rockville General

Hospital for “LACERATION/WOUND CARE” and “SEVERE

HEADACHE/DIZZINESS”, and that he could return to work on March

17, 1991.    Total charges of $749.24 were incurred and billed to

Mr. Oyelola’s insurance.   The only other evidence offered by

petitioners consists of records from the Institute of Living

Medical Group, P.C., indicating that petitioner was evaluated and

treated on various occasions in 1997 and 1998 for anxiety and

delusions.

     The foregoing record in this case does not support a

conclusion that the $30,000 was paid on account of physical

injury.   The sole specific incident of physical injury argued by

petitioners, the damage to Mr. Oyelola’s lips, is not

commensurate with a $30,000 payment.    In contrast, Mr. Oyelola

apparently waged a lengthy battle with stress, anxiety, and other

emotional problems.   The notes contained in the records from the

Institute of Living Medical Group, P.C., indicate that the

ongoing racial discrimination, not the single physical injury,

was the primary source of Mr. Oyelola’s emotional distress.

While we do not dismiss the physical pain Mr. Oyelola experienced
                              - 16 -

as a result of his 1991 collapse, the evidence supports the

conclusion that the 1998 settlement payment was in fact, as the

settlement agreement stated, intended by the Company to

compensate for the far more pervasive emotional distress.

     Accordingly, the $30,000 is not excludable from income,

except to the extent actually paid for medical care attributable

to the emotional distress.   Petitioners have not directed our

attention to any particular amounts paid for such medical care.

The only reference in the record to specific charges incurred for

Mr. Oyelola’s treatment is the $749.24 shown as billed to his

insurance company in 1991.   There is no indication that

petitioners were ever held responsible for any of this amount.

Additionally, as respondent points out on brief, it is noteworthy

that the settlement designated $7,824 for the cost of COBRA

insurance coverage, such that Mr. Oyelola’s medical expenses and

needs would appear to have been contemplated and provided for by

means other than the $30,000 payment.   We hold that the $30,000

is not excludable from gross income under section 104(a).

     To reflect the foregoing and concessions made,


                                         Decision will be entered

                                    under Rule 155.
