                  T.C. Memo. 2010-254



                UNITED STATES TAX COURT



     THOMAS M. AND DONNA GENTILE, Petitioners v.
     COMMISSIONER OF INTERNAL REVENUE, Respondent



Docket No. 14226-08.             Filed November 18, 2010.



     R determined a deficiency and an accuracy-related
penalty pursuant to sec. 6662(a), I.R.C., for the 2005 tax
year. The issues for decision are: (1) Whether a lump-sum
settlement payment Ps received in 2005 is excludable from
their gross income pursuant to sec. 105, I.R.C.; and (2)
whether Ps are liable for the accuracy-related penalty
pursuant to sec. 6662(a), I.R.C.

     Held: Ps’ lump-sum settlement payment constitutes
taxable income under sec. 105(a), I.R.C., for the 2005
tax year.

     Held: Ps are not liable for a penalty under sec.
6662(a), I.R.C.



James G. LeBloch, for petitioners.

Guy H. Glaser, for respondent.
                               - 2 -

              MEMORANDUM FINDINGS OF FACT AND OPINION


     WHERRY, Judge:   This case is before the Court on a petition

for redetermination of an alleged income tax deficiency that

respondent determined for petitioners’ 2005 tax year.     The issues

for decision are:   (1) Whether a disability lump-sum settlement

payment is excludable from petitioners’ gross income pursuant to

section 105(c) for the 2005 tax year; and (2) whether petitioners

are liable for a section 6662 accuracy-related penalty.1

                         FINDINGS OF FACT

     Some of the facts have been stipulated.   The stipulations,

with accompanying exhibits, are incorporated herein by this

reference.   At the time the petition was filed, petitioners

resided in California.

     Petitioner Donna J. Gentile (Mrs. Gentile) was employed by

the Orange County Register, a subsidiary of Freedom Newspapers

Inc. (OC Register), from approximately 1982 to 1993.

     Starting January 1, 1992, the OC Register contracted for a

group long-term disability insurance policy through a company

known as UNUM Life Insurance Co. of America (UNUM).     Under the

UNUM disability policy, UNUM agreed to pay a monthly benefit




     1
      Unless otherwise indicated, all section references are to
the Internal Revenue Code of 1986, as amended and in effect for
the year in issue, and all Rule references are to the Tax Court
Rules of Practice and Procedure.
                                - 3 -

based on the insured employee’s salary, provided it received

proof that the insured employee was disabled.

     As relevant in this case, under the UNUM disability policy

the terms “disability” and “disabled” meant that, because of

injury or sickness:   “1.   the insured cannot perform each of the

material duties of his regular occupation; and 2.   after benefits

have been paid for 24 months, the insured cannot perform each of

the material duties of any gainful occupation for which he is

reasonably fitted by training, education or experience.”

     If an insured employee provided proof of continued

disability and regular attendance of a physician, UNUM agreed to

pay a monthly benefit until a determinable date and during the

period of disability.   The monthly benefit was 60 percent of the

insured employee’s basic monthly earnings, less any other income

benefits received by the insured employee.   Other income benefits

received included benefits such as worker’s compensation.   The

maximum monthly benefit was $10,000, and the minimum monthly

benefit was the greater of $100 per month or 10 percent of the

monthly benefit before deductions for other income benefits.
                               - 4 -

     The maximum benefit period was determined by the insured

employee’s age at disability, as follows:

       Age at Disability                Maximum Benefit Period
        Less than age 60          To age 65 but not less than 60
                                              months
               60                              60 months
               61                              48 months
               62                              42 months
               63                              36 months
               64                              30 months
               65                              24 months
               66                              21 months
               67                              18 months
               68                              15 months
          69 and Over                          12 months


     The OC Register paid the entire premium under the UNUM

disability policy.   Mrs. Gentile was not required to pay any

portion of the premium or to include (and did not include) any

portion of the premium payment in her gross income.

     On or about December 2, 1992, Mrs. Gentile hurt her back

while lifting bundles of newspaper at work and never again worked

for the OC Register.

     In October 1994 Mrs. Gentile submitted a claim to UNUM

seeking long-term disability payments under the disability plan

of approximately $1,300 per month.     UNUM denied the claim on the

basis that it had not been furnished timely notice and proof of
                                 - 5 -

the claim.   Mrs. Gentile appealed the denial of her claim, but

UNUM denied her appeal.

     On February 14, 1996, Mrs. Gentile filed an action against

UNUM in Federal District Court under the provisions of the

Employee Retirement Income Security Act of 1974.   In addition to

seeking declaratory relief, Mrs. Gentile sought damages against

UNUM for:    (1) Breach of contract, and (2) reasonable attorney’s

fees and other costs.   The District Court dismissed Mrs.

Gentile’s case on the grounds that her failure to give timely

notice and proof of her claim barred her from recovery.     However,

in 1998 the District Court’s ruling was reversed on appeal and

the matter was remanded for further proceedings.

     After protracted negotiations, in December 2005, in exchange

for a lump-sum payment of $333,647.46, Mrs. Gentile executed a

receipt and general release discharging UNUM (and the other

defendants in the action) from all her disability claims.

     UNUM sent petitioners a Form 1099-MISC, Miscellaneous

Income, for the 2005 tax year to an address where petitioners no

longer lived.   Petitioners did not receive the Form 1099-MISC.

     Petitioners engaged a tax return preparer, Lee A. Rincon, to

help them file their Form 1040, U.S. Individual Income Tax

Return, for the 2005 tax year.    During the preparation of their

Form 1040 a question was raised regarding the taxability of the

lump-sum settlement payment.   To determine the appropriate tax
                                - 6 -

treatment of the settlement proceeds, petitioner Thomas Gentile

(Mr. Gentile) contacted the Internal Revenue Service (IRS) and

the OC Register.   Mr. Gentile did not disclose to this Court the

employee identification number of the person he spoke with at the

IRS but indicated that he had notes of the conversation and

believes her name was Ms. Dawkins.      Mr. Gentile spoke with Ronda

Haynes at the OC Register.   On the basis of information he

received from the IRS and the OC Register, Mr. Gentile determined

that the proceeds of the lump-sum settlement payment were not

taxable.   Hence, petitioners did not include any of the lump-sum

settlement payment on their Form 1040 for the 2005 tax year.

     On May 29, 2007, respondent sent a Notice CP2501 to

petitioners inquiring why they had failed to report the UNUM

lump-sum settlement payment on their Form 1040 for the 2005 tax

year.   On or about June 15, 2007, petitioners responded in

writing to the Notice CP2501.   Petitioners indicated that “The

money stated on the 1099 form was from a lawsuit.     We did not

receive the full amount & called the IRS office to see if it was

taxable & the rep said no.   That’s why I did not include it with

my 2005 return.”

     On August 27, 2007, respondent sent petitioners a Notice

CP2000 requesting further information concerning the lawsuit and

the nature of the payment received.     Petitioners did not reply to

the Notice CP2000 by the September 26, 2007, deadline.
                                 - 7 -

     Respondent issued a notice of deficiency on March 10, 2008,

determining that petitioners were liable for a deficiency of

$111,624 in income tax for the 2005 tax year (plus interest) and

a $22,325 accuracy-related penalty under section 6662(a) for

failing to report the lump-sum settlement payment on their 2005

tax return.

     In response to the notice of deficiency, petitioners filed a

timely petition with this Court.

                              OPINION

I. Lump-Sum Settlement Payment

     In general, the Commissioner’s determinations in the

deficiency notice are presumed correct, and the taxpayer bears

the burden of proving that the Commissioner’s determinations are

in error.   See Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115

(1933).   Under certain circumstances, section 7491(a) shifts the

burden of proof to the Commissioner with respect to a factual

issue relevant to a taxpayer’s liability.   The burden shifts to

the Commissioner if the taxpayer introduces credible evidence

with respect to the issue, complies with substantiation

requirements, maintains all required records, and cooperates with

the Commissioner’s reasonable requests for witnesses,

information, documents, meetings, and interviews.   Sec.

7491(a)(1) and (2).   The burden is on the taxpayer to show that

he satisfied the prerequisites of section 7491(a)(2).      Polone v.
                               - 8 -

Commissioner, T.C. Memo. 2003-339, affd. 505 F.3d 966 (9th Cir.

2007); H. Conf. Rept. 105-599, at 240-241 (1998), 1998-3 C.B.

747, 994-995.

     In their pretrial memorandum petitioners allege that section

7491(a) is applicable to this case because they “have maintained

all required records * * * [and] fully cooperated with all

reasonable requests made by the secretary for witnesses,

information, documents, meetings and interviews”.   Respondent

contends that petitioners have not satisfied the prerequisites of

section 7491(a)(2) because they did not maintain required tax

records and did not fully cooperate with respondent’s reasonable

requests for information and documents concerning the UNUM

payment.   On the instant record, we agree with respondent.

     Before issuing the notice of deficiency respondent sent two

requests to petitioners for information regarding the lump-sum

settlement payment.   However, the only information petitioners

provided regarding the lump-sum payment was the note they

submitted in response to respondent’s request for information

dated May 29, 2007, in which they stated the lump-sum payment was

“from a lawsuit.”   Additionally, after the notice of deficiency

was issued, respondent sent at least three letters (and placed

telephone calls) requesting that petitioners submit “all

documentation regarding the lawsuit and the settlement”.    In

response to respondent’s first request, the only information
                               - 9 -

petitioners submitted was Mrs. Gentile’s request for a jury

trial.   However, on February 17, 2009, petitioners submitted the

complaint Mrs. Gentile filed in District Court, although they did

not include the settlement agreement.   Accordingly, we conclude

that petitioners did not sufficiently comply with all of

respondent’s reasonable requests for information and/or did not

maintain the requested records.   Therefore, petitioners bear the

burden of proving that respondent’s determination is wrong.    See

sec. 7491(a); Rule 142(a).   However, in this case our resolution

of whether petitioners are liable for the deficiency and the

accuracy-related penalty does not depend on who has the burden of

proof.

     Section 61(a) defines gross income as “all income from

whatever source derived,” unless otherwise provided.   Section

105(a) provides that amounts received by an employee through

accident or health insurance for personal injuries or sickness

shall be included in gross income to the extent that such amounts

(1) are attributable to employer contributions that were not

includable in the employee’s gross income, or (2) were paid by

the employer.   Section 105(c) provides an exception to the

general rule in section 105(a):

     SEC. 105(c). Payments Unrelated to Absence From Work.--
Gross income does not include amounts referred to in subsection
(a) to the extent such amounts--

          (1) constitute payment for the permanent loss or loss
     of use of a member or function of the body, or the permanent
                             - 10 -

     disfigurement, of the taxpayer, his spouse, or a dependent
     (as defined in section 152, determined without regard to
     subsections (b)(1), (b)(2), and (d)(1)(B) thereof), and

          (2) are computed with reference to the nature of the
     injury without regard to the period the employee is absent
     from work.

     In order to qualify for the section 105(c) exception, the

payments to Mrs. Gentile must satisfy both of these requirements.

The payments to her fail to satisfy section 105(c)(2); therefore,

the Court need not, and does not, decide whether the payments to

Mrs. Gentile satisfy section 105(c)(1).

     Section 105(c)(2) itself has two requirements:   (1) The

payments to the taxpayer must be computed with reference to the

nature of the injury; and (2) the payments must be computed

without regard to the period the taxpayer is absent from work.

See Hines v. Commissioner, 72 T.C. 715, 720 (1979); Kees v.

Commissioner, T.C. Memo. 1999-41.   “Payments from a disability

plan do not qualify for the section 105(c)(2) exclusion if the

payments are the same regardless of the nature and severity of

the particular injuries causing the disabilities.”    Hayden v.

Commissioner, T.C. Memo. 2003-184 (citing Hines v. Commissioner,

supra), affd. 127 Fed. Appx. 975 (9th Cir. 2005); see also

Beisler v. Commissioner, 814 F.2d 1304, 1307 (9th Cir. 1987)

(“benefit payments, to be excludable from gross income under

section 105(c), must be made under a plan that varies benefits
                              - 11 -

according to the type and severity of the injury incurred”),

affg. T.C. Memo. 1985-25.

     There is nothing in the UNUM disability policy that computes

payments with reference to the nature of the injury.   Indeed,

regardless of the type or severity of the insured’s injury, a

person receiving benefits for total disability under the plan

gets a monthly payment equal to 60 percent of monthly earnings

subject to a specified minimum and maximum amount.   However,

petitioners claim that the lump-sum settlement payment Mrs.

Gentile received relates to her injury because “without her

injury there would not have been a settlement”.   They claim that

the settlement payment “was arrived at by a push and shove

between the parties and the carrier taking into account the

extent that * * * [Mrs. Gentile] was disabled.”

     At trial petitioners’ lawyer who represented them in their

suit against UNUM, Mr. Scott, indicated that the amount of the

settlement agreement was arithmetically determined and was based

on the amount of the monthly benefit payable under the UNUM

policy and the date that Mrs. Gentile’s benefits were terminated.

He stated that the computation of the settlement agreement would

have included other benefits received, such as worker’s

compensation, and attorney’s fees to the extent they are

recoverable.   Additionally, Mr. Scott indicated that the amount

of the settlement could depend on the future cost of medical
                              - 12 -

services but that the settlement in this case did not include

medical benefits.

      Payments under the UNUM disability policy, even if in the

form of a lump-sum settlement, are designed to replace the income

an employee lost due to a disability and are computed with regard

to the employee’s absence from work.   Accordingly, on the basis

of the record, the Court finds that the lump-sum settlement

payment to Mrs. Gentile fails the requirements of section

105(c)(2) because it was computed arithmetically with reference

to Mrs. Gentile’s absence from work and not to the nature or

severity of her injury.

      At trial Mr. Gentile stated that petitioners received

approximately $216,000 of the $333,647.26 lump-sum settlement

payment after they paid attorney’s fees, expert witnesses, and

doctors.   Petitioners had also previously indicated to the IRS on

June 5, 2007, that they “did not receive the full amount” of the

settlement.   However, as of the trial date, petitioners had not

provided sufficient evidence to substantiate the offset of such

deductions against the lump-sum settlement payment.   Although the

lump-sum settlement payment is includable in petitioners’ 2005

taxable income, petitioners would normally be able, in effect, to

offset against such income any miscellaneous itemized deductions,

for fees paid to attorneys and expert witnesses, subject to the 2

percent of adjusted gross income limitation under section 67(a)
                               - 13 -

and the alternative minimum tax under section 55.    See secs. 55,

67, and 68; see also Commissioner v. Banks, 543 U.S. 426, 435-437

(2005).

II. Accuracy-Related Penalty

     Respondent determined an accuracy-related penalty under

section 6662(a) and (b)(2) of $22,325 on the basis that

petitioners’ underpayment was attributable to a “substantial

understatement of income tax” within the meaning of section

6662(d).

     However, the accuracy-related penalty will not be imposed

with respect to any portion of the underpayment if it is shown,

with regard to such portion, that there was reasonable cause and

that the taxpayer acted in good faith.    Sec. 6664(c)(1).   The

determination of whether there was reasonable cause and good

faith “is made on a case-by-case basis, taking into account all

pertinent facts and circumstances.”     Sec. 1.6664-4(b)(1), Income

Tax Regs.   “Generally, the most important factor is the extent of

the taxpayer’s effort to assess the taxpayer’s proper tax

liability.”   Id.   Reasonable cause and good faith includes “an

honest misunderstanding of fact or law that is reasonable in

light of all the facts and circumstances, including the

experience, knowledge and education of the taxpayer.”     Id.

     In deciding whether the taxpayer acted with reasonable care,

the Court will consider the taxpayer’s mental and physical
                               - 14 -

condition, as well as sophistication with respect to tax laws, at

the time the return was filed.     Kees v. Commissioner, T.C. Memo.

1999-41; Ruckman v. Commissioner, T.C. Memo. 1998-83; see also

Carnahan v. Commissioner, T.C. Memo. 1994-163, affd. without

published opinion 70 F.3d 637 (D.C. Cir. 1995); Gray v.

Commissioner, T.C. Memo. 1982-392.

     Good faith reliance on the advice of an independent,

competent professional as to the tax treatment of an item may

constitute reasonable cause.     Neonatology Associates, P.A. v.

Commissioner, 115 T.C. 43, 98-99 (2000), affd. 299 F.3d 221 (3d

Cir. 2002); Estate of Robinson v. Commissioner, T.C. Memo.

2010-168; sec. 1.6664-4(b)(1), Income Tax Regs.; see also United

States v. Boyle, 469 U.S. 241, 250 (1985).    “Much like a

taxpayer’s reliance on an attorney or an accountant, reliance on

an enrolled agent is a factor we may consider in determining the

reasonableness of a taxpayer’s actions”.     Mortensen v.

Commissioner, 440 F.3d 375, 388 (6th Cir. 2006), affg. T.C. Memo.

2004-279.

     Petitioners never received the Form 1099-MISC sent by UNUM

because it was sent to an address where they no longer resided.

Hence, they were never put on notice by the Form 1099-MISC that

the lump-sum settlement payment was includable in income for the

2005 tax year.   Though they did not receive the Form 1099-MISC,

petitioners engaged a tax return preparer and took the initiative
                              - 15 -

to inquire whether they had to include the lump-sum settlement

payment in income for the 2005 tax year.   Mr. Gentile gave

credible testimony that he contacted both the IRS and the OC

Register to inquire about the taxability of the lump-sum

settlement payment and that on the basis of information he

received, he determined that the payment was not includable in

income.   Mr. Gentile’s testimony is corroborated by petitioners’

response to the Notice CP2501 dated approximately June 15, 2007,

in which they state that they called the IRS to “see if * * *

[the lump-sum settlement payment] was taxable & the rep said no”.

     The Court also recognizes that both petitioners are

unsophisticated in tax matters and further, that Mrs. Gentile’s

physical and mental condition (in light of her use of

medications) is impaired.

     The facts and circumstances in this case indicate that

petitioners exerted reasonable effort to assess their proper tax

liability for 2005 and acted in good faith.   Therefore, we

believe petitioners’ failure to include the lump-sum settlement

payment in income was due to reasonable cause.   See sec.

6664(c)(1).   Thus, the underpayment is not subject to accuracy-

related penalties under section 6662(b)(2).

     The Court has considered all of petitioners’ and

respondent’s contentions, arguments, requests, and statements.
                             - 16 -

To the extent not discussed herein, we conclude that they are

meritless, moot, or irrelevant.

     To reflect the foregoing,


                                      An appropriate order will be

                                 issued, and decision will be

                                 entered for respondent with regard

                                 to the deficiency and for

                                 petitioners with regard to the

                                 accuracy-related penalty.
