                          T.C. Memo. 2003-36



                      UNITED STATES TAX COURT



     CHRISTOPHER J. AND VICKILYNN M. MCCANN, Petitioners v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 370-01.                  Filed February 14, 2003.



     A. Albert Ajubita and Wanda L. Theriot, for petitioners.

     Susan S. Canavello, for respondent.



             MEMORANDUM FINDINGS OF FACT AND OPINION


     COLVIN, Judge:   Respondent determined an $83,922 deficiency

in petitioners’ Federal income tax for 1994.

     Petitioners received $839,000 in 1994 in settlement of a

medical malpractice lawsuit.    Respondent concedes that $583,017

of that amount is excludable under section 104(a)(2).   The sole

issue for decision is whether the remaining $255,983 is also
                                - 2 -

excludable from income under section 104(a)(2), as petitioners

contend, or is interest includable in income under section

61(a)(4), as respondent contends.    We hold that it is interest.

     Unless otherwise specified, section references are to the

Internal Revenue Code in effect for 1994, and Rule references are

to the Tax Court Rules of Practice and Procedure.

                          FINDINGS OF FACT

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

Petitioners resided in Slidell, Louisiana, when they filed the

petition.

A.   The Lawsuits

     1.     The First $100,000 of Damages

     On June 5, 1985, petitioners filed a medical malpractice

lawsuit against Pendleton Memorial Methodist Hospital, et al.

(Pendleton Hospital), in the Civil District Court for the Parish

of New Orleans, Louisiana (State court).      Louisiana law limits

the liability of qualified health care providers for malpractice

claims to $100,000, plus interest.      La. Rev. Stat. Ann. sec.

40:1299.42(B)(2) (West 2001).    In April 1992, petitioners settled

their claim against Pendleton Hospital for $75,000.      This ended

the hospital’s liability for the first $100,000 under the

Louisiana Medical Malpractice Act.
                                - 3 -

     2.     The Remaining $400,000 of Damages

     Under Louisiana law, the Louisiana Patient’s Compensation

Fund (LPCF) pays medical malpractice awards greater than $100,000

up to a ceiling of $500,000, plus interest and additional amounts

for continuing health care costs.    La. Rev. Stat. Ann. sec.

40:1299.42(B)(1) (West 2001); id. sec. 40:1299.44(A)(1), (C)

(West Supp. 2002).    On April 24, 1992, the State court held that

petitioners could seek from LPCF up to $400,000, plus interest,

in connection with their malpractice claim against Pendleton

Hospital.    Petitioners sued to obtain those additional damages

and interest from LPCF.    On February 2, 1993, after a trial and

jury verdict, the State court entered a $500,000 judgment against

LPCF for petitioners.

     On March 25, 1993, petitioners filed a motion to fix

interest and costs based on their claim that LPCF was unfairly

delaying payment of the judgment.    On April 2, 1993, the State

court granted petitioners’ motion to fix interest and costs and

ordered LPCF to pay costs of $8,588, interest on $500,000 from

June 5, 1985, to March 31, 1991, and interest on $400,000 from

April 1, 1991, until paid.    Petitioners’ malpractice counsel

computed the interest owed by LPCF as of March 24, 1993, to be

$407,323, with interest continuing to accrue at a rate of $76.72

per day until paid.
                                - 4 -

     On April 14, 1993, the State court reduced the February 2,

1993, judgment against LPCF by $100,000 to account for the

settlement with Pendleton Hospital.     Thus, judgment for

petitioners totaled $400,000, plus interest.

     LPCF appealed the State court judgment.     On July 14, 1994,

the Louisiana Court of Appeal for the Fourth Circuit affirmed the

judgment.

B.   The Settlement

     Petitioners and LPCF settled the case for $839,000 in August

1994.    On August 16, 1994, LPCF paid $839,000 to petitioners and

their attorneys.   LPCF noted on the check that $400,000 of the

payment was for general damages and $439,000 was for interest.

LPCF calculated interest and attached the calculation to the

check.

     The State court approved the compromise and settlement of

the lawsuit on August 19, 1994.   On that date, the State court

granted a joint motion filed by petitioners and LPCF to dismiss

petitioners’ case with prejudice.   On August 23, 1994,

petitioners signed a Receipt, Release, and Compromise Agreement

with Indemnity (RRC agreement), in which they acknowledged

receipt of $839,000 from LPCF and released LPCF from any further

liability.   The RRC agreement provides that LPCF was released:

     from any and all rights, claims, demands, causes of
     action, damages (including but not limited to general
     and special damages), liabilities, penalties, interest,
     attorneys’ fees, claims for past and future medical
                                - 5 -

     care, treatment and expenses, and claims for past and
     future loss of wages and/or loss of earning capacity,
     of any and every nature and kind whatsoever, past,
     present or future, arising out of, pertaining to or in
     any way connected with or resulting from, directly or
     indirectly, the Lawsuit, the Lawsuit’s subject matter
     and/or the facts, acts or omissions alleged in the
     Lawsuit. Further, the McCanns agree to hold harmless,
     indemnify and defend the Released Parties (with their
     choice of legal counsel) from and against any and all
     rights, claims, demands, causes of action, damages
     (including but not limited to general and special
     damages), liabilities, penalties, interest, attorneys’
     fees, claims for past and future medical care,
     treatment and expenses (including but not limited to
     any such claim asserted by Medicare, Medicaid, any
     government assistance program or any private health or
     other insurer), and claims for past and future loss of
     wages and/or loss of earning capacity, of any and every
     nature and kind whatsoever, past, present or future,
     arising out of, pertaining to or in any way connected
     with or resulting from, directly or indirectly, the
     Lawsuit, the Lawsuit’s subject matter and/or the facts,
     acts or omissions alleged in the Lawsuit, and which
     already have been or might hereafter be asserted by
     anyone against the Released Parties. [Emphasis added.]

The RRC agreement also provides:

          3. Payments. In consideration of the receipt,
     release and indemnification set forth herein, the PCF
     [LPCF] hereby pays the sum of EIGHT HUNDRED THIRTY-NINE
     [sic] AND NO/100 DOLLARS ($839,000.00) to the McCanns,
     receipt of which the McCanns hereby acknowledge.

The RRC agreement does not allocate the $839,000 payment among

damages, interest, and costs.   Petitioners’ counsel and LPCF

signed the RRC agreement.

     Petitioners signed a Release and Satisfaction of Judgment on

August 23, 1994, in which they agreed that the judgment as

amended:
                              - 6 -

     in the amount of FOUR HUNDRED THOUSAND AND NO/100
     DOLLARS ($400,000.00) plus legal interest from the date
     of judicial demand plus costs in the amount of EIGHT
     THOUSAND FIVE HUNDRED EIGHTY-EIGHT AND 05/100 DOLLARS
     ($8588.05), in favor of Christopher J. McCann, III and
     Vickilynn M. McCann and against the Louisiana Patient’s
     Compensation Fund, has been paid in full; * * *.

Petitioners also agreed that all claims and causes of action that

they might have had against LPCF were fully satisfied and

released by the $839,000 payment.

C.   Respondent’s Determination

     Respondent determined that $256,625 of the $839,000 was

prejudgment interest and was includable in petitioners’ income.

Respondent calculated that amount as follows:

     1.   $839,000 less $400,000 damages equals $439,000.

     2.   $439,000 multiplied by 40 percent (the percentage of

          the proceeds paid as attorney’s fees) equals $175,600.

     3.   $175,600 plus $6,7751 of legal expenses equals

          $182,375.

     4.   $439,000 less $182,375 equals $256,625.

     At trial, respondent conceded that $642 of the $256,625

amount was not interest.




     1
        We note that $439,000 is 52 percent of $839,000, and that
$6,775 is 52 percent of $13,028 (the total amount of legal
expenses that petitioners incurred in the State court action).
                                - 7 -

                               OPINION

A.   Contentions of the Parties and Background

     Petitioners contend that all of the $839,000 payment is

excludable from gross income as damages for personal injuries

under section 104(a)(2) and that none is includable in income as

interest.    Respondent contends that $255,983 of the $839,000

settlement is interest includable as income under section

61(a)(4).    We agree with respondent for reasons discussed below.

     Petitioners bear the burden of proving that they may exclude

the $839,000 LPCF payment from income under section 104(a)(2).2

Rule 142(a)(1).

     Gross income does not include damages received (whether by

suit or agreement) on account of personal injuries or sickness.

Sec. 104(a)(2).3   However, interest received on damage awards for

personal injuries is not received on account of personal injuries

or sickness and is not excludable from income under section

104(a)(2).    Rozpad v. Commissioner, 154 F.3d 1, 6-7 (1st Cir.

1998), affg. T.C. Memo. 1997-528; Brabson v. United States, 73



     2
        Petitioners do not contend that respondent bears the
burden of proving that sec. 104(a)(2) does not apply. Rule
142(a)(1).
     3
        The Small Business Job Protection Act of 1996, Pub. L.
104-188, sec. 1605(a), 110 Stat. 1838, amended sec. 104(a)(2) to
limit the exclusion to amounts received for personal physical
injuries or physical sickness. The amount at issue in this case
was received before the effective date of the amendment, and,
thus, the amended version of sec. 104(a)(2) does not apply.
                                  - 8 -

F.3d 1040, 1047 (10th Cir. 1996); Kovacs v. Commissioner, 100

T.C. 124, 130 (1993), affd. without published opinion 25 F.3d

1048 (6th Cir. 1994); Greer v. Commissioner, T.C. Memo. 2000-25;

Delaney v. Commissioner, T.C. Memo. 1995-378, affd. 99 F.3d 20

(1st Cir. 1996).

B.     Whether LPCF Paid More Than $400,000 for Personal Injuries

       The following facts show that LPCF did not pay petitioners

more than $400,000 for personal injuries.

       1.     LPCF Had No Reason To Pay More Than $400,000 for
              Personal Injuries

       The maximum liability under La. Rev. Stat. Ann. section

40:1299.42(B)(1) for medical malpractice claims is $500,000.        The

State court credited LPCF with $100,000 for petitioners’ earlier

settlement with Pendleton Hospital.       Thus, LPCF’s liability for

personal injury damages was limited to $400,000 under Louisiana

law.    Id.    We infer from this fact that LPCF did not pay more

than $400,000 in damages for personal injuries.

       2.     LPCF’s Allocation

       LPCF allocated $400,000 of the $839,000 payment to general

damages and $439,000 to interest.

       3.     The Settlement Negotiations and Settlement Agreement

       Petitioners contend that the settlement negotiations and

settlement agreement show that the entire $839,000 payment was

damages for personal injuries.      Petitioners contend that LPCF

negotiated the settlement to replace the State court judgment
                                 - 9 -

because LPCF was concerned that the malpractice cap would be

ruled unconstitutional by the Louisiana Supreme Court, which

could expose LPCF to even greater liability.    Petitioners contend

that LPCF’s concern about the constitutionality of the

malpractice cap caused it to agree to pay the entire $839,000

payment for personal injuries.    Petitioners’ contention is

unconvincing because the Louisiana Supreme Court held the

malpractice cap constitutional before the parties in this case

signed the RRC agreement, Butler v. Flint Goodrich Hosp., 607 So.

2d 517, 521 (La. 1992), and because there is no evidence that

LPCF was concerned about the constitutionality of the malpractice

cap.

       Petitioners contend that LPCF negotiated to pay no interest.

We disagree.    There is no evidence about what transpired during

the settlement negotiations or that the parties discussed

allocation of the settlement payment between interest and damages

on account of personal injuries.    Cf. Dotson v. United States, 87

F.3d 682 (5th Cir. 1996).

       In the RRC agreement, petitioners released various claims

including damages and interest in exchange for the $839,000

payment.    Petitioners contend that this release shows that none

of the $839,000 payment is for interest.    Petitioners also

contend that the RRC agreement shows that LPCF paid them wholly

on account of personal injuries and that we should give effect to

the RRC agreement here as we did to the settlement agreement in
                               - 10 -

McShane v. Commissioner, T.C. Memo. 1987-151.     The taxpayers in

McShane settled a personal injury lawsuit.     The settlement

agreement in McShane stated that amounts to be paid did not

include costs or interest.    In McShane, we found that the

payments were entirely for the taxpayers’ personal injuries.

     McShane is distinguishable because the RRC agreement does

not state that the settlement payment did not include interest.4

     4.     Conclusion

     Neither the settlement negotiations nor the RRC agreement

shows that the entire $839,000 payment was damages for personal

injuries.    The RRC agreement does not allocate the $839,000

payment between damages and interest or state whether any of the

payment is for interest.5    Cf. id. (settlement agreement stated

that payment included no interest).     We conclude that LPCF did

not pay petitioners more than $400,000 for personal injuries.

Thus, petitioners have not shown that respondent’s determination,

as adjusted, is incorrect.




     4
        Because McShane v. Commissioner, T.C. Memo. 1987-151, is
distinguishable, we need not decide petitioners’ contention that
neither Rozpad v. Commissioner, 154 F.3d 1 (1st Cir. 1998), affg.
T.C. Memo. 1997-528, nor Delaney v. Commissioner, 99 F.3d 20 (1st
Cir. 1996), affg. T.C. Memo. 1995-378, overruled McShane.
     5
        Petitioners contend that, under Robinson v. Commissioner,
70 F.3d 34, 37 (5th Cir. 1995), affg. in part and revg. in part
102 T.C. 116 (1994), the character of the settlement payment is
determined solely by the language of the settlement agreement.
In light of our conclusion regarding the RRC agreement, we need
not further consider petitioners’ reliance on Robinson.
                               - 11 -

C.   Whether There Was No Interest Because the RRC Agreement
     Replaced the State Court Judgment

     Petitioners contend that no part of the $839,000 payment was

for interest because (1) the RRC agreement replaced the State

court judgment; (2) as a result, there was no judgment; and (3)

if there was no judgment, there was no interest.   We disagree.

     The U.S. Court of Appeals for the First Circuit rejected

that argument in Rozpad v. Commissioner, 154 F.3d at 3-4, and

held that a settlement that allocates along the same lines for

damages and interest as a prior jury verdict and judgment that

included separately stated damages and interest includes a pro

rata share of interest.   Id. (citing Robinson v. Commissioner, 70

F.3d 34, 38 (5th Cir. 1995), affg. in part and revg. in part 102

T.C. 116 (1994)).   In Rozpad v. Commissioner, supra at 4, the

Court of Appeals stated that, absent a contrary allocation (as in

McShane), it is fair to assume that interest and damages compose

the same proportion of a settlement as of the prior judgment

replaced by that settlement.   Consistent with Rozpad, we conclude

that the settlement paid by LPCF to petitioners included interest

and damages in the same proportion as the prior State court

judgment.

     Petitioners’ contention that the holding in Rozpad does not

apply here because it was decided by the U.S. Court of Appeals

for the First Circuit misses the mark.   We followed Rozpad in

Greer v. Commissioner, T.C. Memo. 2000-25, where we decided
                                - 12 -

whether an LPCF payment under Louisiana law included interest

which was not excludable from income under section 104(a)(2).

As in Greer, the reasoning of Rozpad is helpful in deciding this

issue.

     Petitioners contend that Greer is distinguishable because

the Agreement and the Satisfaction of Judgment in that case did

not state that the settlement was entirely for personal injuries.

We disagree.    The RRC agreement is similar to the Agreement and

the Satisfaction of Judgment in Greer because the agreement in

each case was silent as to whether any part of the settlement was

for interest.     The check from LPCF to the taxpayer in Greer bore

a numerical code which indicated that part of the payment was for

interest.   Here, the LPCF check to petitioners also bore a

numerical code which indicated $439,000 of the payment was for

interest.

D.   Conclusion

     We conclude that $255,983 of the $893,000 payment was

interest.

     To reflect respondent’s concession and the foregoing,



                                               Decision will be

                                           entered under Rule 155.
