                        T.C. Memo. 1998-274



                      UNITED STATES TAX COURT



       DAVID R. GREEN AND CAROLYN B. GREEN, Petitioners v.
           COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket Nos. 8933-94, 6564-96,              Filed July 27, 1998.
                 26100-96.



     W. Kevin Jackson, for petitioners.

     S. Mark Barnes, for respondent.



                        MEMORANDUM OPINION

     PAJAK, Special Trial Judge:     These consolidated cases were

heard pursuant to section 7443A(b)(3) of the Code and Rules 180,

181, and 182.   All section references are to the Internal Revenue

Code in effect for the years in issue.    All Rule references are

to the Tax Court Rules of Practice and Procedure.    Respondent
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determined the following deficiencies in income tax, addition to

tax, and accuracy-related penalties:

                                    Addition to Tax   Accuracy-Related Penalty
Docket No.   Year      Deficiency     Sec. 6651(a)         Sec. 6662

8933-94      1991      $3,466            ---                 ---
6564-96      1992       3,435            ---                 ---
             1993       2,823            ---                 ---
26100-96     1994       2,946           $737                $589
             1995       4,860            ---                 972


After concessions by petitioners, including the section 6651

addition to tax, the issues for decision in these consolidated

cases are:   (1) Whether petitioners are entitled, on the basis of

section 104(a)(2), to exclude the entire $36,000 payment, or a

portion thereof, that petitioner David R. Green received pursuant

to a settlement agreement, and (2) whether petitioners are liable

for accuracy-related penalties under section 6662 for taxable

years 1994 and 1995.

     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.         Petitioners resided in

Salt Lake City, Utah, at the time the petition was filed in

docket No. 8933-94; petitioner David R. Green resided in

Chandler, Arizona, and petitioner Carolyn B. Green resided in

Salt Lake City, Utah, at the time the petition was filed in

docket No. 6564-96; and petitioner David R. Green resided in

Washington, Utah, and petitioner Carolyn B. Green resided in Salt
                               - 3 -


Lake City, Utah, at the time the petition was filed in docket No.

26100-96.

     On or about June 1, 1980, petitioner David R. Green

(petitioner) entered into a general agency contract (the

Contract) with Washington National Insurance Co. of Evanston,

Illinois (WNIC).   Petitioner was authorized to operate as a

general agent for WNIC in and around Salt Lake City, Utah.     As a

general agent, petitioner was to procure, both personally and

through sales agents, applications for individual life and health

insurance on terms authorized by WNIC.   As a general agent,

petitioner was also responsible for training and supervising

those sales agents of WNIC operating in Utah.   To facilitate his

activities as a general agent, petitioner formed the Financial

Business Corporation (FBC).   Sales agents were not employed by

petitioner or FBC but rather were affiliated with WNIC.

     WNIC unilaterally terminated the Contract in August 1983.

In a letter to petitioner dated August 2, 1983, Richard C.

Heverly (Heverly), vice president and director of general

agencies for WNIC, outlined the reason for the termination of the

Contract.   Heverly indicated that the Contract was being

terminated "for cause".   Heverly also indicated that petitioner

had failed to adequately perform his duty to "supervise the

professional activity and conduct" of the sales agents.
                                - 4 -


     WNIC filed a suit against petitioner and FBC in Federal

District Court for the District of Utah (the District Court).     In

turn, petitioner and FBC filed a suit against WNIC and Washington

National Financial Services (WNFS), a related corporation, in the

District Court.   For convenience and clarity, WNIC and WNFS will

be collectively referred to as WNIC.    In the breach of contract

suit filed by petitioner and FBC against WNIC, tort and tort type

claims were alleged.   In response to WNIC's Motion in Limine, the

District Court limited the presentation in the trial to breach of

contract, as explained below.   The two cases were consolidated

for trial (the District Court Case).

     The jury instructions (Jury Instructions) in the District

Court Case stated that petitioner was suing WNIC for wrongful

termination of his general agency contract.   The jury (the Jury)

executed a special verdict form.   The Jury found that "just

cause" did not exist for the termination of the Contract and

awarded damages to petitioner in the amount of $159,238 (the Jury

Award).   The amount of the Jury Award was the amount that an

economist who testified in the District Court Case calculated

that petitioner would have earned as commissions under the

Contract had the Contract not been terminated by WNIC.

     The Judgment does not make any reference to an award based

on a tort or tort type claim.   Aside from the $159,238, the

Judgment awarded only amounts of commissions plus interest to
                               - 5 -


petitioner and FBC under the breach of contract claims.     One of

the awards of commissions plus interest was made only to

petitioner.   The Judgment, entered on June 2, 1986, in the total

amount of $1,521,628.04 was based on breach of contract claims.

     WNIC's insurance carrier appealed the Judgment to the Tenth

Circuit Court of Appeals (the Court of Appeals).   Petitioner did

not appeal the Judgment.   Prior to the filing of briefs in the

Court of Appeals, the parties entered into a settlement agreement

(the Settlement Agreement), effective September 23, 1987.     In

accord with the Settlement Agreement, petitioner/FBC and WNIC

released all claims that the parties to the District Court Case

asserted against each other, including all contractual and "extra

contractual claims".   The Settlement Agreement provided, inter

alia:   (1) WNIC would make a lump sum payment in the amount of

$581,500 to FBC, and (2) WNIC would make guaranteed monthly

payments to petitioner in the amount of $3,000 for a period of

240 months ($36,000 per year for 20 years) commencing October 1,

1987.   The Settlement Agreement specified that $1,510 of each of

the monthly payments would be paid towards satisfaction of the

Jury Award.   The balance of $1,490 of the $3,000 was not

specifically allocated.

     Petitioners filed joint Federal income tax returns for 1991,

1992, 1993, 1994, and 1995 (the Returns).   On the Returns,

petitioners reported annuity income of $36,000 per year.    Of this
                                - 6 -


amount, petitioners reported that $17,880 ($1,490 x 12) was

taxable for each year.    The remaining $18,120 ($1,510 x 12) for

each year attributable to the amount of the payments made during

the year in satisfaction of the Jury Award was not reported as

taxable.

       Respondent determined that the entire $36,000 in payments

for each year is taxable.

       Petitioners first appeared before this Court with respect to

taxable year 1991, in a case conducted under the "small tax case"

procedures authorized by section 7463 and Rules 170 through 179.

The parties filed cross-motions for summary judgment under Rule

121.    The relevant issue there was whether petitioners were

entitled, on the basis of section 104(a)(2), to exclude the

entire $36,000 payment, or a portion thereof, that petitioner

received pursuant to the Settlement Agreement.    In Green v.

Commissioner, T.C. Summary Opinion 1995-167, we denied

petitioners' motion for summary judgment and granted respondent's

motion for summary judgment insofar as we concluded that the

$18,120, attributable to the amount of the Jury Award, was

includable in petitioners' income for 1991.    We further concluded

that a material fact remained in dispute with respect to the

remaining portion of the $36,000 payment, or $17,880, which

petitioners initially included in income, but later contended was

excludable under section 104(a)(2).     We found that the record was
                                 - 7 -


incomplete as to the claims that were the basis for that portion

of the Settlement Agreement.

     Subsequently, the small tax case designation was removed and

the case was processed according to the regular procedures of

this Court.   Petitioners are now before the Court with respect to

taxable years 1991 through 1995.    We decline to accept

petitioners' request that we revisit the issue in taxable year

1991 which was resolved in Green v. Commissioner, T.C. Summary

Opinion 1995-167.

     Rule 39 requires a party to plead matters constituting an

affirmative defense such as collateral estoppel.    Respondent

failed to so plead so we address for each of the years 1992

through 1995 the issue of whether the $18,120 attributable to the

Jury Award is excludable from income under section 104(a)(2).

     Section 61 broadly defines gross income as all income from

whatever source derived.    Any exclusion of items from income must

be narrowly construed.     Commissioner v. Schleier, 515 U.S. 323,

328 (1995).   Section 104(a)(2) provides that gross income does

not include "the amount of any damages received (whether by suit

or by agreement * * * ) on account of personal injuries or

sickness".    Section 1.104-1(c), Income Tax Regs., provides that

the term "damages received" "means 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
                                - 8 -


settlement agreement entered into in lieu of such prosecution."

Petitioner's settlement proceeds of $18,120 may be excluded from

gross income only if petitioners show that:   (1) The underlying

cause of action giving rise to the recovery is "based upon tort

or tort type rights", and (2) the damages were received "on

account of personal injuries or sickness."    Commissioner v.

Schleier, supra at 337.    Both elements of this two-part test must

be satisfied before a taxpayer is allowed to exclude amounts

received from gross income.

     In the case of amounts received pursuant to a settlement

agreement, the nature of the underlying claim, not the validity

of such claim, determines whether it is excludable under section

104(a)(2).    United States v. Burke, 504 U.S. 229, 237 (1992).

Determination of the nature of the claim is factual.     Bagley v.

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

1997).    A key question to ask is in lieu of what were the damages

paid.    Church v. Commissioner, 80 T.C. 1104 (1983).   Where the

settlement agreement lacks express language stating the reason

for the payment, the most important element is the intent of the

payor.   Knuckles v. Commissioner, 349 F.2d 610, 613 (10th Cir.

1965), affg. T.C. Memo. 1964-33.   Although the payee's belief is

relevant to this inquiry, the ultimate character of the payment

hinges on the payor's dominant reason for making the payment.

Fono v. Commissioner, 79 T.C. 680 (1982), affd. without published
                                 - 9 -


opinion 749 F.2d 37 (9th Cir. 1984); Hess v. Commissioner, T.C.

Memo. 1998-240.

     After a review of the Settlement Agreement, and the facts

and circumstances surrounding it, we find that for 1992 through

1995, with respect to the $18,120 ($1,510 of each of the $3,000

monthly payments) that was specifically allocated to satisfy the

Jury Award, there is no basis to conclude that such recovery was

based upon a tort or tort type claim.

     At the District Court trial, petitioner introduced Mr. Paul

A. Randle (Mr. Paul Randle), an economist and professor of

finance at Utah State University.    Mr. Paul Randle's testimony

was offered to establish an economic value for potential loss of

income suffered by petitioner.    Mr. Paul Randle determined

petitioner's economic loss by taking the total economic value of

petitioner's earning capacity, adjusted for inflation, based on

his historical performance less any actual earnings after

petitioner's termination and prior to trial.    Mr. Paul Randle

determined that petitioner suffered a net economic loss of

$159,238.   Following the Jury's special verdict, the District

Court awarded petitioner that amount in paragraph 5 of the

Judgment.   In the Settlement Agreement, the parties agreed that

$1,510 of each of the $3,000 monthly payments was to be paid

towards satisfaction of paragraph 5 of the Judgment.
                              - 10 -


     On the basis of this record, we conclude that such amount

was not based upon a tort or tort type claim, but rather it was

on account of legal injuries of an economic character arising out

of a contract claim.   Accordingly, the $18,120 is not excludable

under section 104(a)(2) and thus is includable in petitioners'

income for taxable years 1992 through 1995.

     We must now decide whether $17,880, the balance of the

annual $36,000 payment, is excludable from income under section

104(a)(2) for each of the taxable years at issue.

     Again, petitioner's settlement proceeds of $17,880 may be

excluded from gross income only if petitioners show that:     (1)

The underlying cause of action giving rise to the recovery is

"based upon tort or tort type rights" and (2) the damages were

received "on account of personal injuries or sickness."

Commissioner v. Schleier, supra at 337.   The other principles set

forth above also apply.

     Petitioners contend that the $17,880 portion payable under

the Settlement Agreement is excludable under section 104(a)(2)

because, in addition to seeking punitive damages, petitioner

asserted five tort claims against WNIC.   Petitioners further

contend that petitioner suffered personal injuries to his good

name, personal integrity, and business reputation.   Petitioners

made the same contentions with respect to the $18,120 payment

upon which we have ruled above.   Thus, petitioners argue that
                               - 11 -


because they asserted tort claims and a colorable claim for

personal injuries, that is sufficient to sustain the exclusion of

the entire amount from gross income.

     Respondent, on the other hand, contends that the payment

petitioner received pursuant to the Settlement Agreement was not

to settle a tort claim or to pay petitioner on account of

personal injuries.   Rather, respondent contends that the payment

was to redress contract claims.   Thus, respondent's position is

that such payment fails the two-prong test under Commissioner v.

Schleier, supra at 337, and therefore is not excludable from

gross income under section 104(a)(2).

     After a review of the Settlement Agreement, and the facts

and circumstances surrounding it, we find that there is no basis

to conclude that WNIC agreed to pay petitioner $17,880 per year

for 20 years in order to settle a tort or tort type claim, or a

claim for personal injuries.

     The Settlement Agreement sets forth six provisions.    Under

the Settlement Agreement, WNIC was obligated to "make regular,

guaranteed monthly payments to Green in the amount of $3,000.00

per month for a period of Two Hundred Forty (240) months,

commencing October 1, 1987."   There is no language in any part of

the Settlement Agreement that specifically designates any portion

of petitioner's annuity to be paid to settle a tort or tort type

claim.   Thus, we look to the intent of the payor, WNIC.
                              - 12 -


     According to the Settlement Agreement, the parties entered

into the agreement because they "desire to settle and resolve all

present and potential controversies by and between them,

including but not limited to termination of the Suits, the

Appeal, * * * ; and [the parties] desire to terminate any and all

contracts or contractual relationships between them, or any of

them; * * * ."   Further, the Settlement Agreement provided that:

          2. Release. Green/FBC and WNIC/WNFS, for themselves,
     * * * mutually RELEASE, ACQUIT, AND FOREVER DISCHARGE, the
     other, * * * from all contracts of any kind whatsoever, * *
     * , and from all claims, demands, debts, and causes of
     action, known or unknown, past, present or future, arising
     out of, or relating to: (1) all written and oral agreements,
     including all supplements and modifications thereto, between
     them; (2) all claims asserted or assertable by WNIC/WNFS in
     the Suits, including, without limitation, all contractual
     and extra-contractual claims, statutory and common law
     claims, claims for actual and punitive damages, claims for
     an accounting, claims for attorney's fees, court costs, and
     the like; (3) all claims asserted or assertable by Green/FBC
     in the Suits, including, without limitation, all contractual
     and extra-contractual claims, statutory and common law
     claims, claims for actual and punitive damages, claims for
     attorneys' fees, court costs, and the like; (4) all claims
     asserted or assertable by Philips in the Suits, including
     but not limited to all contractual, tort, statutory, common
     law or other claims, * * * ; and (5) any act, transaction or
     occurrence prior to the date hereof.

                          *    *    *    *    *

          5. Dismissal of the Suits. Green/FBC and WNIC/WNFS
     agree to cause all claims asserted in the Suits and in the
     Appeal against each other to be dismissed with prejudice,
     with the parties to bear their own respective attorneys'
     fees and costs.

     Whereas the Green/FBC language in paragraph 2, clause (3)

above encompasses contractual and extra-contractual claims, it
                              - 13 -


does not list "tort".   Yet, in the very next sentence, the

Settlement Agreement in paragraph 2, clause (4) above with

respect to Philips (another party to the suits) specifically

releases all "tort" claims.   We view this as another indication

that the Green/FBC and WNIC suits were based on contract, not on

tort.

     Thus, we do not believe that WNIC entered into the

Settlement Agreement with the intention of settling a tort or

tort type claim with respect to petitioner.   Instead, we believe

that WNIC intended to terminate any and all contractual

relationships between petitioner and FBC.

     Our position is further strengthened upon a review of the

other evidence before us.   Prior to the District Court trial,

WNIC made a Motion in Limine to preclude petitioner from

injecting into trial matters which WNIC believed were irrelevant,

inadmissable, and prejudicial.   WNIC sought to prevent petitioner

from introducing evidence of the kind normally associated with

tort claims and to limit the case to contractual matters.     The

District Court granted WNIC's motion, and directed petitioner to

limit his presentation to a claim of breach of contract.

Petitioner's attorney acquiesced.   Although petitioner initially

alluded to tort type claims in petitioner's complaint, the case

proceeded to trial before the Jury to determine whether a breach

of contract had occurred.   It therefore follows that the Jury's
                              - 14 -


deliberation was limited to a cause of action under a breach of

contract theory.

     Moreover, in the Jury Instructions with respect to

petitioner, the Jury was instructed to deliberate based upon only

a breach of contract cause of action.    The Jury was specifically

instructed that "in awarding damages, if any, you are not

permitted to award any amount for the purpose of punishing any

party, or to make an example of any party."    There were no tort

or tort type cause of action instructions to the Jury with

respect to petitioner.

     As noted, the District Court's Judgment also is devoid of

any reference to an award based on a tort or tort type claim.     In

addition to the $159,238, the Judgment awarded only amounts of

commissions plus interest to petitioner and FBC.    The Judgment of

$1,521,628.04 was based solely on breach of contract claims.

     After the Jury Trial, WNIC was faced with a liability of

$1,521,628.04, in favor of petitioner and FBC.    This Judgment

reflected commissions due, interest thereon, and an amount for

wrongful termination of the general agency contract.    Obviously,

WNIC thought it could reduce this liability by its appeal of the

Judgment.   Petitioner did not appeal.   After settlement

negotiations, WNIC was able to settle for $894,800.00, a

reduction of $626,828.04.   WNIC's liability as a result of the
                                - 15 -


Judgment based on breach of contract claims was substantially

reduced by the Settlement Agreement.

     Petitioner personally was to receive $3,000 a month for 20

years under the Settlement Agreement.    This amount had a present

value of $313,000.   Mr. Stephen R. Randle (Mr. Stephen Randle),

attorney for petitioner in the District Court action (and brother

of Mr. Paul Randle), claimed he made representations about tort

claims during the settlement negotiations.    Because WNIC had

opposed such contentions and the District Court had rejected such

contentions, we do not see how such contentions at the settlement

negotiations could change the nature of the underlying claims

which were based on contract.    Moreover, Mr. Stephen Randle

testified that in the Settlement Agreement he designated $1,510

out of the $3,000 monthly annuity as representing personal injury

to petitioner under paragraph 5 of the Judgment.    Yet the

Settlement Agreement contains no such designation, and that

$1,510 is the amount we have found above is due to legal injuries

of an economic character arising out of a contract claim.     The

only conclusion we can draw is that the remaining $1,490 monthly

payment flows from the commissions plus interest awards and thus

is clearly economic in nature.

     As we stated above, petitioner's settlement proceeds may be

excluded from gross income if petitioners show that not only was

the underlying cause of action giving rise to the recovery based
                              - 16 -


upon tort or tort type rights, the damages were received on

account of personal injuries or sickness.     Commissioner v.

Schleier, 515 U.S. 323, 337 (1995).    Petitioner must prove the

existence of both of these elements.

     In the instant cases, we find that petitioners failed to

establish that WNIC awarded petitioner the annuity on account of

personal injuries or sickness.   The phrase "on account of"

requires a causal connection between the personal injury

sustained and the compensation received.    O'Gilvie v. United

States, 519 U.S. 79 (1996); Brabson v. United States, 73 F.3d

1040 (10th Cir. 1996).

     Although petitioners contend that petitioner suffered

personal injuries to his good name, personal integrity, and

business reputation, the Settlement Agreement does not provide

for any part of the payment to be on account of personal

injuries.   Further, petitioners failed to introduce any competent

evidence to prove that WNIC intended to make payments to

petitioner on account of personal injuries.

     We find that WNIC's intent when it entered into the

Settlement Agreement was to settle a contract dispute and not to

settle a tort or tort type claim or a claim for personal

injuries.   Accordingly, we conclude that section 104(a)(2) does

not apply to exclude the $17,880 portion of the settlement

payment from gross income.
                               - 17 -


     In sum, in Green v. Commissioner, T.C. Summary Opinion 1995-

167, we held that the $18,120 attributable to the Jury Award was

includable in petitioners' income in 1991.      We likewise hold that

the $18,120 is includable in income for 1992 through 1995.       Also,

we find that the $17,880 is includable in income for 1991 through

1995.   Thus, the entire annual payment of $36,000 ($18,120 +

$17,880) is includable in income for each of the years from 1991

through 1995.

     Finally, we must decide whether petitioners are liable for

accuracy-related penalties in the amounts of $589 and $972 for

1994 and 1995, respectively.   Section 6662(a) imposes an

accuracy-related penalty in the amount of 20 percent of the

portion of an underpayment of tax attributable to negligence or

disregard of rules or regulations.      Sec. 6662(a) and (b)(1).

Negligence is any failure to make a reasonable attempt to comply

with the provisions of the internal revenue laws.      Sec. 6662(c);

sec. 1.6662-3(b)(1), Income Tax Regs.      Moreover, negligence is

the failure to exercise due care or the failure to do what a

reasonable and prudent person would do under the circumstances.

Neely v. Commissioner, 85 T.C. 934, 947 (1985).      Disregard

includes any careless, reckless, or intentional disregard of

rules or regulations.   Sec. 6662(c); sec. 1.6662-3(b)(2), Income

Tax Regs.
                               - 18 -


     Under section 6664(c), no penalty will be imposed with

respect to any portion of any underpayment if it is shown that

there was a reasonable cause for such portion and that the

taxpayer acted in good faith with respect to such portion.     This

determination is based on all of the facts and circumstances.

Sec. 1.6664-4(b)(1), Income Tax Regs.    The most important factor

is the extent of the taxpayers' effort to assess their proper tax

liability for the years at issue.    Sec. 1.6664-4(b)(1), Income

Tax Regs.

     On the record before us, we find that respondent's

determination of penalties under section 6662(a) is correct.

Petitioners filed their 1994 and 1995 returns after Green v.

Commissioner, T.C. Summary Opinion 1995-167 was filed on

September 5, 1995.    Petitioners filed their 1994 return on

October 12, 1995.    Notwithstanding our holding that the $18,120

payment was not excludable under section 104(a)(2), petitioners

nonetheless continued to exclude that amount on their 1994 and

1995 returns.   Petitioners offered no reasonable explanation as

to its exclusion.    In this regard, we find that petitioners'

actions were not those of a reasonable and prudent person under

the circumstances.    Accordingly, we sustain respondent's

determination on this issue for 1994 and 1995.
                             - 19 -


     We have considered all arguments made by petitioners and to

the extent not discussed, we find them to be irrelevant or

without merit.

     To reflect the foregoing,

                                        Decisions will be entered

                                   for respondent.
