                        T.C. Memo. 2000-342



                      UNITED STATES TAX COURT



          RONALD N. AND KAREN M. GROSS, Petitioners v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 3440-98.                   Filed November 7, 2000.



     Mark A. Pridgeon, for petitioners.

     Blaine C. Holiday, for respondent.



             MEMORANDUM FINDINGS OF FACT AND OPINION


     MARVEL, Judge:   Respondent determined deficiencies in

petitioners' Federal income taxes for taxable years 1993 and 1994

of $120,226 and $39,914, respectively.    The sole issue for

decision1 is whether petitioners may exclude from gross income



     1
      The only other issues are computational.
                               - 2 -

under section 104(a)(2)2 three sets of payments received during

the years at issue pursuant to a settlement agreement.

                         FINDINGS OF FACT

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

The stipulation of facts is incorporated herein by this

reference.   Petitioners are married and resided in Brooklyn Park,

Minnesota, at the time the petition was filed.   References to

petitioner are to Ronald N. Gross.

Petitioner’s Employment at Okabena Co.

     Petitioner is a certified public accountant.   In October

1977, petitioner accepted a position as staff accountant at

Okabena Co. (Okabena).   In 1980, petitioner was promoted to vice

president of administration, and in 1990, petitioner was promoted

to executive vice president of administration.   At no time during

petitioner’s employment did Okabena have more than 15 employees.

     On April 6, 1993, a female employee at Okabena made a sexual

harassment claim against petitioner to the president of Okabena,

Bruce Lueck.   That same day, Mr. Lueck informed petitioner of the

allegations, and, upon advice of counsel, Okabena began an

investigation.   On April 7 and 8, 1993, Okabena’s outside legal

counsel interviewed each female employee of Okabena regarding



     2
      All section references are to the Internal Revenue Code in
effect for the years in issue, and all Rule references are to the
Tax Court Rules of Practice and Procedure. Monetary amounts are
rounded to the nearest dollar.
                                - 3 -

these allegations.    Petitioner was instructed not to discuss the

investigation with anyone and to continue normal business

operations.   At the conclusion of its investigation, Okabena

determined that sufficient evidence existed to conclude that

petitioner had conducted himself improperly, that he no longer

could manage the employees effectively, and that he was subject

to termination.

     On the morning of April 9, 1993, petitioner retained the

legal services of James Roth to represent petitioner in

connection with the investigation of the alleged sexual

harassment.   At a conference that morning, petitioner and Mr.

Roth discussed the allegations against petitioner and a possible

resolution of them.   After this meeting, petitioner submitted a

handwritten letter of resignation to Mr. Lueck.

     Over the weekend of April 10 and 11, 1993, petitioner worked

at Okabena to review tax files and clean up his desk.   On April

10, 1993, petitioner and Mr. Lueck discussed petitioner’s

situation in petitioner’s office at Okabena.   During the

discussion, Mr. Lueck informed petitioner that petitioner’s

resignation was unnecessary and that he should reconsider it.

     On April 12, 1993, petitioner met with Mr. Lueck and

withdrew his resignation.    At the same time, petitioner requested

an employment contract with Okabena and submitted a proposed

handwritten employment contract for consideration.   At this
                               - 4 -

meeting, Mr. Lueck asked petitioner to leave the Okabena offices

and not to return until further notice.   Petitioner departed and

never returned to Okabena.

The Negotiations

     From April 15 to June 21, 1993, petitioner, Mr. Roth,

Okabena officials, and Okabena’s attorneys engaged in

negotiations to resolve the matter and to formulate a severance

package for petitioner.   Several meetings were held regarding the

terms and conditions of petitioner’s termination from Okabena.

The negotiations between Okabena and petitioner were adversarial.

     At the first meeting, on or about April 15, 1993, petitioner

and Mr. Roth met with Mr. Lueck, Robert Dayton, chairman of the

board of Okabena, and Okabena’s outside counsel.    Okabena

presented petitioner with the option either of being terminated

or of submitting a voluntary resignation and accepting 12 months

of severance pay.   Petitioner rejected the offer and made a

counteroffer proposing, among other things, that a portion of any

funds paid be allocated to personal injuries in order to enable

him to exclude such proceeds under section 104.    Okabena asked

petitioner to turn over his keys and not to return to Okabena’s

offices.

     Additional negotiating sessions and conferences regarding

the proposed settlement were held on April 16, 19, 20, and 21,

1993.   On April 21, 1993, Mr. Lueck sent petitioner a termination
                                 - 5 -

letter confirming that Okabena had terminated petitioner’s

employment effective April 20, 1993.

     Throughout the negotiations, petitioner threatened

litigation against Okabena and specifically mentioned a potential

claim for age discrimination, referring to a pattern of alleged

age discrimination at Okabena.     During these meetings, petitioner

also mentioned claims of wrongful termination and defamation of

character.   Petitioner never filed a complaint against Okabena in

any court.

The Settlement Agreement

     On May 12, 1993, Okabena’s counsel sent petitioner a draft

settlement proposal.    After extended negotiations over the terms

of the proposed settlement agreement, a final settlement

agreement (settlement agreement) and two releases were signed on

June 21 and 22, 1993.

     Pursuant to the settlement agreement, both petitioner and

Okabena agreed to release all claims that either party had or

might have against the other.     The settlement agreement

acknowledged the following facts, among others:

          WHEREAS, Gross has alleged that certain matters
     relating to his employment with * * * [Okabena] and
     his separation from * * * [Okabena] give rise to legal
     claims against * * * [Okabena] for age discrimination;
     and

          WHEREAS, Gross claims that he is entitled to
     receive damages from * * * [Okabena] for loss of future
     income and for personal injuries, and to be reimbursed
                              - 6 -

     by * * * [Okabena] for his attorneys’ fees and costs;
     and

          WHEREAS, * * * [Okabena] expressly denies that it
     may be liable to Gross on any basis or that it has
     engaged in any improper or unlawful conduct or
     wrongdoing against him * * *

     The settlement agreement required Okabena to make several

distinct categories of payments to or on behalf of petitioner.

Three of those categories, severance payments, lump-sum payments,

and liquidation payments, are at issue here.3

     Severance Payments

     Under paragraph 3(a) of the settlement agreement, Okabena

agreed to make 18 monthly payments of $10,417, less all

applicable withholding, beginning on May 1, 1993, and concluding

on October 31, 1994 (severance payments).   Petitioners included

these severance payments in gross income and paid the applicable

Federal income taxes on these amounts in 1993 and 1994.   The

severance payments form the basis of petitioners’ claim that they

overpaid their Federal income taxes in 1993 and 1994 and are

entitled to a refund.

     The Lump-Sum Payments

     Under paragraph 3(b) of the settlement agreement, Okabena

agreed to make two lump-sum payments to petitioner--one of

$112,500 shortly after the settlement agreement was executed and



     3
      Okabena satisfied all its obligations under the settlement
agreement.
                                - 7 -

a second payment of $100,000 on May 15, 1994 (lump-sum payments).

Petitioner excluded the lump-sum payments from gross income as

damages received on account of personal injuries.

     The Liquidation Payment

     Under paragraph 5(a) of the settlement agreement, Okabena

agreed to pay petitioner $516,907 for his interests in several

Okabena investment entities (liquidation payment).    Okabena made

the required payment in 1993.   Petitioner excluded the

liquidation payment from gross income as damages received on

account of personal injuries.

     The Tax Clause

     The settlement agreement also contained the following

provision with respect to the tax treatment of the payments made

to petitioner pursuant to the settlement agreement:

          7. Payment of Taxes. The parties expressly
     acknowledge that the payments to be made to Gross under
     subparagraph 3(b) of this Agreement [the lump-sum
     payments] are intended solely as compensation for
     claimed damages on account of alleged personal injuries
     arising from an occurrence within the meaning of
     Section 104(a)(2) of the Internal Revenue Code, the
     administrative regulations promulgated thereunder, and
     applicable case law. No part of the payments to be
     made to Gross under subparagraphs 3(b) or 5(a) [the
     liquidation payment] is allocable to punitive damages,
     compensation for other claimed damages, or interest
     thereon. The Company makes no representation or
     warranty to Gross or his attorneys regarding the tax
     treatment or consequences of any payment made to Gross
     under this Agreement by the Internal Revenue Service or
     any other tax authority. Gross will be solely
     responsible for the payment of any and all taxes of
     whatever kind that may be due or payable from him in
     connection with any payment made to him under this
                               - 8 -

     Agreement. Gross agrees to indemnify and hold harmless
     the Company from any and all liens, actions, or claims
     on the part of the Internal Revenue Service or any
     other tax authority in connection with any payment made
     to Gross under subparagraphs 3(b) or 5(a) of this
     Agreement. This indemnity and hold harmless agreement
     will apply as to the full amount of any such liens,
     actions, or claims, and as to the amount of any
     expenses incurred in connection therewith.

The Release

     The release signed by petitioner defined the universe of

claims released by petitioner in the settlement agreement as

follows:

     “My Claims” means all of my existing rights to any
     relief of any kind from * * * [Okabena] or the
     Investments,[4] whether or not I now know about those
     rights including, but not limited to:

     1.    all claims that arise out of or that relate to my
           employment or the termination of my employment
           with * * * [Okabena];

     2.    all claims that arise out of or that relate to the
           statements or actions of * * * [Okabena] or the
           Investments;

     3.    all claims for any alleged unlawful discrimination
           or any other alleged unlawful practices that arise
           out of or that relate to the statements or actions
           of * * * [Okabena] or the Investments, including,
           but not limited to, claims under the Civil Rights
           Act of 1964, the Age Discrimination in Employment
           Act, the Americans with Disabilities Act, the
           Civil Rights Act of 1991, the National Labor
           Relations Act, the Employee Retirement Income
           Security Act, the Minnesota Human Rights Act, the
           Minnesota Workers’ Compensation Act, and any


     4
      “Investments” was defined as “any present or past
investment entities managed by Okabena Company, and any person
who acted on behalf of or on instructions from any present or
past investment entities managed by Okabena Company.”
                              - 9 -

          federal or state wage and hour laws; and claims
          that * * * [Okabena] or the Investments engaged in
          conduct prohibited on any other basis under any
          federal, state, or local statute, ordinance, or
          regulation;

     4.   All claims for alleged unpaid compensation,
          expenses, and employee benefits; wrongful
          discharge; breach of contract; breach of implied
          contract; breach of a covenant of good faith and
          fair dealing; breach of fiduciary duty; promissory
          or equitable estoppel; defamation; intentional or
          negligent infliction of emotional distress; fraud;
          negligent misrepresentation; negligence; assault
          and battery; false imprisonment; invasion of
          privacy; interference with contractual or business
          relationships; and any other wrongful employment
          practices;

     5.   All claims for accountings, distributions,
          payments, and any other compensation from the
          Investments, except from Okabena Partnership V-8
          and Energy Corporation E-2; and

     6.   All claims for attorneys’ fees, liquidated
          damages, punitive damages, costs, and
          disbursements.

     [Emphasis added.]

The Notice of Deficiency

     In his statutory notice of deficiency, respondent

recharacterized the lump-sum payments as ordinary income taxable

to petitioner when received in 1993 and 1994 and also determined

that the liquidation payment was taxable to petitioner as

proceeds from the sale or exchange of various capital assets;

i.e., petitioner’s interests in various Okabena partnerships and

investments.
                               - 10 -

     Petitioners timely petitioned this Court for redetermination

of the deficiencies set forth in respondent’s notice.    In their

petition, petitioners contested respondent’s determinations and

further alleged that respondent erred in failing to determine

that petitioners were entitled to a refund of overpayments of

income taxes for 1993 and 1994 resulting from petitioners’

reporting of the severance payments as gross income.

                               OPINION

     Gross income means all income from whatever source derived,

unless excluded by law.    See sec. 61(a); sec. 1.61-1(a), Income

Tax Regs.    Exclusions from income are construed narrowly, and

taxpayers must bring themselves within the clear scope of the

exclusion.    See Commissioner v. Schleier, 515 U.S. 323, 336-337

(1995); United States v. Burke, 504 U.S. 229, 233 (1992);

Mayberry v. United States, 151 F.3d 855, 859 (8th Cir. 1998);

Dobra v. Commissioner, 111 T.C. 339, 349 n.16 (1998) (citing

Graves v. Commissioner, 89 T.C. 49, 51 (1987), supplementing 88

T.C. 28 (1987)).    Petitioner bears the burden of proof with

respect to whether he is entitled to an exclusion.    See Rule

142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933).

     Section 104(a)(2) excludes from gross income “the amount of

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

lump sums or as periodic payments) on account of personal
                                - 11 -

injuries or sickness”.5    “The term ‘damages received (whether by

suit or agreement)’ 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

settlement agreement entered into in lieu of such prosecution.”

Sec. 1.104-1(c), Income Tax Regs.

     In order to exclude payments under section 104(a)(2)

petitioner must show:     (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.   See Commissioner v. Schleier, supra at 337; Mayberry

v. United States, supra at 858; Bagley v. Commissioner, 105 T.C.

396, 416 (1995), affd. 121 F.3d 393 (8th Cir. 1997).

     The tax consequences of payments made pursuant to a

settlement agreement depend on the nature of the claims that were

the actual basis for settlement, not on the validity of those

claims.   See Bagley v. Commissioner, supra at 406; Threlkeld v.

Commissioner, 87 T.C. 1294, 1297 (1986), affd. 848 F.2d 81 (6th

Cir. 1988); Bent v. Commissioner, 87 T.C. 236, 244 (1986), affd.

835 F.2d 67 (3d Cir. 1987); Seay v. Commissioner, 58 T.C. 32, 36-


     5
      The Small Business Job Protection Act of 1996, Pub. L. 104-
188, sec. 1605(a), 110 Stat. 1755, 1838, amended sec. 104(a)(2)
to narrow the exclusion for personal injury damages received
after Aug. 20, 1996, in tax years ending after that date. Under
the amendment, personal injury or sickness must be physical. The
amendment, however, does not apply to the years before us in this
case and, therefore, has no bearing on our decision.
                              - 12 -

37 (1972); Burditt v. Commissioner, T.C. Memo. 1999-117.      The

proper inquiry is:   In lieu of what were damages awarded?    See

Bagley v. Commissioner, supra at 406.    Determination of the

nature of the claim is factual and is made by examining the

relevant facts and circumstances.   See id.; Burditt v.

Commissioner, supra.

I.   Were The Underlying Causes of Action Giving Rise to the
     Payments Based Upon Tort or Tort Type Rights?

     The first prong of the Schleier test requires a taxpayer to

prove the existence of a claim based upon tort or tort type

rights.   See Commissioner v. Schleier, supra at 337.     We must

decide, therefore, whether petitioner’s alleged claims were tort

or tort type claims and whether the claims were bona fide, but

not necessarily valid or sustainable.    See Pipitone v. United

States, 180 F.3d 859, 862 (7th Cir. 1999); Taggi v. United

States, 35 F.3d 93, 96 (2d Cir. 1994).   State law controls

whether the nature of the claim is a tort or tort type right, and

Federal law controls Federal tax consequences pertaining to such

interests and rights.   See Commissioner v. Tower, 327 U.S. 280,

288 (1946); Threlkeld v. Commissioner, supra at 1305-1306; Barnes

v. Commissioner, T.C. Memo. 1997-25.

     Petitioner asserts that two primary legal claims were the

basis for his settlement with Okabena-–defamation and age

discrimination.
                               - 13 -

     A.   Defamation

     The State of Minnesota recognizes a cause of action based on

the tort of defamation.    See Lake v. Wal-Mart Stores, Inc., 582

N.W.2d 231, 236 (Minn. 1998); Ferrell v. Cross, 557 N.W.2d 560,

562 (Minn. 1997); Bolton v. Department of Human Servs., 540

N.W.2d 523 (Minn. 1995).   General or compensatory damages

received by way of settlement for injury to personal reputation

and health caused by defamatory statements are exempt from

taxation.   See Seay v. Commissioner, supra at 40; Hawkins v.

Commissioner, 6 B.T.A. 1023 (1927).

     Under well-settled Minnesota law, in order to establish a

prima facie case of defamation, the plaintiff must show (1) a

statement was communicated to someone other than the plaintiff,

(2) the statement was false, and (3) the statement tended to harm

the plaintiff’s reputation and to lower the plaintiff in the

estimation of the community.   See Lewis v. Equitable Life

Assurance Socy. of the U.S., 389 N.W.2d 876, 886 (Minn. 1986);

Stuempges v. Parke, Davis & Co., 297 N.W.2d 252, 255 (Minn.

1980).    “Slanders affecting the plaintiff in his business, trade,

profession, office or calling are slanders per se and thus

actionable without any proof of actual damages.”    Stuempges v.

Parke, Davis & Co., supra at 255.

     The record in this case establishes that petitioner made a

bona fide claim of defamation against Okabena.   Petitioner
                               - 14 -

testified that immediately following the allegation of sexual

harassment, Okabena commenced an investigation into the matter,

and each female employee at Okabena was interviewed by its

outside counsel.    Petitioner testified that when the female

employees returned to the office, they were “totally pale and

really shook up”.    At that point, petitioner felt his rights were

violated.   Petitioner immediately hired legal counsel and

resigned the next day because he felt he no longer could manage

the employees at Okabena effectively as a result of the damage to

his reputation.    The investigation, including the interviews of

employees petitioner supervised, affected petitioner’s personal

and professional reputation adversely, and his relationships with

employees quickly deteriorated.

     Although petitioner could not point to a specific defamatory

comment, petitioner’s belief that he had been defamed was made in

good faith and was not frivolous.   In addition, because

settlement negotiations began promptly after the harassment claim

was made and the investigation was conducted, petitioner and his

counsel had no opportunity to discover precisely what had been

said and to whom.   If litigation had been filed, that opportunity

would have been available to petitioner and his counsel.     The

important fact here, however, is that petitioner asserted a

nonfrivolous claim for defamation in good faith, and that claim
                               - 15 -

was taken into account by both Okabena and petitioner in

negotiating their settlement agreement.

     We find that petitioner had asserted a bona fide claim for

defamation at the time the settlement agreement was executed;

therefore, the first element of Schleier is met.6

     B.   Age Discrimination

     Petitioner asserts that his age discrimination claim was

grounded upon the Minnesota Human Rights Act, Minn. Stat. Ann.

secs. 363.01-363.15 (West 1991 & Supp. 2000), and not the Age

Discrimination in Employment Act of 1967 (ADEA), Pub. L. 90-202,

sec. 2, 81 Stat. 602, currently codified at 29 U.S.C. secs. 621-

634 (1994), due to jurisdictional limitations of the ADEA.7


     6
      Petitioner argued, in the alternative, that the first
element of a defamation claim, i.e., that a statement was
communicated to someone other than the plaintiff, may be met
through the doctrine of “self-publication”. Lewis v. Equitable
Life Assurance Socy. of the U.S., 389 N.W.2d 876, 886 (Minn.
1986). Generally, there is no publication where a statement is
communicated directly to the plaintiff, who then communicates it
to a third person. Minnesota law, however, recognizes the
doctrine of compelled self-publication and acknowledges that the
publication requirement of a defamation action “may be satisfied
where the plaintiff was compelled to publish a defamatory
statement to a third person if it was foreseeable to the
defendant that the plaintiff would be so compelled.” Id. at 888.
In light of our holding, however, we need not address the merits
of petitioner’s alternative argument.
     7
      The Age Discrimination in Employment Act of 1967 (ADEA),
Pub. L. 90-202, sec. 2, 81 Stat. 602, currently codified at 29
U.S.C. secs. 621-634 (1994), prohibits claims against employers
with fewer than 20 employees. In contrast, age discrimination
actions under the Minnesota Human Rights Act may be brought
against employers with one or more employees. See Minn. Stat.
                                                   (continued...)
                              - 16 -

Petitioner asserts that the Minnesota Human Rights Act is a broad

statute that provides for tort or tort type remedies, including

compensatory damages, punitive damages, and damages for mental

anguish and suffering.

     The U.S. Supreme Court has held that amounts received by a

taxpayer in settlement of an age discrimination claim under the

ADEA are not excludable from gross income under section 104(a)(2)

because the ADEA provides no compensation “for any of the other

traditional harms associated with personal injury”.   Commissioner

v. Schleier, 515 U.S. at 335; see also United States v. Burke,

504 U.S. 229 (1992) (backpay awards in settlement of claims

brought under title VII of Civil Rights Act of 1964, Pub. L. 88-

352, 78 Stat. 253, as amended, 42 U.S.C. secs. 2000e through

2000e-17 (1994), are not damages received on account of personal

injuries within meaning of section 104(a)(2) and must be included

in income because Act does not provide remedies for personal

injuries).   But cf. Bent v. Commissioner, 87 T.C. at 249 (gross

income does not include damages received under 42 U.S.C. sec.

1983 claim based on violation of First Amendment rights to free

speech).   In Schleier, the Supreme Court concluded that monetary

remedies under the ADEA are either of an “economic character” or

liquidated damages, which serve no compensatory function.


     7
      (...continued)
Ann. sec. 363.01, subd. 17 (West 1991 & Supp. 2000). Okabena did
not employ more than 15 at any time relevant to this proceeding.
                              - 17 -

Commissioner v. Schleier, supra at 336.   Thus, a recovery under

the ADEA is not one “based upon tort or tort type rights.”       Id.

In Schleier, the Court emphasized that “one of the hallmarks of

traditional tort liability is the availability of a broad range

of damages to compensate the plaintiff ‘fairly for injuries

caused by the violation of his legal rights.’”    Id. at 335; see

also Mayberry v. United States, 151 F.3d at 859 (“the proper

focus is the remedial scheme in the statute providing the cause

of action and the nature of the relief available under the

scheme”).

     In contrast, an age discrimination claim pursued under the

Minnesota Human Rights Act appears to be “based upon tort or tort

type rights.”   Commissioner v. Schleier, supra at 336.8   The

Minnesota Human Rights Act specifically provides for damages

other than those of a purely economic nature.    For example, in

all cases where there is a finding of unfair discrimination, as

defined in Minn. Stat. Ann. sec. 363.03, subd. 1, the person

against whom the complaint has been filed or issued shall pay a

civil penalty to the State and compensatory damages to the

aggrieved party in an amount up to three times the actual damages

sustained.   See Minn. Stat. Ann. sec. 363.071, subd. 2 (West 1991



     8
      “The provisions of the Minnesota Human Rights Act are
liberally construed to accomplish its purposes.” Continental Can
Co. v. State, 297 N.W.2d 241, 248 (Minn. 1980) (citing City of
Minneapolis v. Richardson, 239 N.W.2d 197, 203 (Minn. 1976)).
                               - 18 -

& Supp. 2000).    Damages for mental anguish or suffering,

reasonable attorney’s fees, and punitive damages also may be

awarded to the aggrieved party.    See id.9   Thus, we conclude that

the Minnesota Human Rights Act compensates an aggrieved party for

“the other traditional harms associated with personal injury.”

Commissioner v. Schleier, supra at 336.

     Under the Minnesota Human Rights Act, it is an unfair

employment practice for an employer to discharge an employee

because of age.    See Minn. Stat. Ann. sec. 363.03, subd. 1(2)(b).

In order to prove a prima facie case of age discrimination under

Minnesota law, a plaintiff must show:     (1) He was a member of a

protected class,10 (2) he was qualified for the position he held,

(3) despite his qualifications, his position was terminated, and

(4) a younger person was assigned to do his work.     See Ward v.



     9
      In an employment case involving discrimination, the statute
also provides for:

     the hiring, reinstatement or upgrading of an aggrieved
     party, who has suffered discrimination, with or without
     back pay, admission or restoration to membership in a
     labor organization, or admission to or participation in
     an apprenticeship training program, on-the-job training
     program, or other retraining program, or any other
     relief the administrative law judge deems just and
     equitable. [Minn. Stat. Ann. sec. 363.071, subd. 2(a)
     (West 1991 & Supp. 2000).]

     10
      Minn. Stat. Ann. sec. 363.01,     subd. 3 (West 1991 & Supp.
2000) protects individuals over the     age of majority, except for
Minn. Stat. Ann. sec. 363.03, subd.     5 (West 1991 & Supp. 2000),
which protects individuals over the     age of 25 years.
                              - 19 -

Employee Dev. Corp., 516 N.W.2d 198, 201 (Minn. Ct. App. 1994).

Minnesota law permits plaintiffs to use circumstantial evidence

to prove discriminatory intent.   See Feges v. Perkins

Restaurants, Inc., 483 N.W.2d 701, 710 (Minn. 1992).

     The record confirms that petitioner had a nonfrivolous claim

of age discrimination under the Minnesota Human Rights Act, which

he asserted in good faith.   By reason of his age, petitioner was

a member of a protected class under the Minnesota Human Rights

Act when Okabena terminated his employment.   See Minn. Stat. Ann.

sec. 363.01, subd. 3.   Petitioner was qualified for his position;

indeed, petitioner was employed at Okabena for 16 years and

received at least two promotions during that period.     Petitioner

was terminated from Okabena and replaced with a younger worker.11

Petitioner also testified that during the negotiations he

specifically mentioned a potential claim for age discrimination

and pointed to a specific pattern of discrimination against

Okabena employees.

     We find, therefore, that petitioner also had asserted a bona

fide claim of age discrimination at the time the settlement

agreement was executed.




     11
      At the time he was terminated, petitioner was
approximately 49 years old. Mr. Dayton testified that petitioner
was replaced by a younger person.
                                 - 20 -

II.   Were the Payments Received on Account of Personal Injuries
      or Sickness?

      The second prong of the Schleier test requires a taxpayer to

show that the payments were received on account of personal

injuries or sickness.   See sec. 104(a)(2); Commissioner v.

Schleier, 515 U.S. at 337.      In order to satisfy Schleier, a

causal connection must be established between the tort, the

personal injury resulting, and the amount received in settlement.

See O’Gilvie v. United States, 519 U.S. 79, 82-83 (1996);

Commissioner v. Schleier, supra at 329-331.      Each element of the

tort settlement must be examined to determine whether there is a

direct causal link between that element and the personal injury

or sickness.   See Commissioner v. Schleier, supra at 330.

      A.   Severance Payments

      Petitioners assert that they erroneously included the

severance payments in their gross income and that, as a result,

they have overpaid their Federal income taxes for 1993 and 1994

and are entitled to a refund.     We disagree.

      Generally, severance pay, like the pay it replaces, is

includable in income.   See sec. 61(a)(1); Lubart v. Commissioner,

154 F.3d 539 (5th Cir. 1998), affg. T.C. Memo. 1997-343; Keel v.

Commissioner, T.C. Memo. 1997-278; sec. 1.61-2(a)(1), Income Tax

Regs.   Where, as here, the settlement agreement lacks express

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

account of personal injury, the most important factor in
                              - 21 -

determining whether the payments are excluded from income is the

intent of the payor.   See Knuckles v. Commissioner, 349 F.2d 610,

613 (10th Cir. 1965), affg. T.C. Memo. 1964-33; Bagley v.

Commissioner, 105 T.C. at 406; Bent v. Commissioner, 87 T.C. at

244; Laber v. Commissioner, T.C. Memo. 1997-559.

     Petitioner has not presented any credible evidence to prove

that Okabena’s intent was other than to provide him with

severance pay under the settlement agreement.   To the contrary,

the evidence establishes that Okabena intended the payments to be

exactly what they purported to be--severance payments.   The

severance payments were made over a period of 18 months in

amounts equal to petitioner’s salary before he was terminated.

Okabena continued to process and withhold Federal taxes on the

severance payments as it did with other employees’ salaries.   The

fact that the severance payments were treated as “wages” and

taxes were withheld provides compelling evidence that the

payments were not intended to be compensation for personal

injuries.   See Mayberry v. United States, 151 F.3d at 860-861.

     Petitioners contend that, under Roemer v. Commissioner, 716

F.2d 693 (9th Cir. 1983), revg. 79 T.C. 398 (1982), and Threlkeld

v. Commissioner, 87 T.C. 1294 (1986), when payments are based on

amounts of income lost due to tortious conduct, the amounts

received by the tort plaintiff or prospective tort plaintiff are

exempt from taxation pursuant to section 104(a)(2).
                              - 22 -

     In this case, we are not presented with the problem of

determining the correct tax treatment of a lump-sum payment,

which may or may not have encompassed lost income, as the courts

faced in Roemer and Threlkeld.   Here, the parties to the

settlement agreement carefully drafted the settlement agreement

so as to separate the severance payments from other types of

payments, including lump-sum payments that, in fact, were made to

compensate petitioner for his alleged personal injuries.    Under

the circumstances of this case, the failure of the settlement

agreement to provide that the severance payments were intended to

compensate petitioner for personal injuries is compelling

evidence that the severance payments were not made for that

purpose.   The settlement agreement contains a specific provision

acknowledging that the lump-sum payments made to petitioner were

intended “solely as compensation for claimed damages on account

of personal injuries arising from the occurrence within the

meaning of Section 104(a)(2)”.   No such provision was included

with respect to the severance payments.   The settlement agreement

also indicated that the severance payments were subject to

withholding taxes.

     On this record, we can find no causal link between the

severance payments and petitioner’s alleged tort claims.    There

is no evidence that the severance payments were made in

settlement of petitioner’s alleged claims for defamation and age
                              - 23 -

discrimination or that the severance payments were made on

account of personal injury or sickness.   See sec. 104(a)(2);

Commissioner v. Schleier, 515 U.S. at 337; Agar v. Commissioner,

290 F.2d 283, 284 (2d Cir. 1961) (despite taxpayer’s belief that

company paid him to avoid litigation, payments were in nature of

severance payments and were not excludable from income under

section 104(a)(2)), affg. T.C. Memo. 1960-21.

     We conclude that the severance payments were not made to

petitioner “on account of personal injuries”, and no personal

injury affected the amount of the severance payments received.

Sec. 104(a)(2); Commissioner v. Schleier, supra at 330.    The

severance payments properly were included in petitioners’ 1993

and 1994 gross income, and petitioners properly paid Federal

income taxes on the severance payments.   Petitioners are not

entitled to their claimed refund.

     B.   Lump-Sum Payments

     Paragraph 7 of the settlement agreement specifically stated

that the lump-sum payments were “intended solely as compensation

for claimed damages on account of alleged personal injuries

arising from an occurrence within the meaning of Section

104(a)(2)”.   Where, as here, there is an express allocation

contained in the agreement between the parties, it generally will

be respected if the settlement agreement was negotiated by

parties with adversarial interest, at arm's length, and in good
                               - 24 -

faith.   See Bagley v. Commissioner, 105 T.C. at 406; Robinson v.

Commissioner, 102 T.C. 116, 133-134 (1994), affd. on this issue

70 F.3d 34 (5th Cir. 1995); Burditt v. Commissioner, T.C. Memo.

1999-117.    However, an express allocation is not necessarily

determinative if other facts indicate that the payment was

intended by the parties to be for a different purpose.     See

Bagley v. Commissioner, supra at 406.

     We are satisfied that Okabena intended the lump-sum payments

to compensate petitioner for his personal injury claims.     Okabena

recognized that petitioner had bona fide claims for defamation

and age discrimination at the time of the settlement agreement

and agreed to make the lump-sum payments “on account of”

petitioner’s personal injuries.    When Mr. Dayton was asked at

trial whether petitioner’s personal injuries were of concern to

Okabena at the time the settlement was made, Mr. Dayton

responded:   “To a certain degree.   Yes.”   When Mr. Dayton was

asked, “And why was that concern to the company?”, he responded:

“Well, I think we were concerned about Ron’s well-being, at that

point.   He has – was a long-time employee of Okabena.    But the

overriding factor was that we were just trying to agree – to

reach an agreeable settlement between both parties.”     Before

finalizing the settlement agreement, Okabena evaluated

petitioner’s defamation and discrimination claims and certainly

was aware of petitioner’s allegations that his reputation and his
                                 - 25 -

professional career had been damaged severely by Okabena’s

actions.

     We find that Okabena made the lump-sum payments “in lieu of”

petitioner’s prosecution of his tort claims.     Id.; see also sec.

1.104-1(c), Income Tax Regs.     We hold, therefore, that the lump-

sum payments are excludable from petitioner’s income under

section 104(a)(2).

     C.    Liquidation Payment

     Paragraph 5(a) of the settlement agreement clearly and

expressly states the purpose for making the liquidation payment

to petitioner:    “[Okabena] will pay Gross $516,907.33 * * * as

the value of his interests in the partnerships and other

investments, except Okabena Partnership V-8 and Energy

Corporation E-2”.    The carefully structured settlement agreement

does not designate the liquidation payment as compensation for

alleged personal injuries.

     The liquidation payment was not made to petitioner “on

account of personal injury or sickness”; rather, petitioner

received the liquidation payment because he terminated his

employment with Okabena and liquidated his interests in Okabena

investment entities.    The liquidation of petitioner’s interests

in the investment entities was prompted by the desire of

petitioner and Okabena to sever most of petitioner’s ties with
                               - 26 -

Okabena.12   The liquidation payment was not in lieu of litigation

of petitioner’s alleged defamation or age discrimination claim.

We conclude, therefore, that petitioner is not entitled to

exclude the liquidation payment from his income under section

104(a)(2) because the liquidation payment was not received “on

account of personal injuries or sickness.”    Commissioner v.

Schleier, 515 U.S. at 330.    The payment received by petitioner

comprised the proceeds from the sale of capital assets and must

be included in income as such in the year it was received.

III.    Conclusion

       We have carefully considered all remaining arguments made by

the parties for contrary holdings and, to the extent not

discussed, conclude they are irrelevant or without merit.

       To reflect the foregoing,


                                          Decision will be entered

                                     under Rule 155.




       12
      Petitioner retained his interests in two of the Okabena
investment entities under certain supplemental agreements that
were modified as part of the settlement.
