                  T.C. Summary Opinion 2001-46



                     UNITED STATES TAX COURT



                RICHARD W. WATERS, Petitioner v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent


     Docket No. 5578-99S.               Filed April 3, 2001.


     Bradley S. Shannon and John Howell, for petitioner.

     Paul K. Voelker, for respondent.



     COUVILLION, Special Trial Judge:   This case was heard

pursuant to section 7463 in effect when the petition was filed.1

The decision to be entered is not reviewable by any other court,

and this opinion should not be cited as authority.

     Respondent determined a deficiency of $10,894 in



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


petitioner's Federal income tax for 1995.

     The sole issue for decision is whether certain amounts

received by petitioner from his former employer during 1995 in

connection with the settlement of a class action against his

former employer are excludable from gross income under section

104(a)(2).   At trial, the parties conceded certain amounts, and

those concessions are noted hereafter.

     Some of the facts were stipulated.       Those facts, with the

annexed exhibits, are so found and are incorporated herein by

reference.   At the time the petition was filed, petitioner was a

legal resident of Las Vegas, Nevada.

     Petitioner was an employee of PayLess Drug Stores Northwest,

Inc. (PayLess), from approximately 1986 to 1993.       He started his

employment with PayLess as a temporary employee at Big Spring,

Texas, doing building maintenance.       He later was employed by

PayLess on a permanent basis as a shipping and receiving clerk.

After approximately 1 year, he was promoted to supervisor for

approximately 2-3 years, then as a floor manager for 3 years.

After that, petitioner worked approximately 9 months opening new

stores and closing old stores.    Following that, PayLess sold its

remaining stores in Texas and Oklahoma, and petitioner was

offered a position with PayLess as a supervisor at Las Vegas,

Nevada, which he accepted.   Petitioner's employment with PayLess

terminated in 1993.   The record does not reflect the reasons for
                               - 3 -


the termination of petitioner's employment.

     On March 16, 1993, an action was filed in the U.S. District

Court for the District of Iowa against PayLess by three of its

former employees for themselves and on behalf of other present

and former employees of PayLess.    The complaint alleged that the

purpose of the action was to recover on behalf of the class of

employees unpaid overtime compensation, liquidated damages,

attorney's fees, and costs under section 16(b) of the Fair Labor

Standards Act of 1938, ch. 676, 52 Stat. 1069, currently codified

at 29 U.S.C. secs. 201-209 (1994).     Petitioner was not one of the

plaintiffs instituting the action; however, petitioner qualified

for participation as a member of the class of employees for whom

the action was filed.   Petitioner never elected to be excluded

from the class, nor did petitioner ever claim or institute any

separate action against PayLess.    The class action did not

proceed to trial but was settled.    PayLess agreed to pay $5

million for the benefit of all qualifying members of the class,

including petitioner.   As part of the settlement, the plaintiffs

in the class action executed a written Settlement Agreement and

Release (the Settlement Agreement) effective January 25, 1995, in

consideration for payment of the $5 million by PayLess.    The

Settlement Agreement included a release by the plaintiffs of

PayLess that was embodied as section 3 and provided in pertinent

part:
                              - 4 -



     the * * * Plaintiffs * * * hereby release and discharge
     PayLess * * * from all actions, claims, or demands for
     damages, liabilities, costs, or expenses, which the
     Plaintiffs * * * have against PayLess on account of, or in
     any way arising out of the claims that were asserted or that
     could have been asserted in the Lawsuit by the Plaintiffs *
     * * including, but not limited to, claims for personal
     injuries, intentional infliction of emotional distress,
     negligent infliction of emotional distress, and from all
     known claims, whether based on tort, statute or contract,
     which are based in whole or in part, or arise out of, or in
     any way relate to: (1) the Lawsuit; and (2) anything done or
     allegedly done by PayLess arising out of, or in conjunction
     with or relating to, the employment of any and/or all
     Plaintiffs * * * by PayLess.


     The Settlement Agreement additionally included section 8,

entitled Liability Denial and Basis For Settlement, which

provided:


          PayLess denies any liability on its part and enters
     into this agreement solely to avoid litigation and to buy
     its peace. All Settlement Proceeds are paid to Plaintiffs
     on account of personal injuries. This Settlement Agreement
     and the releases contained herein settle and resolve all
     claims which have to this point been contested and denied by
     the parties, as well as all other claims released by
     paragraphs 3 and 4 of this Settlement Agreement. None of
     the provisions of this Settlement Agreement and nothing
     contained in this Settlement Agreement shall be construed as
     an admission of any liability whatsoever by any party hereto
     to any other party hereto.


     As a member of the class of former employees of PayLess,

petitioner received the following amounts out of the $5 million

settlement:
                               - 5 -


     Back wages                                           $14,116.97
     Compensation for participation in the class action     6,000.00
     Liquidated damages                                    32,858.21
       Total                                              $52,975.18


Petitioner's share of attorney's fees and costs amounted to

$18,292.33; consequently, petitioner received a net payment of

$34,682.85 during 1995.   As a condition for settlement,

petitioner executed an Individual Certification and Release in

which he acknowledged receipt of documents regarding settlement

of the class action, acknowledged receiving a copy of the

Settlement Agreement that was incorporated by reference as part

of his release, expressly affirmed "the authority of the named

Plaintiffs to release my claims and settle the Lawsuit", and

individually released PayLess in paragraph 8 of the release that

provided, in pertinent part:


          In exchange for the payment of the amount * * * [to
     petitioner] I hereby release and discharge PayLess * * *
     from all actions, claims, or demands for damages,
     liabilities, costs, or expenses, which the Plaintiffs,
     individually or collectively, have against PayLess on
     account of, or in any way arising out [of] the claims that
     were asserted or that could have been asserted in the
     Lawsuit by the Plaintiffs, which Lawsuit is hereby
     acknowledged as not fully plead, further including, but not
     limited to, claims for personal injuries, intentional
     infliction of emotional distress, negligent infliction of
     emotional distress, and from all known claims, whether based
     on tort, statute or contract, which are based in whole or in
     part, or arise out of, or in any way relate to: (1) the
     Lawsuit; and (2) anything done or allegedly done by PayLess
     arising out of, or in conjunction with or relating to, the
     employment of any and/or all Plaintiffs prior to November 1,
     1992 by PayLess.
                                 - 6 -



     On his 1995 Federal income tax return, petitioner did not

include in gross income any of the amounts received by him in

settlement of the class action.    Petitioner claimed the standard

deduction under section 63(c).    In the notice of deficiency,

respondent determined that the entire amount of $52,975 allocated

to petitioner in the settlement constituted gross income and that

petitioner was entitled to an itemized deduction of $18,292 for

the attorney's fees and costs allocable to petitioner.    Because

petitioner had claimed the standard deduction, respondent

disallowed the standard deduction and substituted that with an

allowed itemized deduction of $18,292.    At trial, respondent

conceded that petitioner was entitled to an additional itemized

deduction of $2,222 for charitable contributions.    Petitioner

conceded that $6,000 of his award as compensation for

participation in the class action constituted gross income.

Petitioner, however, challenged the back pay of $14,116.97 and

the liquidated damages of $32,858.21.2

     Petitioner contends that the amount he received in the



     2
          Petitioner has not challenged respondent's inclusion of
the $18,292 for attorney's fees in gross income and allowance of
that amount as an itemized deduction. The $18,292 in attorney's
fees is subject to the 2-percent limitation under sec. 67(a).
See Miller v. Commissioner, T.C. Memo. 2001-55; Benci-Woodward v.
Commissioner, 219 F.3d 941 (9th Cir. 2000).
                               - 7 -


settlement represented damages to him for a racial discrimination

claim he had against PayLess, and the Settlement Agreement was

broad enough to include such claim.    Petitioner contends that

throughout the period he was employed by PayLess, from 1986 to

1993, he was subjected to racial discrimination, which he

discussed with his superiors at PayLess.    Petitioner alleges

that, although no suit was filed by petitioner against PayLess

(including one for racial discrimination), petitioner discussed

the matter with the attorneys representing plaintiffs in the

class action.   However, no action was taken by these attorneys to

assert a racial discrimination claim in the class action, and

there is no evidence that the matter was ever taken up with the

opposing attorneys who represented PayLess.    Nevertheless,

petitioner contends that the proceeds from the class settlement

constituted damages for personal injuries; i.e., resulting from

racial discrimination practices by PayLess, relying on Rev. Rul.

1993-88, 1993-2 C.B. 61;3 Metzger v. Commissioner, 88 T.C. 834

(1987), affd. 845 F.2d 1013 (3d Cir. 1988); Morabito v.



     3
          Rev. Rul. 93-88, 1993-2 C.B. 61, provides that
compensatory damages, including back pay, received in
satisfaction of a claim of racial discrimination under 42 U.S.C.
sec. 1981 and Title VII of the Civil Rights Act of 1964 are
excludable from gross income as damages for personal injury under
sec. 104(a)(2). In Rev. Rul. 96-65, 1996-2 C.B. 6, Rev. Rul. 93-
88 was declared obsolete prospectively from June 14, 1995.
Petitioner's payment was received by him prior to June 14, 1995.
                               - 8 -


Commissioner, T.C. Memo. 1997-315.     Petitioner also relies on

section 8 of the Settlement Agreement that states that "all

settlement proceeds are paid to plaintiffs on account of personal

injuries".

     Section 104(a)(2) provides that gross income does not

include "the amount of any damages received (whether by suit or

agreement* * *) on account of personal injuries or sickness".

Under section 1.104-1(c), Income Tax Regs., "damages" means a

recovery "based upon tort or tort type rights".    See also

Commissioner v. Schleier, 515 U.S. 323 (1995).     While personal

injuries, under section 104(a)(2), may generally include both

physical as well as nonphysical emotional injuries, such as "pain

and suffering, emotional distress, harm to reputation, or other

consequential damages (e.g., a ruined credit rating)", the

Supreme Court has distinguished such personal injuries from

"legal injuries of an economic character" such as those arising

out of the unlawful deprivation of the opportunity to earn wages

through a wrongful termination.   United States v. Burke, 504 U.S.

229, 239, 245 (1992).   Damages received for lost wages in

connection with the settlement of economic rights, such as those

arising out of a breach of contract, are not excludable from

income under section 104(a)(2).   See Robinson v. Commissioner,

102 T.C. 116, 126 (1994), affd. in part, revd. in part on another
                               - 9 -


issue 70 F.3d 34 (5th Cir. 1995).

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

term 'damages received (whether by suit or agreement)' means an

amount received * * * 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."

Thus, in order to exclude damages from gross income pursuant to

section 104(a)(2), the taxpayer must prove:    (1) The underlying

cause of action 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 336-337.

     Where amounts are received pursuant to a settlement

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

settlement controls whether such amounts are excludable from

gross income under section 104(a)(2).    See United States v.

Burke, 504 U.S. 229, 237 (1992).    The crucial question is "in

lieu of what was the settlement amount paid."    Bagley v.

Commissioner, 105 T.C. 396, 406 (1995), affd. 121 F.3d 393 (8th

Cir. 1997). Determining the nature of the claim is a factual

inquiry.   See Robinson v. Commissioner, 102 T.C. 116, 127 (1994),

affd. in part, revd. in part, and remanded 70 F.3d 34 (5th Cir.

1995).

     Here, the complaint in the class action was exclusively for
                              - 10 -


recovery of "overtime compensation, liquidated damages, attorney

fees and costs" under the Fair Labor Standards Act of 1938.

Nowhere in the complaint or in the Settlement Agreement is there

any reference to or any indication that the recovery included

damages for racial discrimination.     Moreover, the record

satisfies the Court that petitioner's claim to racial

discrimination practices against him was not called to the

attention of PayLess or its attorneys in connection with the

class action.   Since there was no claim made for such injury by

petitioner, the rhetorical question posed in Bagley v.

Commissioner, supra, is that whatever the settlement was for, it

certainly was not for personal injuries attributable to racial

discrimination practices.   Petitioner's reliance on Rev. Rul.

1993-88, therefore, is misplaced.4     Moreover, the general

language relied on by petitioner in the Settlement Agreement that

"all settlement proceeds are paid to plaintiffs on account of

personal injuries" is inconsistent with the other provisions of

the agreement that quite clearly indicate and establish that the

settlement was intended to satisfy the claims made in the class



     4
          The Court notes further that revenue rulings do not
have the force of law and are merely statements of the
Commissioner's litigating and administrative position. See Dixon
v. United States, 381 U.S. 68, 73 (1965); Stubbs, Overbeck &
Associates v. United States, 445 F.2d 1142, 1146-1147 (5th Cir.
1971).
                              - 11 -


action.   Such language relied on by petitioner in the Settlement

Agreement, therefore, can be ignored.   See Peaco v. Commissioner,

T.C. Memo. 2000-122.   The Court, therefore, holds that the

amounts awarded to petitioner for back pay and liquidated damages

under the Fair Labor Standards Act as part of the class action

constitute gross income and are not excludable under section

104(a)(2).   See Commissioner v. Schleier, supra.     Respondent,

therefore, is sustained.

     Reviewed and adopted as the report of the Small Tax Case

Division.



                                         Decision will be entered

                                    under Rule 155.
