                         T.C. Memo. 2000-302



                       UNITED STATES TAX COURT



         DAVID STEVAN AND KAREN ANN BRANDRIET, Petitioners v.
             COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 4311-99.                  Filed September 25, 2000.


     David Stevan Brandriet and Karen Ann Brandriet, pro sese.

     Melissa J. Hedtke, for respondent.



               MEMORANDUM FINDINGS OF FACT AND OPINION


     PARR, Judge:    Respondent determined a $75,739 deficiency in

petitioners' Federal income tax for the 1993 taxable year.

     After concessions,1 the issues for decision are:    (1)


     1
      Respondent concedes that the compensatory damage award of
$41,453.22 that petitioners received in 1993 is excluded from
petitioners' gross income pursuant to sec. 104(a)(2).
Respondent also concedes that petitioners' business, Malligan's
                                                   (continued...)
                                 - 2 -

Whether a punitive damage award of $200,000 that petitioners

received in 1993 is includable in their gross income.     We hold it

is.2    (2)   Whether petitioners are entitled to deduct interest on

a consumer loan in an amount greater than that allowed by

respondent.     We hold they are not.

       All section references are to the Internal Revenue Code in

effect for the taxable year in issue, and all Rule references are

to the Tax Court Rules of Practice and Procedure, unless

otherwise indicated.     References to petitioner are to David


       1
      (...continued)
Car Cleaning, had gross receipts of $1,842 in 1993.
     Petitioners concede that the $48,440 of interest they
received in 1993 pursuant to a judgment order is includable in
their gross income.
     In the notice of deficiency, respondent determined that
petitioners were not entitled to claim deductions of $1,011 for
vehicle expenses and $322 for utility expenses, because of lack
of substantiation and because petitioners did not establish an
ordinary and necessary business purpose for the expenditures.
     As we read the petition in this case, we do not construe it
as containing any reference to respondent's determinations
disallowing petitioners' vehicle and utility expense deductions.
See Rule 34(b)(4). Furthermore, petitioners did not address
these determinations at trial or on brief and did not proffer any
evidence to substantiate these claimed deductions. Accordingly,
we consider petitioners to have conceded these amounts.
       2
      Respondent determined that for the year at issue certain
computational adjustments should be made, which would: (1)
Reduce petitioners' deduction for exemptions, (2) reduce
petitioners' itemized deductions, and (3) preclude petitioners
from claiming the earned income credit.
     In their petition, petitioners raised the issue of whether
the punitive damage award is includable in their gross income
and, on the basis of that issue, disputed respondent's
computational adjustments. Our decision of the punitive damage
award issue will resolve the dispute of respondent's
computational adjustments.
                                - 3 -

Stevan Brandriet.

                           FINDINGS OF FACT

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

The stipulated facts and the accompanying exhibits are

incorporated into our findings by this reference.   At the time

the petition in this case was filed, petitioners resided in

Watertown, South Dakota.

     On September 18, 1989, petitioners filed suit against

Norwest Bank S.D., N.A. (Norwest) for rejection of petitioners'

application for a Veterans' Administration home mortgage loan.

The original complaint alleged fraudulent misrepresentation,

negligent misrepresentation, and negligent processing of the

application.   The pleadings were later amended to include claims

of intentional infliction of emotional distress and punitive

damages.   After an 8-day trial, the jury returned a verdict

holding Norwest liable for negligent processing, fraudulent

misrepresentation, and negligent misrepresentation; however,

Norwest was found not liable for intentional infliction of

emotional distress.   Petitioners were awarded $41,453.22 in

compensatory damages and $200,000 in punitive damages.   The

verdict was affirmed on appeal.    See Brandriet v. Norwest Bank

S.D., N.A., 499 N.W.2d 613 (S.D. 1993).

     Petitioners received the punitive damages in 1993; however,

they did not report any of this amount on their 1993 Federal
                                - 4 -

income tax return.

                               OPINION

Issue 1.   Whether the Punitive Damages Are Includable in
           Petitioners' Gross Income

     Respondent determined that the punitive damages received by

petitioners are taxable.   Petitioners contend that the punitive

damages portion of their award is excludable from gross income

pursuant to section 104(a)(2), because their lawsuit was based

upon tort or tort type rights and the jury "awarded damages it

believed would compensate their civil injuries."

     Not Compensatory

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

include "the amount of any damages received * * * on account of

personal injuries or sickness".   An award of punitive damages is

not paid on account of a personal injury to the extent that the

damages are noncompensatory.   See O'Gilvie v. United States, 519

U.S. 79 (1996).   Whether damages are noncompensatory rests upon

applicable State law.   See Bagley v. Commissioner, 105 T.C. 396,

417 (1995), affd. 121 F.3d 393 (8th Cir. 1997).

     The present case involves South Dakota law.    See Brandriet

v. Norwest Bank S.D., N.A., supra at 616, 618.     In Hulstein v.

Meilman Food Indus., Inc., 293 N.W.2d 889, 891, 892 (S.D. 1980),

the South Dakota Supreme Court stated that, while the "sole

object of compensatory damages is to make the injured party

whole", the "purpose of awarding punitive damages is to punish
                                - 5 -

the wrongdoer."   See also S.D. Codified Laws sec. 21-3-2 (Michie

Supp. 2000) (the jury, in addition to the actual damage, may give

punitive damages for the sake of example, and by way of punishing

the defendant); Veeder v. Kennedy, 589 N.W.2d 610, 622 (S.D.

1999) (punitive damages may properly be imposed to further

State's legitimate interests in not only punishing unlawful

conduct but also in deterring its repetition).    Contrary to

petitioners' assertion, we conclude that the punitive damages

were not compensatory.

     No Physical Injury or Physical Sickness

     The Omnibus Budget Reconciliation Act of 1989 (OBRA), Pub.

L. 101-239, sec. 7641(a), 103 Stat. 2106, 2379, amended section

104(a) by adding the sentence "Paragraph (2) shall not apply to

any punitive damages in connection with a case not involving

physical injury or physical sickness."   OBRA section 7641(b)(2)

provided that the amendment is applicable to amounts received

pursuant to suit filed after July 10, 1989.    Because petitioners

filed suit more than 2 months after this date, the amendment is

applicable to the instant case.

     The complaint in petitioners' suit was based upon several

claims.   Although petitioners claimed to have suffered "emotional

injuries" on account of the defendant's actions, the complaint

did not mention any physical injury or physical sickness

resulting from those actions.   The fact that a taxpayer suffers
                               - 6 -

"personal" injury from a defendant's conduct is insufficient to

satisfy the "physical injury or physical sickness" requirement.

Kightlinger v. Commissioner, T.C. Memo. 1998-357.

     The jury found Norwest liable for fraudulent

misrepresentation, negligent misrepresentation, and negligent

processing of a loan application.   Petitioners did not obtain

redress for any physical injury or physical sickness.

     Having considered the allegations in the complaint and the

jury's verdict, we find that petitioners did not receive the

punitive damages in connection with a case involving physical

injury or physical sickness.   We hold that petitioners' punitive

damages are includable in their gross income.

Issue 2.   Whether Petitioners Are Entitled to a Greater Interest
           Expense Deduction3

     Petitioners claimed a $3,000 deduction for interest paid on

a consumer loan.   Respondent determined that petitioners are

entitled to deduct $238 of the claimed interest expense as a

business expense and disallowed the balance.

     Respondent's determinations of fact are presumptively

correct, and petitioners bear the burden of proving otherwise.

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

Taxpayers do not have an inherent right to take tax deductions.

Deductions are a matter of legislative grace, and a taxpayer


     3
      Petitioners raised this issue at trial.   We consider it
tried by consent. See Rule 41(b).
                                 - 7 -

bears the burden of proving entitlement to any deduction claimed.

See Deputy v. du Pont, 308 U.S. 488, 493 (1940); New Colonial Ice

Co. v. Helvering, 292 U.S. 435, 440 (1934).      Moreover, a taxpayer

is required to maintain records that are sufficient to

substantiate his deductions.    See sec. 6001.

     At trial, petitioner proffered a photocopy of a cashier's

check dated August 6, 1993, made payable to First Federal Savings

Bank in the amount of $10,368.49, as evidence of petitioners'

payment of interest.   However, petitioners provided no evidence,

other than petitioner's vague and uncertain testimony, of the

amount of the interest and principal portions of the payment or

of the purpose of the loan.    Accordingly, petitioners have not

met their burden of proving entitlement to deduct any expense for

interest in an amount greater than that allowed by respondent.

     To reflect the foregoing,

                                              Decision will be entered

                                         under Rule 155.
