T.C. Memo. 1997-542

UNITED STATES TAX COURT

CHERYL DENESE BREWER, Petitioner v

. COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 8612-96. Filed December 9, 1997.

Cheryl Denese Brewer, pro se.

Jason M. Silver , for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

JACOBS, Judge : Respondent determined a $47,047 deficiency in

petitioner's 1992 Federal income tax.

Th e issues for decision are: (1) Whether petitioner is

entitled to exclude from gross income amounts received in

settlement of a class action suit pursuant to section 104( a)(2),- 2 -

1 On Sept. 9, 1981, the District Court for the Northern

District of California certified a class in Kraszewski to

maintain the action. See Kraszewski v. State Farm Gen. Ins. Co.

, 27 Fair Empl. Prac. Cas. (BNA) 27 (N.D. Cal. 1981). and (2) whether petitioner is entitled to exclude from gross income

amounts paid as legal fees.

Unless otherwise indicated, all section references are to the

Internal Revenue Code as in effect for the year in issue, and all

Rule references are to the Tax Court Rules of Practice and

Procedure.

FINDINGS OF FACT

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

stipulation of facts and attached exhibits are incorporated herein

by this reference.

Cheryl Denese Brewer (petitione r) resided in Los Angeles,

California, at the time she filed her pet ition. At all relevant

times, petitioner was an insurance agent.

On June 1, 1979, a class action lawsuit, Kraszewski v. State

Farm Gen. Ins. Co.

, was filed against State Farm General Insurance

Co., State Farm M utual Automobile Insurance Co., State Farm Life

Insurance Co., and State Farm Fire and Casualty Co. (State Farm) in

t he U.S. District Court for the Northern District of Californi a. 1

The class repre sentatives alleged that State Farm had engaged in

statewide discrimination in California in the recruiting, hiring,

and training of women for sales agent trainee positions in- 3 -

violation of title VII of the Civil Rights Act of 1964, Pub. L. 88-

352, sec. 701, 78 Stat. 241, 42 U.S.C. sec. 200 0e to 2000e-17

(title VII). The representatives sought backpay, as well as

injunctive and declaratory relief.

On November 6, 1981, the Distri ct Court bifurcated the

litigation into a liability and a remedy phase. On April 29, 1985,

the court ruled in the liability phase that State Farm was liable

under title VII for classwide discrim ination on the basis of

gender. See K raszewski v. State Farm Gen. Ins. Co.

, 38 Fair Empl.

Prac. Cas. (BNA) 197 (N.D. Cal. 1985). The court concluded that

women who attempted to become trainee agents were "lied to,

misinformed, and discouraged in their efforts to attain the entry

level sales position." I d. at 257. The court then ruled that the

cla ss action suit properly included "all female applicants and

deterred applicants who, at any time since July 5, 1974, have been,

are, or will be denied recruitment, selection and/or hire as

trainee agents by defendant companies within the State of

California." Id. at 258.

On July 17, 1986, the court held that individual hearings were

appropriate to determine the relief for class members. The court

decided that class members were entitled to show that they were

actual victims of discrimination as to any of the vacancies at

State Farm that occurred during the period of liability and were

filled by men.- 4 -

On June 17, 1979, petitioner sought employment as a State Farm

trainee agent but was not hired. She subsequently became aware of

the class action suit against State Farm and became a plaintiff in

the suit. On February 6, 1992, petitioner and State Farm entered

into a "Settlement Agreement and General Release" (settlemen t

agreement), which provided in relevant part:

1. For and in consideration of the sum of

$186,677.00, and potential additional payments

of up to $18,000.00 as provided in Paragraph 13

below, * * * less all requir ed payroll

deductions applicable to the period of Trainee

Agency, if any, and inclusive of attorneys's

[sic] fees and cost s to which * * *

[petitioner] Cheryl Denese Brewer or Claimant's

Counsel is entitled on a prevailing party basis

but excluding attorneys' fees and costs as set

forth in Paragraph 4 below, Cheryl Denese

Brewer * * * does hereby completely release and

forever discharge * * * [State Farm] * * * from

any claim * * * or liability of any and every

kind based on any federal, state, or local law,

statut e, or regulation, excepting only claims

for worker's compensation benefits,

(hereinafter "Claim") which arose prior to the

e xecution of this Settlement Agreement and

General Release, and which was raised, or could

have been raised in the above-captioned case,

as well as any and all Claims (including, where

applicable, claim s under the federal Age

Discrimination in Employm ent Act) arising out

of or relating to any alleged discriminatory,

improper, or unlawful act or omission of State

Farmin connection with any term or condition

of employment or independent contractor status

or the process of securing or att e mpting to

secure employee or independen t contractor

status including, without limitation,

recruitment, selection, hiring, job assignment,

job transfer, training, promotion, or

termination, which arose prior to the execution

of this Settl ement Agreement and General

Release.- 5 -

* * * * * * *

3 . * * * [Petitioner] hereby agrees and

promises * * * (3) that by entering into this

Se ttlement Agreement and General Release, she

is waiving any and all right[s] she may have

under the terms of the Consent Decree

respecting instatement or rights to any other

future class relief * * *

* * * * * * *

5. It is understood and agreed that this

is a full and final Gene ral Release applying

not only to all Claims which ar e presently

known, anticipated or disclosed to * * *

[petitioner], but also to all Claims which are

presently unknown, unanticipated, and

undisclosed to * * * [petitioner] and which may

have arisen prior to the date of execution of

this Settlement Agreement and General Release.

* * * [Petitioner] hereby waives any and all

rights or b enefits which she may now have, or

may in the future have, under the terms of

Section 1542 of the California Civil Code,

which provides as follows:

A general release does not

extend to claims which the creditor

does not know or suspect to exist in

his favor at the time of executing

the release, which if known by him

must have materially affected his

settlement with the debtor.

* * * * * * *

7. It is understood and agreed that this

comp romise settlement includes the compromise

settlement of any and all legal, evidentiary,

discovery, and do cument production issues

regarding Claim No. 554 * * *. The parties

further agree and understand that neither State

Farm nor * * * [petitioner] will bring any

motions, either individually or as part of the

class, relative to such Claim No. 554 issues *

* *- 6 -

* * * * * * *

13. * * * The approximate full value of

* * * [petitioner's] c laim under the Consent

De cree damage formula as of February 1, 1992,

is $499,912.00, which represents back pay as a

State Farm agent a ccrued from the year of the

chal lenged appointment to February 1, 1992,

plus six month s of front pay from that date

forward.

b. S ettlement Cash at 87. 5 %

Acceptance Rate : State Farm offers * * *

[petitioner] Settlement Cash of $186,677.00,

which is approximately 37% of the estimated

full Consent Decree value of her claim, to

release her claims against State Farm. * * *

* * * * * * *

c. I ncent ive Cash for Acceptance

Rate Above 90% : The Ince ntive Cash will be

$1,800.00 per claimant for each full percentage

point by which the Acceptance Rate * * *

exceeds 90%. * * *

* * * * * * *

e. Attorney's Fees : The payments

State Farm is offering to * * * [petitioner]

include her attorneys' fees and costs * * *.

That is, * * * [petitioner] will have to pay

her attorneys' fees * * * out of the payment

State Farm makes to her. * * *

In 1992, pursuant to the terms of the settlement, State Farm issued

petitioner and her attorney a check in the amount of $202,877.

Petitioner's attorney retained legal fees of $40,620.

Petitioner did not report th e State Farm payment on her 1992

Federal income tax return. Respondent determined in the notice of

deficiency that the entire State Farm payment should have been

included in petitioner's gross income and that petitioner is- 7 -

entitled to claim legal fees in the amoun t of $40,620 as a

miscellaneous itemized deduction.

OPINION

Issue 1. Excludability of Settlement Proceeds

The first issue for decision is whether petitioner is entitled

to exclude from gross income, pursuant to section 104(a)(2), amounts

received in settlement of a class action suit. Petitioner contends

that she is so entitled. Respondent disagrees.

Except as otherwise provided, gross income includes income from

all sources. Sec. 61; C ommissioner v. Glenshaw Glass Co.

, 348 U.S.

426, 429-430 (1955). Although section 61(a) is to be broadly

construed, statutory exclusions from income must be narrowly

construed. C ommissioner v. Schleier

, 515 U.S. 323, 327-328 (1995).

Pursuant to s ection 104(a)(2), gross income does not include

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

and whether as lump sums or as periodic payments) on a c count of

personal injuries or sickness". The regulations provide 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." Sec. 1.104-

1(c), Income Tax Regs. Thus, in order to exclude damages from gross

income pursuant to section 104(a)(2), the taxpayer must prove that:

(1) The underlying cause of action is based upon tort or tort type- 8 -

rights, and (2) the damages were received on account of personal

injuries or sickness. C ommissioner v. Schleier

, supra at 336-337.

Where amounts are received pursuant to a settlement agreement,

the nature of the claim t hat was the actual basis for settlement

controls whether such amounts are excludable from gross income under

section 104(a)(2). U nited States v. Burke

, 504 U.S. 229, 237

(1992). The crucial question is "in lieu of what was the settlement

a mount paid?" B agley 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. R obinson v. Commissioner

, 102 T.C. 116,

127 (1994), affd. in part, revd. in part, and remanded 70 F.3d 34

(5th Cir. 1995).

The amounts petitioner received pursu a nt to the settlement

agreement wer e intended to settle her claim under title VII.

Although petitioner did not file an ind ividual complaint in that

case, and the settlement agreement does not contain a specific

reference to title VII, it is clear that title VII is the basis for

the underlying claim. The nature of petitioner's claim is identical

to that stated in t he complaint filed by the K raszewski class

rep resentatives, which alleged that State Farm had engaged in

statewide discrimination in the recruiting, hiring, and training of

women for sales agent trainee positions in violation of title VII.

The plaintiffs sought backpay and injunctive and declaratory relief.

The District Court held that State Farm was liable under title VII- 9 -

2 Although petitioner did not have a hearing to determine

whether she was entitled to damages, petitioner and State Farm

nevertheless entered into a settlement. to all members of the class who had been discriminated against and

ordered individual hearings. 2 K raszewski v. State FarmGen. Ins.

Co.

, 38 Fair Empl. Prac. Cas. (BNA) 197 (N.D. Cal. 1985). The

court did not limit relief to State Farm employees.

The U.S. Supreme Court's decision in United States v. Burke

,

supra

, controls. The issue in Burke was whether amounts received

in se ttlement of a title VII claim were excludable pursuant to

section 104(a)(2). The Court analyzed title VII and held that it

did not provide for remedies to recompense claimants for tort type

personal injuries. Rather, the Court noted that the statute offered

only injunctions, back and front pay, and other equitable relief.

Id. at 238-239. Accordingly, the Court held that title VII did not

redress a tort type personal injury and consequently that settlement

proceeds based on such a claim are not excludable pursuant to

section 104(a)(2).

Here, petitioner and State Farm entered into a s ettlement

agreement pursuant to which State Farm paid $202,877 to petitioner

for her release of a claim "arising out of or relating to any

alleged discriminatory, improper, or unlawful act or omission of

State Farm in connection with * * * recruitment, selection, hiring,

job assignment, job transfer, training, promotion, or termination".

In addition, the settlement agr eement specifically stated that it- 10 -

3 Claim No. 554 was the identification of petitioner's

claim against State Farm in the class action suit.

4 As petitioner's claim arose in 1979 and the class

action suit was filed in that year, the amendments to title VII

made by sec. 102 of the Civil Rights Act of 1991, Pub. L. 102-

166, 105 Stat. 1072-1074, do not apply. Landgraf v. USI Film

Prods. , 511 U.S. 244 (1994). includes "the compromise settlement of any and all leg al,

evidentiary, discovery, and document production issues regarding

Claim No. 554." 3 Thus, the entire award petitioner received in

settlement of her title VII claim against State Farm represented a

compromise and settlement of petitioner's rights pursuant to her

claim against State Farm alleging discrimination under title VII. 4

In sum, no portion of petitioner's settlement award was

attributable to a claim based upon tort or tort type rights. Thus,

we hold that petitioner improperly excluded the settlement proceeds

($202,877) from her 1992 gross income. C ommissioner v. Schleier

,

supra at 337; United States v. Burk e

, supra at 242. Accordingly,

we sustain respondent's determination.

We note that our opinion herein is consistent with prior

decisions of this Court, which also held that settlement proceeds

received pursuant to the Kraszewski litigation were not excludable

from gross income pursuant to section 104(a)(2). See G illette v.

Commissioner

, T.C. Memo. 1997-301; Hayes v. Commissioner

, T.C. Memo.

1997-213; Hard in v. Commissioner , T.C. Memo. 1997-202; R aney v.

Commissioner

, T.C. Memo. 1997-200; Clark v. Commissioner

, T.C. Memo.- 11 -

1997-156; Berst v. Commissioner , T.C. Memo. 1997-137; M artinez v.

Commissioner

, T.C. Memo. 1997-126; Fredrickson v. Commissioner

, T.C.

Memo. 1997-125.

Issue 2. Excludability of Legal Fees

The second issue is whether petitioner is entitled to exclude

from gross income amounts paid as legal fees. Petitioner argues

that because her legal fees were paid to counsel from the settlement

proceeds and petitioner n ever received such fees, petitioner is

entitled to exclude the legal fees from her 1992 income. Respondent

contends that petitioner may deduct attorney's fees of $40,620 as

a miscellaneous itemized deduction to the extent they exceed 2

percent of petitioner's adjusted gross income.

Although State Farm issued a check jointly to petitioner and

her attorney, petitioner was responsible for her legal costs. The

settlement agreement provided, inter alia, that the State Farm

paymen t included petitioner's attorney's fees and that it was

petitioner's responsibility to pay her attorney's fees.

T hus, we agree with respondent that the attorney's fees are

includable in petitioner's gross income and dedu ctible as a

miscellaneous itemized deduction. See A lexander v. Commissioner

,

72 F.3d 938, 946 (1st Cir. 1995), affg. T.C. Memo. 1995-51.- 12 -

We have considered all of petitioner's ot her arguments and

found them to be either irrelevant or without merit.

To reflect the foregoing,

Decision will be entered

for respondent

.