1All section references are to the Internal Revenue Code

(Code) in effect for the years at issue, and all Rule references

are to the Tax Court Rules of Practice and Procedure, unless

(continued...)

T.C. Memo. 2008-158

UNITED STATES TAX COURT

JOYCE M. SANFORD, Petitioner v. 

COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket Nos. 20897-05, 1031-07. Filed June 23, 2008.

 Michael T. Wells, for petitioner.

 Valerie Makarewicz, for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

KROUPA, Judge: Respondent determined a $15,505 deficiency

in petitioner’s Federal income tax and a $3,101 accuracy-related

penalty under section 6662(a) for 2003.1 Respondent determined a
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1(...continued)

otherwise indicated. All dollar amounts are rounded to the

nearest dollar. 

$41,012 deficiency in petitioner’s Federal income tax and an

$8,202 accuracy-related penalty under section 6662(a) for 2004. 

There are four issues for decision. The first issue is whether

compensation petitioner received for nonpecuniary damages and

future pecuniary losses in a legal action against her employer is

excludable from petitioner’s income under section 104(a)(2) as

damages received on account of personal physical injury or

physical sickness. We hold that it is not. The second issue is

whether compensation petitioner received for past medical

expenses and transportation in the legal action is excludable

from petitioner’s income under section 104(a)(2) under the

exception for amounts paid for medical care attributable to

emotional distress. We hold that it is not. The third issue is

whether the attorney’s fees paid to petitioner’s attorney under a

fee-shifting regulation regarding the legal action are excludable

from petitioner’s income. We hold that they are not. The fourth

issue is whether petitioner is liable for the accuracy-related

penalty. We hold that she is.

FINDINGS OF FACT

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

The stipulation of facts and the accompanying exhibits are
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2These two cases were consolidated for trial, briefing, and

opinion in an Order from this Court dated Sept. 13, 2007.

incorporated by this reference. Petitioner resided in California

at the time she filed the petitions.2

Petitioner’s Legal Action

Petitioner was an employee of the U.S. Postal Service (USPS)

for several years continuing through 2004. Petitioner filed

complaints with the U.S. Equal Employment Opportunity Commission

(EEOC) in 1998 and 1999 alleging unlawful employment

discrimination. Specifically, petitioner alleged she was

discriminated against on the bases of race, national origin, sex,

religion, color, and age and that she was retaliated against for

previously participating in EEOC activity. Petitioner asserted

in the complaint that she was sexually harassed by a USPS

coworker. 

The EEOC issued a decision in petitioner’s legal action in

September 2002. The EEOC found that petitioner was sexually

harassed at work and was discriminated against because of her

sex. The EEOC did not find that petitioner was discriminated

against because of her race, national origin, religion, or age,

or that she was retaliated against for previously participating

in EEOC activity. The EEOC awarded petitioner reasonable

attorney’s fees pursuant to 29 C.F.R. sec. 1614.501(e) (the feeshifting regulation). 
-4-

3The EEOC, the USPS, and the parties variously refer to

certain of the damages as nonpecuniary compensatory damages. 

While the damages themselves are pecuniary, they compensated an

injury that was not. We shall use the terms the parties used in

referring to the damages as nonpecuniary compensatory damages.

Once the EEOC issued its decision, the USPS then issued its

Final Agency Decision in the legal action. The USPS awarded

petitioner compensatory damages of $7,662 in past medical

expenses and transportation, $14,033 for past benefits lost

(leave without pay), and $12,000 in nonpecuniary compensatory

damages.3 The USPS paid petitioner the damages, totaling

$33,695, on March 28, 2003. 

Petitioner’s Appeal

Petitioner appealed the $33,695 USPS Final Agency Decision

to the EEOC. The EEOC decided petitioner’s appeal in May 2004. 

The EEOC found that petitioner was sexually harassed by her

coworker and that the USPS failed to take appropriate corrective

action. The EEOC noted that petitioner had provided sufficient

documentation to substantiate or justify her request for

additional compensatory damages, including a report from her

psychologist and statements from friends and coworkers. The EEOC

indicated that petitioner had suffered emotional distress due to

the sexual harassment and USPS’ failure to take action to stop

the harassment. The EEOC also noted that petitioner’s

psychologist reported petitioner had experienced physical

symptoms due to the psychiatric problems the harassment created. 
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Petitioner’s friends and coworkers also indicated that petitioner

suffered from physical symptoms due to the stress of the longterm harassment. These physical symptoms included

intensification of petitioner’s asthma, sleep deprivation, skin

irritation, appetite loss, severe headaches, and depression. 

The Award

The EEOC determined on appeal that it was appropriate to

modify the USPS Final Agency Decision. The EEOC determined that

the USPS should pay petitioner a total of $115,000 in

nonpecuniary damages, $33,542 in future pecuniary losses, $7,662

for medical expenses, and $14,033 for use of annual leave, sick

leave and leave without pay. The EEOC again awarded petitioner

reasonable attorney’s fees pursuant to the fee-shifting

regulation. 

The USPS had already compensated petitioner for the medical

expenses and the loss of leave in the Final Agency Decision. 

Therefore, the USPS paid petitioner an additional $103,000 in

future pecuniary losses (in addition to the $12,000 it paid

petitioner a year earlier) and the $33,542 in future pecuniary

losses in June 2004. 

Attorney’s Fees

The EEOC determined in both decisions, in September 2002 and

May 2004, that petitioner was entitled to reasonable attorney’s

fees pursuant to the applicable fee-shifting regulation. In
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4Respondent concedes that petitioner reported $14,033 on the

return for 2003, which corresponds to the portion of the award

compensating petitioner for annual leave, sick leave, and leave

without pay.

accordance with this decision, the USPS paid $16,602 in

attorney’s fees in 2003 and $4,686 in 2004 on petitioner’s

behalf. 

Petitioner’s Returns and the Deficiency Notices

Petitioner timely filed returns for 2003 and 2004. 

Petitioner reported $43,050 of wages and $14,033 of other income

on the return for 2003. Petitioner failed to report any of the

income from the legal action other than the $14,033 of other

income for 2003. Petitioner reported $43,086 of wages and $1,500

of income from gambling winnings on the return for 2004. 

Petitioner failed to report any of the income from the legal

action for 2004. 

Respondent issued deficiency notices to petitioner for 2003

and 2004 (the years at issue). Respondent determined that

petitioner should have included the amounts she received in the

legal action in her income for 2003 and 2004.4 Respondent also

determined that the accuracy-related penalty applies to

petitioner’s tax liabilities for 2003 and 2004. Petitioner

timely filed petitions.

OPINION

We are asked to decide whether petitioner must include in

her income an award from a legal action against her employer. We
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5Petitioner does not claim that the burden of proof shifts

to respondent under sec. 7491(a). Petitioner also did not

establish that she satisfies the requirements of sec. 7491(a)(2). 

We therefore find that the burden of proof remains with

petitioner.

6We apply sec. 104(a)(2) as amended in 1996 by the Small

Business Job Protection Act of 1996 (SBJPA), Pub. L. 104-188,

sec. 1605, 110 Stat. 1838, effective generally for amounts

received after Aug. 20, 1996. That amendment, in relevant part,

added the modifier “physical” after “personal” and before

“injuries,” to clarify that amounts received on account of

personal injuries must be received for physical injuries. Id.

are also asked to decide whether petitioner is liable for the

accuracy-related penalty. The funds awarded from the legal

action fall into three categories, each with different rules

governing when the funds must be included in income. We shall

consider each category separately, beginning with nonpecuniary

damages and future pecuniary losses.5

Nonpecuniary Damages and Future Pecuniary Losses

We now consider whether petitioner must include in income

the portion of the award for nonpecuniary damages and future

pecuniary losses.6 Gross income generally includes all income

from whatever source derived. Sec. 61(a). The definition of

gross income is broad in scope, while exclusions from income are

narrowly construed. Commissioner v. Schleier, 515 U.S. 323, 328

(1995); Commissioner v. Glenshaw Glass Co., 348 U.S. 426, 430

(1955). 

Damages (other than punitive damages) received on account of

personal physical injuries or physical sickness may generally be
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7The Supreme Court analyzed sec. 104(a)(2) before its

amendment by the SBJPA sec. 1605(a), when the restrictive

modifier “physical” was added to limit the scope of “personal

injuries.” Commissioner v. Schleier, 515 U.S. 323, 328 n.3

(1995).

excluded from gross income. Sec. 104(a)(2). For the damages to

be excludable under this provision, however, the underlying cause

of action must be based in tort or tort-type rights, and the

proceeds must be damages received on account of personal physical

injury or physical sickness. Commissioner v. Schleier, supra at

328, 337.7 Emotional distress is not treated as a personal

physical injury or physical sickness except for damages not in

excess of the amount paid for medical care attributable to

emotional distress. Sec. 104(a) (flush language).

Respondent concedes that the underlying cause of action in

this case is based in tort or tort-type rights. Respondent

argues, however, that the damages petitioner received were not on

account of personal physical injuries or physical sickness. We

agree. We find compelling the EEOC and USPS decisions and

orders.

It is evident from the EEOC and USPS decisions and orders

that none of the award was predicated on personal physical injury

or physical sickness as the statute requires. The EEOC decision

noted, and we acknowledge, that the sexual harassment petitioner

suffered caused her emotional distress. We further acknowledge,

as did the EEOC, that the emotional distress manifested itself in
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physical symptoms such as asthma, sleep deprivation, skin

irritation, appetite loss, severe headaches, and depression. 

These physical symptoms were not the basis of the award

petitioner received, however. Petitioner sought, and was

awarded, relief for sexual harassment, discrimination based on

sex, and the failure of the USPS to take appropriate corrective

action.

The EEOC and USPS decisions and orders compensated

petitioner for the emotional distress she suffered because of 

the sexual harassment she experienced at work and her employer’s

failure to take appropriate corrective action. Despite her

argument to the contrary, petitioner was not compensated for the

physical symptoms she experienced as a result. Damages received

on account of emotional distress, even when resultant physical

symptoms occur, are not excludable from income under section

104(a)(2). Hawkins v. Commissioner, T.C. Memo. 2005-149.

We conclude that the nonpecuniary damages and future

pecuniary losses awarded to petitioner as a result of the legal

action were not received on account of personal physical injury

or physical sickness. Petitioner therefore must include these

damages in her income under section 104(a)(2) for the years at

issue.
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Past Medical Expenses and Transportation

We now turn to the portion of the award for petitioner’s

past medical expenses and transportation. While a taxpayer may

generally not exclude damages for emotional distress from income,

an exception applies for amounts paid for medical care for

emotional distress. Sec. 104(a). Damages for emotional distress

are treated as a personal physical injury or sickness, and thus

excludable from income, up to the amount paid for medical care

(as described in section 213(d)(1)(A) or (B)) attributable to

emotional distress. Id.

A reimbursement for medical expenses must be included in

income in the year it was received to the extent a deduction was

claimed on account of the medical expenses in a prior year. Sec.

1.213-1(g)(1), Income Tax Regs. If no deduction was claimed in

an earlier year, the taxpayer is not required to include the

reimbursement in income. Sec. 104(a); sec. 1.213-1(g)(2), Income

Tax Regs. To substantiate deductions for medical expenses under

section 213, the taxpayer must furnish the name and address of

each person to whom payment for medical expenses was made and the

amount and date of each payment. Sec. 1.213-1(h), Income Tax

Regs.

Petitioner received $7,662 for past medical expenses and

transportation in 2003. Petitioner failed to introduce evidence

that she had not deducted the medical expenses in a prior taxable
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8Petitioner did not claim any deductions for medical

expenses in 2003 or 2004. The record lacks any evidence

regarding medical expenses in prior years.

9Petitioner did not make any arguments on brief regarding

why she should be entitled to exclude fees paid to her attorney

on her behalf. She also did not argue, and we do not find, that

(continued...)

year.8 Petitioner also failed to introduce evidence to

demonstrate her costs for treating her emotional distress. 

Petitioner therefore cannot exclude the $7,662 reimbursement from

income for 2003.

Attorney’s Fees

We now consider whether petitioner must include in income

amounts paid to her attorney pursuant to the fee-shifting

regulation. A litigant generally may not exclude the portion of

recovery paid to his or her attorney where the litigant’s

recovery constitutes income. Commissioner v. Banks, 543 U.S.

426, 436-437 (2005). This is true whether the attorney’s fee was

paid on a contingent fee basis or pursuant to a fee-shifting

statute. Sinyard v. Commissioner, 268 F.3d 756 (9th Cir. 2001),

affg. T.C. Memo. 1998-364; Green v. Commissioner, T.C. Memo.

2007-39; Vincent v. Commissioner, T.C. Memo. 2005-95. A third

party’s discharge of a taxpayer’s obligation is income to the

taxpayer. Old Colony Trust Co. v. Commissioner, 279 U.S. 716,

729 (1929).

The USPS paid petitioner’s attorney $16,602 in 2003 and

$4,686 in 2004 on petitioner’s behalf.9 These funds paid
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9(...continued)

she is entitled to any deduction for attorney’s fees paid or

incurred to prosecute unlawful discrimination under the

amendments to sec. 62(a) that became effective Oct. 22, 2004.

American Jobs Creation Act of 2004, Pub. L. 108-357, sec. 703,

118 Stat. 1546. The date the payments were made to petitioner’s

attorney is not evident from the record, and it is thus unclear

whether the payments would be within the effective date of the

amendments to sec. 62(a). Petitioner bears the burden of proof,

however, and made no argument that she is entitled to this

deduction. She is therefore deemed to have conceded it.

pursuant to the fee-shifting regulation are not excludable from

petitioner’s income. See Sinyard v. Commissioner, supra; Vincent

v. Commissioner, supra. That the funds were paid directly to

petitioner’s attorney and not to petitioner does not alter this

result. See Sinyard v. Commissioner, supra at 759. We conclude

that petitioner must include in income the attorney’s fees paid

to her attorney.

Accuracy-Related Penalty

We finally consider whether petitioner is liable for the

accuracy-related penalty under section 6662(a). Respondent has

the burden of production under section 7491(c) and must come

forward with sufficient evidence that it is appropriate to impose

the accuracy-related penalty. See Higbee v. Commissioner, 116

T.C. 438, 446-447 (2001).

A taxpayer is liable for an accuracy-related penalty for any

portion of an underpayment attributable to, among other things,
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10Respondent determined alternatively that petitioner is

liable for the accuracy-related penalty for substantial

understatements of income tax under sec. 6662(b)(2) for 2003 and

2004. Because of our holding on the negligence issue, we need

not consider whether the underpayments were also substantial

understatements.

negligence or disregard of rules and regulations.10 Sec. 6662(a)

and (b)(1). Negligence is defined as any failure to make a

reasonable attempt to comply with the provisions of the Code. 

Sec. 6662(c). Negligence is the lack of due care or failure to

do what a reasonably and ordinarily prudent person would do under

the circumstances. Neely v. Commissioner, 85 T.C. 934, 947

(1985). Disregard is characterized as any careless, reckless, or

intentional disregard. Sec. 6662(c); sec. 1.6662-3(b)(2), Income

Tax Regs. Disregard of rules and regulations is careless if the

taxpayer does not exercise reasonable diligence to determine the

correctness of a return position that is contrary to the rule or

regulation. Kooyers v. Commissioner, T.C. Memo. 2004-281. We

have previously found a taxpayer negligent where the taxpayer

excluded a settlement amount relying solely on his attorney’s

statement that the settlement was for punitive damages. Corrigan

v. Commissioner, T.C. Memo. 2005-119. 

Petitioner failed to report all but $14,033 of the funds she

received from the legal action in 2003 and 2004. Petitioner

testified that she consulted H&R Block to file the returns, but

her testimony was unclear as to what advice she received and when

she received it. Petitioner did not testify about any other
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11A return position generally has a reasonable basis if it

is reasonably based on one or more of the authorities that

constitute substantial authority for purposes of substantial

understatements under sec. 6662(b)(2). Sec. 1.6662-3(b)(3),

Income Tax Regs. These authorities include, among others, the

Code and other statutory provisions, proposed, temporary, and

final regulations construing the statutes, court cases, and

Congressional intent as reflected in Committee reports. Sec.

1.6662-4(d)(3)(iii), Income Tax Regs. The reasonable basis

standard is not satisfied by a return position that is merely

arguable or is merely a colorable claim. Sec. 1.6662-3(b)(3),

Income Tax Regs.

efforts she made to properly report the award. Petitioner did

not show she exercised reasonable diligence to determine that

excluding the payments from income was the correct treatment. 

Nor has petitioner shown she had a reasonable basis for excluding

the award from income.11 Petitioner essentially argues that she

suffered physical injuries and therefore the award should be

excluded from her income. Petitioner misapplies the law because,

under section 104(a), awards for emotional distress are not

excludable from income, and the physical symptoms petitioner

suffered resulted from emotional distress. Petitioner makes no

argument why she should be entitled to exclude the attorney’s

fees from her income. She also did not support her exclusion of

the medical expense portion of the award with any documentary

evidence indicating that she incurred medical expenses and had

not deducted them in a prior year. We conclude that petitioner

was negligent in preparing her returns for 2003 and 2004.

The accuracy-related penalty under section 6662(a) does not

apply to any portion of an underpayment if the taxpayer proves
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there was reasonable cause for the taxpayer’s position with

respect to that portion and that he or she acted in good faith

with respect to that portion. Sec. 6664(c)(1); Higbee v.

Commissioner, supra at 446; sec. 1.6664-4(a), Income Tax Regs. 

The determination of whether a taxpayer acted with reasonable

cause and in good faith is made on a case-by-case basis, taking

into account all pertinent facts and circumstances, including the

taxpayer’s reasonable reliance on a professional tax adviser, the

taxpayer’s efforts to assess his or her proper tax liability, and

the knowledge and experience of the taxpayer. Sec. 1.6664-

4(b)(1), Income Tax Regs.

A taxpayer reasonably relied on a professional tax adviser

if the adviser was a competent professional who had sufficient

expertise to justify the taxpayer’s reliance on him or her, the

taxpayer provided necessary and accurate information to the

adviser, and the taxpayer relied in good faith on the adviser’s

judgment. See Neonatology Associates, P.A. v. Commissioner, 115

T.C. 43, 99 (2000), affd. 299 F.3d 221 (3d Cir. 2002). A

taxpayer generally must prove each of these elements to show his

or her reliance on a professional tax adviser was reasonable. 

Bowen v. Commissioner, T.C. Memo. 2001-47.

Petitioner argues that she reasonably relied on H&R Block to

prepare the returns. We disagree. While petitioner testified at

trial that she sought advice from H&R Block regarding her taxes,
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petitioner was unclear in her testimony about when she received

advice and what advice she received. Petitioner’s tax preparer

did not testify. Petitioner has also failed to establish that

she provided her preparer with all the necessary and accurate

information concerning her legal action. We therefore do not

find that petitioner reasonably relied on a professional tax

adviser.

After considering all the facts and circumstances, we find

that petitioner has failed to establish that she had reasonable

cause and acted in good faith with respect to the underpayments

of tax for the years at issue. Accordingly, we conclude that the

accuracy-related penalty applies.

To reflect the foregoing and respondent’s concession,

Decisions will be entered

under Rule 155.