TAX COURT OPINION

Case: Amie Schill
Docket Number: 15361-13
Judge: Holmes
Opinion Type: bench
Filed: 11/10/2014
Pages: 20

UNITED STATES TAX COURT WASHINGToN, DC 20217 Amie Schill, Petitioner, v. COMMISSIONER OF INTERNAL REVENUE, Respondent. ) ) ) ) ) Docket No. 15361-13. ) ) ) ORDER Pursuant to Rule 152(b), Tax Court Rules of Practice and Procedure, it is ORDERED that the Clerk of the Court shall transmit herewith to petitioner and to respondent a copy of the pages of the transcript of the trial in the above case before Judge Mark V. Holmes at San Antonio, Texas on October 29, 2014 containing his oral findings of fact and opinion rendered at the trial session at which the case was heard. In accordance with the oral findings of fagd opinion, a Decision will be ëïff6f8d under rule 155. (Signed) Mark V. Holmes Judge Dated: Washington, D.C. November 10, 2014 SERVED NOV 2 0 2014 Capital Reporting Company 3 1 Bench Opinion by Judge Mark V. Holmes 2 October 29, 2014 3 4 5 6 7 8 9 10 11 12 13 14 Amie Schill v. Commissioner Docket Number 15361-13 In the case of Amie Schill v. Commissioner, Docket Number 15361-13, the Court has decided to render oral findings of fact and opinion in this case, and the following is the Court's oral findings of fact and opinion: The bench opinion is made pursuant to the authority granted by Section 7459(b) of the Internal Revenue Code of 1986, as amended, and Rule 152 of the Tax Court's Rules of Practice and Procedure. The taxpayer here is a woman named Amie 15 Schill, who was a resident of Texas at the time she 16 17 18 19 20 21 22 23 24 25 filed the petition. The petition stems from her challenge to the IRS's determination of deficiencies in her '09 and 2010 tax years. The case began with several concessions by both parties on the relatively minor issues raised by the notice of deficiency. They stipulated most of those away with both sides conceding some of the issues and the IRS waiving the penalty related to those issues on which Ms. Schill conceded. There is also a written stipulation, and 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company 4 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 it, together with the oral testimony in the case, constitute the record of the case. Two substantive issues remain: deductions of $18,509 taken in 2009 as unreimbursed employee business expenses and the characterization of settlement proceeds that Ms. Schill received from her former employer in 2010. And then there is also the accuracy-related penalty under Section 6662 for each of these adjustments. Each of these substantive adjustments requires very different analyses. I'll begin with the $18,509 in unreimbursed employee business expenses. These expenses themselves fall into two categories. The first category of unreimbursed employee business expenses are the gifts that Ms. 17 Schill made in 2009 to some of her customers. She's 18 19 20 21 22 23 24 25 a very successful young woman in her current employment as a sort of direct mail or auto service specialist. Automobile dealers will contact her employer, and she will go searching for business leads to do direct-mail campaigns and advertising campaigns for their service departments. She's paid a commission on the fees 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company 5 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 received by her employer for this, and she has expenses, some of which are reimbursed by her employer and some which aren't. The ones that she's seeking in this category are a number of gifts in the value of a couple hundred dollars or more that she made in 2009. Here the relevant Code section is Section 274 and specifically 274(b)(1), which states: "No deduction shall be allowed under Section 162...for any expense for gifts made directly or indirectly to any individual to the extent that such expense, when added to prior expenses of the taxpayer for gifts made to such individual during the same taxable year exceeds $25." . . I do find that Ms. Schill made a gift of a $359 driver -- and that's a golf-club type driver -- to one of her customers in the 2009, but under Section 274 she can't be allowed a deduction of more than $25 for this gift. So she's allowed a deduction for that. For the other gifts that she spoke about in her testimony, she did not have receipts or these kind of email mentions of whom they were for. There was one email that mentioned an intent to make a 25 gift, but that's not actually proof that she 866.488.DEPO www.CapitalReportingCompany.com . Capital Reporting Company 6 1 2 3 4 5 6 7 completed that gift. So on this one I rule for the Commissioner, except to the extent of $25 for one gift. The second and by far the largest category of unreimbursed business expenses that Ms. Schill claimed for 2009 were what are called goodwill credits. These are credits or actually repayments of 8 money from customers to her employer that she took 9 out of her own pocket to preserve the goodwill that 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 she had with some of her very best customers. Sometimes the campaigns that she would manage and write copy for were completely unsuccessful because of some error or missing phone number, scheduling something during Christmas week, or the like, as she testified, and I find her credible on this. She's not legally liable for these goodwill credits, as she testified and as she acknowledges, but she did make them to preserve the business relationship that she had personally with these customers, who are technically customers of her employer. This puts her in a different category, because she did not have a contractual relationship herself; it was her employer who did. And so I look 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company 7 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 to cases in which one person tries to deduct the business expenses of another. Sometimes this works. In the case of Lohrke v. Commissioner, 48 T.C. 679, 688 (1967), we held that "the test as established by all of these cases are that we must first ascertain the purpose of motive which caused the taxpayer to pay the obligations of the other person. Once we have identified that motive, we must then judge whether it is an ordinary and necessary expense of the individual's trade or business; that is, is it an appropriate expenditure for the furtherance or promotion of that trade or business? If so, the expense is deductible by the individual paying it." In the famous case involving Conway Twitty, the country and western singer of note, who repaid investors in a corporation with which he was associated, the wonderful restaurant called Twitty Burger, we allowed a deduction for Mr. Jenkins, which was Conway Twitty's real name, because although Respondent argued the payments Conway Twitty made to ~ the investors in Twitty Burger are not deductible by we him as ordinary and necessary business expenses under Section 162, because there was no business purpose for the payments and, additionally, there was no 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company 8 1 2 3 4 5 6 relationship between his involvement in Twitty Burger and his business of being a country music entertainer, Respondent argues that the payments in question here were made by Conway Twitty gratuitously and that Petitioner had no personal liability to the holders of the debentures and made the payments 7 merely "out of a sense of moral obligation." 8 9 Nevertheless, we found that "we are convinced that Petitioner Conway Twitty repaid the 10 investors in Twitty Burger with the primary motive of 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 protecting his personal business reputation." Much the same as here with Ms. Schill, and so I find entirely credible her testimony that she made these payments out of her own pocket to preserve her own business relationships with these car dealerships. I can find no other reason that a young woman would pay thousands of dollars to random car dealerships throughout South Texas. So on these three that she produced canceled checks for, a $6500 payment on 10/21/09 to a Volvo dealership; an $80.54 payment to a Chevy dealership on July 7, '09; and a $6000 payment to a Jaguar distributorship on 9/17/09, I'll allow her the deductions under Section 162. However, that leaves a $7500 check to a 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company 9 1 Chevy dealer that she wrote in early 2010. I find it 2 more likely than not that this related to some flub 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 in December. She had testified about a promotion that brought in no customers because it was during Christmas week. And it's understandable in her case that she would think that that related to her 2009 taxes even though, as a cash-bas taxpayer, it should have gone on her 2010 return. I'll treat this one as having been tried by consent, and although I can't allow her the $7500 deduction for 2009, I'll allow it in 2010. That will require computations on that issue alone. That leaves the very different issue of the characterization of the $75,000 in settlement proceeds that Ms. Schill received in 2010, where she was represented by the Plaintiff in the landmark case of Rutherford v. US, 702 F.2d 580 (1983). Section 61 provides that, except as otherwise provided, gross income means "all income from whatever source derived." The law is well settled that the tax consequences of an award for damages depend upon the nature of the litigation and the origin and character of the claims adjudicated and not upon the validity of those claims. 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company 10 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 The determination of the nature of the underlying claim is a factual one and is generally made by reference to the settlement agreement considered in light of the facts and circumstances surrounding that settlement. When the settlement agreement allocates the damage award to the underlying claims, that allocation is generally binding for tax purposes to the extent the parties entered into the agreement in an adversarial context at arm's length and in good faith. And here let me quote from a recent case, Stadgnyk v. Commissioner, T.C. Memo 2008-289. "When the settlement agreement lacks express language that identifies the basis for the settlement award, the court considers the details surrounding the underlying proceedings, the allegations in the complaint, the arguments made by the parties, and the settlement discussions between the parties. The most important factor in determining the nature of the claim is the intent of the payor in making the payment." What are the facts and circumstances here? The settlement relates to a series of incidents that happened in a previous job that Ms. Schill held when 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company 11 1 2 3 4 5 6 7 8 9 she was in her early 20s. She found herself in a perverse and lewd environment in which there was rather gross sexual harassment from at least one and probably two of her colleagues, both herself and 4,1m s t another young woman. They contacted Mr. Rutherford in his capacity as a plaintiff's lawyer but then broke off contact with him when they began receiving large amounts of compensation that they thought they were 10 entitled to. 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 It turns out that somebody there was cheating customers and, according to the lawsuit that was later filed, that person then ratted them out to the police, who arranged for their arrest in 2003 on theft charges. Ms. Schill was arrested. She ended up being incarcerated overnight in jail, handcuffed, put into prison, where she underwent rather gruesome affronts to her person, according to the complaint that was filed, and here I refer to the amended complaint, Exhibit 12. She was "stripped naked, fingerprinted, photographed, forced to bend over and, with her own hands, spread her buttocks and then be poked and probed by officers while standing naked before them." 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company 12 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 She was then placed in a cell with heroin and other drug addicts, where she remained until she was finally released from jail some 10 hours later. This led to a lawsuit in which one of the causes of action was clearly for infliction of bodily injury; that was the second cause of action. There were allegations that contact had caused bodily injury to both her and the other young woman, who was similarly situated. And finally, in damages, the damages sought included physical pain and suffering, past and future. As it turned out, the charges were dropped; she made bail, but she did continue to suffer from some serious emotional consequences. As Mr. Rutherford himself credibly testified and as was corroborated, though more obliquely by Ms. Schill, something happened to.her in the cell at the hands of the other inmates, in which she couldn't sit down for days. Given her previous experience with 21 difficult working environments, this quite 22 23 24 25 understandably has caused her to continue to suffer emotional distress and be under the care of a therapist and put onto anti-anxiety medications to this day. 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company 13 1 2 3 4 And indeed perhaps discretion here didn't allow Mr. Rutherford or his client to get into the seamy details of what happened in the prison cell, but it was clearly understood by the defendants, in 5 Exhibit 16, that Ms. Schill impliedly alleges assault 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 committed by San Antonio police officers and fellow detainees. This is on page 16 of Exhibit 16. So the people involved in the suit did understand that there had been some offensive touching, but obviously also a considerable amount of emotional distress. As it turns out, the lawsuit settled during trial, and it took an unusual form. Exhibit 32 shows that it was handwritten quite literally on the steps of the courthouse, apparently, and says, in relevant part, "in full and final satisfaction of plaintiff's claims...if the jury returns a verdict in favor of defendant on plaintiff's claim or a verdict in favor less than $75,000, defendant will pay plaintiff $75,000. If the jury returns a verdict for the 21 plaintiff more than $75,000 and less than $150,000, 22 plaintiff will be paid the verdict amount. If the 23 24 25 verdict exceeds $150,000, plaintiff will be paid $150,000. Nothing in the payment shall be deemed to be punitive damages." And then there's another 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company 14 1 2 3 4 5 6 7 8 paragraph that says the settlement payment will be reported on a 1099. So with those being the facts and circumstances that led to the lawsuit -- and here I'm careful to say I'm not pronouncing on the merits of the lawsuit but only the alleged facts and circumstances that certainly gave rise to the lawsuit -- and the clear language of the settlement, 9 which both parties agree is the settlement, how does 10 11 12 this fit into tax law? Here we have to look at Section 104. The general rule, remember, as I've already said, is that 13 all settlement proceeds are includable in income. 14 15 16 17 18 19 20 21 22 23 24 25 There is an exception in 104, and specifically 104(a)(2), which says that gross income does not include "the amount of any damages other than punitive damages received, whether by suit or agreement and whether as lump sums or as periodic payments on account of personal physical injuries or physical sickness." Now, plainly there were damages received by Ms. Schill, but for what? And here let me make four points. The first is the only cause of action that was deemed settled was the only one that was still alive in the lawsuit, not the action for assault, but 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company rather for malicious prosecution. All the other causes of action had been defeated by summary judgment to that point, and only the malicious prosecution cause of action went to the 15 jury. So I do have to look at the malicious prosecution settlement only and try to characterize these proceeds as settlement proceeds for a malicious prosecution cause of action under Texas law. Second point, Texas law does allow for recovery in malicious prosecution actions of physical damage. In Texas, the elements of a cause for 1 2 3 4 5 6 7 8 9 10 11 12 13 14 malicious prosecution were listed most recently in 15 16 17 18 19 20 21 22 23 24 25 Kroger Texas Limited Partnership v. Suberu, 216 S.W.3rd 788, 793 N.3 (Tex 2006), as "one, a criminal prosecution; two, initiation or procurement of that prosecution by the defendant; three, termination of the prosecution in favor of the plaintiff; four, innocence of the charges; five, lack of probable cause to initiate the prosecution; six, malice; seven, damages. Here we're talking about that seventh element, the damages. Texas is also unusual in that it requires as a condition for any damages what they 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company 16 1 2 3 4 5 call special injury in Texas. And here this was explained in Airgas-Southwest, Inc., v. IWS Gas & Supply of Texas, 390 S.W.3d 472, 479 (Court of Appeals Texas 2012). "Texas law requires actual interference 6 with the defendant's person, such as an arrest or 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 detention where property, such as an attachment or appointment of receiver, a writ of replevin, or an injunction in order to meet the special injury requirement." Well, here that's obviously been met, and nobody really disputed it. Ms. Schill was arrested and put into jail for a night. But here is where Texas law specifies something that's important in the case. In Airgas- Southwest the court went on to say, "But once the special injury hurdle has been cleared, that injury serves as a threshold for recovery for the full range of damages incurred as a result of the malicious litigation." Id, at 480, "citing Texas Beef, 921 S.W.2d at 209." Third, this may well make a difference here. The two closest cases in Tax Court looking at these sort of intentional torts and the taxability of settlement proceeds are cases called Venable v. 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company 17 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 Commissioner and Stadenyk, already cited, v. Commissioner. Venable v. Commissioner, which actually involved a case in which a woman won damages for the tort of malicious prosecution, the jury returned a verdict that was broken down into four categories of recovery: loss of earning capacity, attorney's fees to defend the criminal charges, mental anguish, and lost reputation. It was fairly easy for us to hold in Venable, which is T.C. Memo 2003-240, that this recovery for Ms. Venable was fully taxable. We found "Petitioner's award comprised amounts for loss of earning capacity, for attorney's fees to defend criminal charges, for mental anguish, and for lost reputation. None of these categories is based on a physical injury or sickness." That made Venable a rather easy case. In Stadenyk, which is about the related tort of false imprisonment, we found that "Petitioner's wife had admitted that she did not suffer physical harm during the course of her arrest and detention. She was not grabbed, jerked around, or bruised... Physical restraint and physical detention are not physical injuries for purposes of 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company 18 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 Section 104(a)(2). "Being subjected to police arrest procedures may cause physical discomfort; however, being handcuffed or searched is not physical injury for purposes of Section 104(a)(2), nor is the deprivation of personal freedom a physical injury for purposes of Section 104(a)(2)... "The tort of false imprisonment protects personal interest in freedom from physical restraint. Such an interest is 'in a sense a mental one.' Banks v. Fritsch, 39 S.W.3d 474, 479-80 (Kentucky Court of Appeals 2001). "Injury from false imprisonment is 'in large part a mental one' where the plaintiff can recover for mental suffering and humiliation. Id, at 479. "The alleged false imprisonment against 18 Petitioner wife did not cause her to suffer physical 19 20 21 22 23 24 25 injury as required for relief under Section 104(a)(2)", Stadenyk, 96 TCM 475 (2008). Texas law, however, is simply different here in allowing recovery for physical injuries suffered during the course of imprisonment that gives rise to a suit for malicious prosecution. And to that extent it's distinguishable 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company 19 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 from the situation in Venable in which the jury specifically found no damages for physical harm, and it's different as well from the tort of false imprisonment, which, under Kentucky law, which was the law relevant in that case, the recovery was purely for mental anguish. This is at least then potentially different. And fourth, here is my conclusion under the Sabot language of Section 104: "For purposes of paragraph 2, emotional distress shall not be treated as a physical injury or physical sickness." However, in a case like this where emotional distress is related causally to physical distress, the regulation 26 CFR 1.104-1(c)(1) states, "However, damages for emotional distress attributable to a physical injury or physical sickness are excluded from income under Section 104(a)(2)." I therefore find that based on the peculiar facts and circumstances of this case and on the credible testimony of Ms. Schill, that her damages were mostly for emotional distress, but they were occasioned by the physical damages that she suffered in jail. These were not extreme; they didn't require hospitalization or continuing medical care, but they 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company 20 1 2 3 4 5 6 were the trigger for the complete suite of damages that she suffered and for which she made a recovery. I therefore conclude that these are excludable from her gross income in 2010. That leaves only the penalty issues, which, because most of my decision is in favor of Ms. 7 Schill, are limited to a couple of very small items. 8 9 The penalty issue disappears with the deficiency for 2010, and in 2009 hinges only on what we do with the 10 minor gift disallowance for that year. 11 12 13 14 15 I asked Ms. Schill what her education was. She has no specific background in tax law. She hasn't been in trouble with the IRS before, and there was no particular reason for her to think about Section 274(b) and associated regulations in limiting 16 gifts to $25. So I won't assess the negligence 17 18 19 20 21 22 23 24 25 penalty against -- or I won't determine a negligence penalty against her on those. She was behaving in good faith, and given all the other accurate things that she put on her tax return for that year, I find her omission of -- or rather her inclusion of gifts in excess of $25 reasonable under the circumstances. There's also the much more substantial payment of $7500 that she took in 2009 which I found she should have taken in 2010, but it related to 866.488.DEPO www.CapitalReportingCompany.com Capital Reporting Company 21 things that happened at the end of 2009. And, again, I find her taking it in 2009 rather than 2010 to be reasonable and in good faith under the circumstances and given her particular level of education and experience with the tax system. Because of the concessions of the parties and the somewhat mixed nature of this decision, decision will require computations under Rule 155. This concludes the Court's oral findings of fact and opinion in this case. (Whereupon, at 9:55 a.m., the above- entitled matter was concluded.) 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 866.488.DEPO www.CapitalReportingCompany.com