t c memo united_states tax_court patrick s elliott and donna j elliott petitioners v commissioner of internal revenue respondent larry s elliott and julia f elliott petitioners v commissioner of internal revenue respondent docket nos filed date george w connelly jr and linda s paine for petitioners david b mora for respondent - - memorandum findings_of_fact and opinion gerber judge respondent determined deficiencies in income_tax additions to tax and penalties in these consolidated’ cases as follows patrick s and donna j elliott docket no addition_to_tax penalty year deficiency sec_6651 a sec_6662 a dollar_figure dollar_figure dollar_figure big_number --- big_number big_number --- big_number big_number --- larry s and julia f elliott docket no addition_to_tax penalty year deficiency sec_6651 a sec_6662 a dollar_figure dollar_figure dollar_figure big_number big_number big_number big_number big_number big_number big_number big_number numerous issues have been settled by the parties leaving the following issue for our consideration whether the notices of deficiency sufficiently informed petitioners that they were not being allowed to offset deductions against compensation on their form sec_2106 employee business_expenses ' these cases have been consolidated for purposes of trial briefing and opinion petitioners do not attempt to substantiate the expenses in guestion instead they ask us to find they are allowable as claimed on the basis of petitioners’ procedural argument continued - - findings_of_fact fach set of petitioners patrick and donna elliott and larry and julia elliott respectively was married and filed joint federal_income_tax returns for each of the years under consideration all petitioners resided in the state of texas at the time their petitions were filed patrick and larry at all pertinent times were employees officers and shareholders of american energy services inc aes patrick owned percent of the aes stock and he served as its vice president larry owned percent of the aes stock and he served as its president patrick and larry received forms w-2 wage and tax statement showing wages from aes and reported the amounts as gross_income from wages on page line of their federal_income_tax returns patrick and larry also received forms misc miscellaneous income reflecting additional_amounts paid to them by aes the form 1099-misc income was received from aes under its employee reimbursement plan for patrick and larry aes’ reimbursements were made without review of the employee’s expenditures and provided for reimbursement of amounts up to dollar_figure annually aes did not have an accountable_plan for reimbursement of travel and business_expenses as that term i sec_2 continued accordingly if petitioners’ procedural attack is unsuccessful they will not be entitled to deductions q4e- used in the regulations under sec_62 patrick and larry included the form 1099-misc nonemployee compensation on their respective form sec_2106 in conjunction with their claims for employee_expenses accordingly the nonemployee compensation from aes was offset by patrick’s and larry’s employee business_expenses claimed on their respective form sec_2106 in this manner the offset portion of the nonemployee compensation from aes was not included in patrick’s and larry’s gross_income reported on page of their returns for each tax_year in the process of offsetting the income and expenses on their form sec_2106 patrick and larry generally treated the excess_amount of employee business_expenses or nonemployee compensation in a similar manner if their claimed expenses exceeded the nonemployee compensation reflected on the form_2106 the excess expense amount was carried to schedule a itemized_deductions and claimed as employee_expenses deductible from adjusted_gross_income if their nonemployee compensation exceeded their claimed employee business_expenses then the excess compensation was included in gross_income on page of their form sec_1040 u s individual tax_return patrick and larry differed in their unless otherwise indicated section references are the internal_revenue_code in effect for the period under consideration and rule references are to the tax court’s rules_of_practice and procedure - inclusion of the excess compensation in that one included the excess as wage income and the other as other income respondent determined that petitioners should have reported the nonemployee compensation as part of their gross_income and not in connection with patrick’s and larry’s form sec_2106 in addition to determining that nonemployee compensation was includable in gross_income respondent also determined that the excess employee_expenses over nonemployee compensation that had been claimed on the schedules a were not allowable for failure to show them to be ordinary and necessary and or lack of substantiation petitioners have conceded that respondent did not err in disallowing the excess portions of employee business_expenses claimed on petitioners’ schedules a opinion petitioners on form sec_2106 offset employee_expenses against employee reimbursement compensation received from their company employer accordingly no portion of the compensation that had been offset was included in gross_income reported on page of petitioners’ income_tax returns petitioners should have included the compensation in gross_income and deducted the expenses if adegquately substantiated on schedules a as deductions from adjusted_gross_income respondent’s determination was to simply include the compensation unreduced by the offsetting expenses in petitioners’ gross_income in -- - effect respondent’s determination did not allow the offsetting expenses in calculating gross_income respondent explains that it was not necessary to make a further adjustment regarding the offsetting expenses insofar as they did not exceed the compensation that is so because petitioners did not claim them on schedules c profit or loss from business or schedules a of their returns as deductions from the gross or adjusted_gross_income that was used to compute petitioners’ respective taxable_income accordingly respondent did not expressly state that the offsetting expenses up to the amount of the compensation were disallowed as business deductions or as miscellaneous_itemized_deductions petitioners argue that respondent’s failure to make an express determination with respect to the employee_expenses claimed on form sec_2106 results in the employee expenses’ not being placed in issue petitioners further argue that if the expenses are not in issue then the court lacks subject-matter jurisdiction over the offsetting expenses next petitioners contend that they did not raise the expenses in their petitions and therefore the expenses are allowable as reflected on their form sec_2106 respondent counters that his determination corresponded to petitioners’ reporting approach respondent determined that the nonemployee compensation is includable in gross_income on page - of petitioners’ form sec_1040 without the offset of the expenses claimed on the form sec_2106 because the expenses were not claimed on the schedules a as deductions from reported adjusted_gross_income agi there was no need for respondent to expressly disallow the expenses by increasing gross_income without a reduction for the expenses respondent contends that tacit disallowance has been effected under those circumstances respondent contends that it was up to petitioners to assert the manner in which the employee_expenses they had reflected on the form sec_2106 would be deductible if not allowable in offset of the compensation shown on the forms 1099-misc the parties have each postured their arguments to facilitate the result they seek from the court’s perspective however the guestion boils down to whether respondent’s determination provided sufficient information to advise petitioners that they were not receiving the benefit of the expense offset we agree with petitioners that no express language was employed by respondent to advise petitioners that no offset of expenses was being allowed in that regard respondent’s income-side adjustments did carry with them the implication that the setoff of the expenses was not being allowed petitioners’ methodology of offsetting expenses directly from what would have otherwise been reported as gross_income was not permissible from an employee’s perspective there are --- - generally two types of deductible expenses---those used in computing agi and those that are deductible from agi deductions used in arriving at agi would be favored because such deductions are not subject_to certain limitations including those provided for in sec_67 and sec_68 congress in defining agi provided that certain reimbursed expenses of employees could be treated as deductions in computing agi sec_62 a under the sec_62 regulations a distinction is made between the so- called accountable reimbursement plans and those which are nonaccountable if an employer establishes an accountable_plan the employees are not required to report the reimbursement in gross_income if the employer’s plan is nonaccountable the regulations provide that the employee’s expenses if properly substantiated are allowable as deductions from agi and subject_to various limitations including those of sec_67 sec_1_62-2 income_tax regs likewise if there is no reimbursement arrangement the employee deductions will be from agi and not allowable under sec_62 the parties have stipulated that aes did not have an accountable_plan and so petitioners were not entitled to offset or reduce the form 1099-misc compensation nonaccountable reimbursement by their employee_expenses without including the compensation in gross_income as outlined above petitioners were required to include the form 1099-misc compensation in gross --- - income and to claim their employee_expenses if properly substantiated on schedule a as a deduction from agi subject_to certain limitations accordingly we must conclude that respondent’s determinations that the nonemployee compensation reflected on the forms 1099-misc is includable in gross_income were not in error ’ petitioners contend that they need not prove or justify their employee_expenses because of respondent’s failure to expressly state that petitioners were not entitled to claim the expenses petitioners argue that the offsetting expenses reflected on the form sec_2106 are not in issue and that we have no jurisdiction over them if that were petitioners’ sole argument even if they were successful it would have no effect on the income_tax deficiencies determined by respondent that is so because petitioners used the expenses to offset compensation that in addition petitioners do not question the correctness of respondent’s determination that they failed to show that the excess amounts of employee_expenses that were claimed on the schedules a were ordinary and necessary or expended for the purpose stated we must note that if respondent had merely disallowed the offsetting expenses reflected by petitioners on their form sec_2106 and had not made any adjustment to the form 1099-misc compensation there would have been no resulting income_tax deficiency that is so because petitioners did not first include the compensation in the gross_income that was used to compute their adjusted_gross_income and ultimately their taxable_income -- - had not been included in the gross_income and or used in the computation of petitioners’ respective taxable_income in his determination respondent increased petitioners’ gross_income by the amount of the compensation that had been reflected on the form sec_2106 in an attempt to negate respondent’s income-side determination petitioners have argued that without an explicit expense determination by respondent petitioners’ reported positions would remain unchanged petitioners make that argument in spite of the undisputed fact that their employee_expenses were not allowable in offset of gross_income petitioners have attempted an end run around the error in their reporting position by arguing that they have already included the form 1099-misc compensation in gross_income by reflecting it on the form sec_2106 and that respondent’s determination is a duplication petitioners’ duplication argument 1s circuitous and obviously begs the guestion because petitioners used the expenses for direct offset the compensation was not included in the gross_income petitioners used in computing their tax_liabilities sec_6212 authorizes the commissioner to determine a tax_deficiency petitioners argue that any failure to make such a determination results ina lack of our subject-matter if allowable the expenses would have been deductible from agi and subject_to sec_67 and other limitations jurisdiction over the issue of whether the expenses claimed on the form sec_2106 are deductible ’ respondent’s position however is that subsumed within the inclusion of the form 1099-misc nonemployee compensation in gross_income is a disallowance of the employee_expenses that petitioners used to offset the income on the form sec_2106 respondent also points out that petitioners did not claim the offsetting expenses as deductions for or from agi following that reasoning respondent contends that there was nothing to disallow petitioners rely on sec_7522 requiring that the commissioner in notices of deficiency describe the basis for and identify the amounts if any of the tax due sec_7522 provides however that an inadequate description shall not invalidate a notice in addition as we pointed out in 112_tc_183 congress enacted sec_7522 with the expectation that the irs would ‘make every effort to improve the clarity of all notices that are sent to taxpayers ’ h conf rept vol ii pincite 1988_3_cb_473 ’ in addition to their contention that respondent did not make a determination petitioners also point out that their petitions did not include an assignment of error with respect to the questioned expenses petitioners did however allege error with respect to respondent’s determination that the form misc compensation should be included in gross_income on page of petitioners’ returns generally respondent determined that petitioners should have included the nonemployee income reflected on the forms misc in gross_income and not in an offset format on their form sec_2106 in years where petitioners claimed the excess of employee_expenses over nonemployee compensation on the schedules a respondent determined that said excess expenses had not been substantiated or shown by petitioners to be ordinary and necessary respondent employed the following explanatory language with certain minor variations for each group of petitioners in determining the relevant adjustments to petitioners’ income nonemployee compensation it is determined that you have nonemployee compensation from american energy services inc in the amount of rather than as reported on your income_tax returns accordingly your taxable_income is increased itemized_deductions year it is determined that you have miscellaneous expenses subject_to the two percent of adjusted_gross_income in years where there was an excess of expenses over the amount of nonemployee compensation on the form sec_2106 petitioners claimed the excess on the schedules a as itemized_deductions in those years respondent determined that the nonemployee compensation was includable in gross_income and disallowed the excess expenses claimed on the schedules a in years where the nonemployee compensation exceeded the expenses claimed on the form sec_2106 and petitioners reported the excess on page as gross_income respondent determined that the amounts that had been offset on the form sec_2106 were also includable on page as gross_income in either event respondent did not explicitly disallow the expenses claimed on the form sec_2106 limitation in the amount of rather than as claimed on your income_tax return since it has not been established that any amount in excess of that allowed constitutes an ordinary and necessary business_expense was expended or was expended for the designated purpose accordingly you are not allowed a deduction in the amount of as claimed on your x income_tax return there is no explanatory language in the notices expressly disallowing the offset of expenses that petitioners had claimed on the form sec_2106 it is clear however from the above explanatory language that respondent determined that petitioners’ income should be increased by the amount of the form 1099-misc nonemployee compensation that petitioners had reflected and offset on form sec_2106 it also follows that respondent’s determinations increasing gross_income were not first being reduced by the employee_expenses claimed by petitioners on the respective form sec_2106 petitioners contend that respondent’s determination would have passed muster if it had been expressed by means of the following three paragraphs petitioners propose it is determined that you did not receive nonemployee compensation in the respective amounts of as a result the amounts reported as nonemployee compensation on your form sec_2106 are reduced in the following amounts it is determined that you received income from american energy services inc in the respective amounts of which should have been reported as compensation_for services accordingly your gross_income is increased in the following amounts it is determined that the expenses claimed on your form sec_2106 in the amounts of including those claimed as miscellaneous_itemized_deductions are disallowed because reason for disallowance petitioners argue that the above-quoted paragraphs would have made it clear that the expenses claimed on the form sec_2106 were being disallowed we note that petitioners’ suggested explanation treats reporting the compensation on the form sec_2106 as the egquivalent of including it in gross_income we do not agree with petitioners’ approach it is petitioners’ contention that without the third paragraph the issue of the deductibility of the expenses claimed on the form sec_2106 has not been subjected to our jurisdiction we must note that petitioners’ first recommended paragraph addressing the reduction of income by the compensation reflected on the form_2106 is incorrect and or unnecessary the compensation referred to in petitioners’ first paragraph had no effect on petitioners’ taxable_income because of the offset the language used by respondent to increase gross_income by the form 1099-misc compensation identified the source of the increase and the variance from the method petitioners used to reflect the income certainly respondent’s determination would have been more explicit and thorough if it had contained some reference to the expenses that petitioners had offset on their form sec_2106 for example the following language would have been helpful -- - to the extent that you wish to claim the expenses shown on form_2106 they must be claimed on schedule a but they are allowable only to the extent that you show them to be ordinary and necessary business_expenses and or to have been expended for the designated purposes if respondent had made an explanation regarding the offsetting expenses it would have been merely advisory and precatory it would not explain a disallowance that resulted in an income_tax deficiency in the circumstances of these cases respondent’s failure to expressly disallow the offsetting expenses was not tantamount to approving them as petitioners have contended the commissioner is required to inform taxpayers of deficiency determinations there is no particular form to be used or specific requirement as to the content of a notice_of_deficiency 78_tc_646 the notice must fairly advise petitioners that deficiencies in income taxes and additions to the tax had been determined and the years and amounts thereof id in addition sec_7522 requires that the notices describe the basis for and identify the amounts if any of the tax due the notices that respondent issued to petitioners met those basic standards respondent did provide a paragraph explaining each adjustment that accounted for the total_amounts of the deficiencies determined respondent increased gross_income by the form 1099-misc compensation unreduced by the amounts of expenses that petitioners had used as setoffs on the form sec_2106 -- - respondent also increased income by the amounts of the excess expenses claimed on the schedules a which respondent disallowed for lack of a showing that the expenses were ordinary and necessary or that they were expended for the stated purpose if respondent had specifically and expressly disallowed the offsetting expenses as petitioners suggest the disallowance would not have resulted in any increase or decrease in the amounts of the deficiencies determined finally because respondent included the unreduced amounts of the form 1099-misc compensation in income petitioners would be able to comprehend that respondent was giving no effect to the expense setoffs ’ in a recent case we considered whether the commissioner’s position was new_matter in the context of sec_7522 shea v petitioners’ arguments herein make it obvious that they were aware that the expenses that they had offset against the income on the form sec_2106 were not being given any effect because of the resultant income_tax deficiency if petitioners had chosen to give them effect they would have had to assert and prove their entitlement to the expenses if petitioners had been successful in showing their entitlement to the expenses they would not have been entitled to deduct them from or offset them against gross_income as they attempted to do on the form sec_2106 the expenses would have been deductible on schedule a and subject_to various limitations that would result in reduced amounts’ being allowable we also note that petitioners deducted the excess by which the expenses exceeded the forms 1099-misc compensation on their schedules a petitioners however did not follow that route and instead chose to wage a collateral attack on respondent’s determination in that regard petitioners did not question respondent’s determination that they had not shown that such expenses claimed on the schedules a were not ordinary and necessary and or that they were expended for the stated purpose commissioner t cc in that case the commissioner’s adjustment and explanation in the notice_of_deficiency related to the total amount of business gross_receipts based on a bank deposit analysis subsequently the taxpayer contended that the reconstructed receipts were community_income and that only half of the amount determined was includable the commissioner countered that sec_66 authorized the disallowance of community_property benefits in certain circumstances the language of the notice had no reference to community_property interests or sec_66 in shea we held that where a notice_of_deficiency fails to describe the basis on which the commissioner relies to support a deficiency determination and that basis requires the presentation of evidence that is different than that which would be necessary to resolve the determinations that were described in the notice_of_deficiency the commissioner will bear the burden_of_proof regarding the new basis emphasis added id pincite that holding was predicated on our understanding that the purpose of sec_7522 is to give taxpayers notice of the basis for a deficiency determination id pincite in these cases respondent did provide petitioners with explanations for all of the adjustments that made up the deficiency unlike the taxpayer in shea petitioners are not seeking to place the burden_of_proof on respondent instead petitioners contend that the expenses are not in issue and therefore they have no burden to show their entitlement to the expenses however as already explained respondent’s -- - determination that the form 1099-misc compensation is includable as page gross_income makes it incumbent on petitioners rather than respondent to show their entitlement to the deduction items petitioners’ approach to reporting the compensation and expenses was wrong as a matter of law respondent’s determination adequately described the basis for the income_tax deficiencies for purposes of sec_7522 it would have been helpful for respondent to expressly state that the expenses were not allowed in the manner petitioners had claimed them such a statement however would have no effect on the amount of the income_tax deficiencies that respondent determined sec_7522 does not require the commissioner to make suggestions recommendations or comments in a notice_of_deficiency concerning taxpayers’ reporting positions that have no effect on the deficiency that the commissioner has determined accordingly we find that respondent was not required to explicitly disallow the expenses we also find that it is irrelevant that the form_2106 expenses were not placed in issue in these cases in effect it is petitioners’ failure to substantiate the expenses that results in their not being allowed as deductions from agi in accord with the foregoing and to reflect the agreements of the parties decisions will be entered under rule


third party communication none date of communication not applicable office_of_chief_counsel internal_revenue_service memorandum number release date cc psi b5 dselig postf-109368-15 uilc date date to thomas j kane division counsel large business international barbara b franklin deputy division counsel operations large business international from nicole r cimino senior technician reviewer branch passthroughs special industries subject sec_199 chief_counsel request on the qualified_film issue this chief_counsel_advice responds to your request for clarification of cca in particular you asked that we clarify whether league contracted with network to produce a qualified_film for taxpayer for purposes of sec_199 this advice may not be used or cited as precedent legend taxpayer league network --------------------------------------- ----------------------- ---------------------------------- -------------------------------- contract ------------------------------------------------------------------------ -------------------------------------------------------------------------------------------------------------------- --------------------------------------------- postf-109368-15 game broadcasts b c issue --------------------------------------------------- --------------------------------------------- ----- --- whether network performed its production activities with respect to the game broadcasts pursuant to the contract so that it is necessary to determine whether taxpayer had the benefits_and_burdens_of_ownership of the game broadcasts during the period of production for purposes of sec_1_199-3 and sec_1_199-3 conclusion network produced the game broadcasts on its own behalf pursuant to the rights granted to network in contract rather than pursuant to a contract with taxpayer for purposes of sec_1_199-3 and sec_1_199-3 for this reason gross_receipts that taxpayer derived from the contract are non-dpgr and a benefits_and_burdens_of_ownership analysis is not required facts the facts considered and the terms used in this chief_counsel_advice are stated in cca analysis you requested clarification regarding whether network produced the game broadcasts for taxpayer for purposes of sec_1_199-3 and sec_1_199-3 rather than on its own behalf pursuant to rights granted by contract for the reasons explained below we conclude that network produced the game broadcast on its own behalf rather than on behalf of taxpayer therefore all gross_receipts that taxpayer derived from the contract are non-dpgr as the gross_receipts cannot be considered derived from a disposition of qualified_film produced by taxpayer network is a producer of television programming as part of its business and seeks out events of the type offered by taxpayer to make programming for its own stations network entered into the contract to make the game broadcasts for itself a review of the facts indicates that network controlled most aspects of the creative production of the game broadcasts first network had editorial control_over how to film the game and how to incorporate that film into coherent and complex broadcasts that were consistent with network standards for example network had largely unfettered discretion to decide which of several camera feeds it would broadcast at any point during the game postf-109368-15 when and where to zoom in on players umpires cheerleaders coaches etc when to show a replay in slow or real-time motion which players to focus on and when to pan to the live audience or the sidelines network also decided whether and when to add graphics sound effects and music network also provided the commentators who described events on the field and provided background statistical information and color commentary network decided when to use various technologies such as the skycam all of these activities were part of creating a unique game broadcast which involved a much different experience than simply recording a game broadcast for taxpayer moreover all of these activities were largely within the discretion of network further network provided and controlled all equipment essential to the game broadcasts and a game day staff of b employees and freelance contractors those employees were responsible for all aspects of production from setting up and testing the equipment to recording the games producing the game feeds monitoring the broadcasts and tearing down the production equipment network’s employees included a director who was responsible for calling out the camera shots a technical director who controlled the cameras and a producer who decided on whether and when to show replays and commercials network’s producer was in charge of the particular broadcast network also brought in support staff graphics staff and audio staff about c network employees worked inside the broadcasting trucks the remaining staff worked at the stadiums network’s graphics team prepared thousands of graphics to be shown at specific times throughout a broadcast based on these facts network not taxpayer is the producer of the game broadcasts on its own behalf and not pursuant to a contract for purposes of sec_1_199-3 and sec_1_199-3 accordingly all gross_receipts that taxpayer derived from the contract are non-dpgr as the gross_receipts cannot be considered derived from a disposition of qualified_film produced by taxpayer however if the irs were to determine that network produced the game broadcasts pursuant to a contract for purposes of sec_1_199-3 and sec_1_199-3 then a benefits_and_burdens_of_ownership analysis would be required case development hazards and other considerations this writing may contain privileged information any unauthorized disclosure of this writing may undermine our ability to protect the privileged information if disclosure is determined to be necessary please contact this office for our views please call david selig pincite-4137 if you have any further questions


t c no united_states tax_court hughes a bagley and marilyn b bagley petitioners v commissioner of internal revenue respondent docket no filed date in p received dollar_figure in compensatory_damages and dollar_figure in punitive_damages pursuant to judgment on a claim for tortious interference with future employment with statutory interest thereon and dollar_figure million in settlement of claims for tortious interference with future employment libel and invasion of privacy p excluded all of these amounts from income under sec_104 i r c r determined that the punitive_damages and interest received from the judgment and dollar_figure5 million of the settlement amount attributable to punitive_damages were not excludable under sec_104 i r c as damages received on account of personal injuries or sickness p paid attorney's_fees in connection with the litigation held dollar_figure of the settlement proceeds is properly characterized as punitive_damages held further commissioner v schleier u s ___ 115_sct_2159 has effectively overruled our decision in 100_tc_93 affd 33_f3d_625 6th cir insofar as it held that punitive_damages even if noncompensatory are excludable from income under sec_104 i r c if the underlying claim is based on tort or tort type rights and to this extent we will no longer follow horton v commissioner supra held further to the extent p's attorney's_fees are allocable to the taxable_portion of p's awards they are deductible as a miscellaneous itemized_deduction to which the provisions of sec_67 i r c are applicable held further the interest on the judgment award received by p is not excludable from income but attorney's_fees applicable to this portion of the award are deductible as miscellaneous_itemized_deductions mark arth for petitioners jack forsberg for respondent scott judge respondent determined a deficiency in petitioners' income_tax for the calendar_year in the amount of dollar_figure the issues for decision are what portion if any of the amount of dollar_figure million paid to hughes bagley petitioner in settlement of a suit against iowa beef processors inc ibp is allocable to punitive_damages whether the dollar_figure in punitive_damages paid to petitioner pursuant to a judgment against ibp and the portion if any of the dollar_figure million paid to petitioner in settlement of his suit against ibp which is allocable to punitive_damages are excludable from petitioner's income under sec_104 as damages received on account of personal injuries whether the portion of the legal fees of dollar_figure paid_by petitioner during in connection with his suit against ibp which was a contingency fee based on a percentage of the recovery is properly to be offset against the recovery and therefore not includable in income or is a miscellaneous itemized_deduction subject_to the adjustment for percent of adjusted_gross_income under sec_67 and whether the portion of the legal fees paid_by petitioner in which was computed on an hourly basis is deductible by petitioner on schedule c or is an itemized_deduction to the extent deductible whether the amount of dollar_figure of prejudgment and the amount of dollar_figure of postjudgment interest_paid to petitioner pursuant to a judgment against ibp are includable in petitioners' gross_income findings_of_fact some of the facts have been stipulated and are found accordingly petitioners husband and wife who resided in sioux city iowa at the time of the filing of their petition in this case filed their federal income all section references are to the internal_revenue_code in effect for the year in issue and all rule references are to the tax_court rules_of_practice and procedure unless otherwise indicated tax_return form_1040 for the calendar_year with the internal_revenue_service center at atlanta georgia petitioner was vice president of retail sales development for ibp from date until date in date ibp terminated petitioner's employment and in date ibp and petitioner entered into a settlement agreement resolving certain issues arising from the termination of petitioner's employment when petitioner left ibp he took with him numerous documents the bagley documents including ibp's weekly profit and loss statements ibp's monthly production and sales reports confidential legal memoranda and memoranda outlining ibp's goals marketing strategies and pricing formulas in late and early petitioner met with various individuals who were interested in the activities of ibp including several attorneys who were contemplating pursuing antitrust litigation against ibp petitioner discussed ibp's activities with the attorneys and provided them with access to the bagley documents on date ibp filed a suit against petitioner and others in the u s district_court for the northern district of iowa seeking dollar_figure million in damages and injunctive relief including recovery_of the bagley documents the ibp suit the suit was civil no and was entitled iowa beef processors inc v amalgamated meat cutters butcher workmen of n am et al the claims asserted in the suit against petitioner by ibp were breach of contract breach of fiduciary duty causing and assisting in another's breach of fiduciary duty and conspiracy in late the subcommittee on general small_business problems of the u s house of representatives' committee on small_business the subcommittee initiated an investigation into the meat packing industry the subcommittee's investigation focused in large part on the activities of ibp in the course of its investigation the subcommittee subpoenaed the bagley documents and various witnesses including petitioner for oral testimony petitioner testified before the subcommittee on july and petitioner's testimony tended to show that ibp was involved in monopolistic and questionable business practices ibp was invited to send a representative to the subcommittee's hearing but declined to do so on date ibp by its president robert peterson responded to the subcommittee by a 31-page letter the peterson letter the peterson letter was in answer to testimony given to the subcommittee about ibp and its business practices approximately pages of the peterson letter addressed the testimony of petitioner the peterson letter not only addressed the business practices with respect to which petitioner testified but also included statements which attacked petitioner's character and veracity among other things the peterson letter alleged that petitioner was a disgruntled ex-ibp employee who had stolen ibp documents and that petitioner's testimony was absolutely false and constituted perjury and was a malicious attempt to blacken ibp's name and belatedly manufacture a defense to ibp's breach-of-fiduciary duty suit ie the ibp suit the peterson letter in essence called petitioner a liar and a thief ibp sent a copy of the peterson letter to each member of the subcommittee and requested that it be made a part of the public record at the time petitioner testified before the subcommittee he was employed as vice president of dubuque packing co dubuque packing petitioner's employment at dubuque packing was abruptly terminated on date the contents of the peterson letter had been widely reported by the media on date petitioner filed a suit against ibp in the u s district_court for the northern district of iowa bagley v iowa beef processors inc civil no the bagley suit in the complaint petitioner asserted five claims against ibp the five claims asserted were ibp's suit against petitioner constituted an abuse of process ibp tortiously interfered with an existing contract of employment by causing dubuque packing to terminate petitioner's employment ibp tortiously interfered with petitioner's future employment within the meat-packing industry ibp libeled petitioner by publishing and circulating the peterson letter and ibp invaded petitioner's privacy in the complaint petitioner asked for dollar_figure million in compensatory_damages and dollar_figure million in punitive_damages the jurisdiction of the district_court in the ibp suit and the bagley suit was based on diversity of citizenship some of the claims made by petitioner in his suit against ibp alleged physical injuries which he sustained as a result of ibp's conduct petitioner had suffered a heart attack after ibp took his deposition for straight week this was the third deposition of petitioner that ibp had taken the ibp suit and the bagley suit were consolidated for trial prior to trial ibp voluntarily dismissed its claim for compensatory and punitive_damages petitioner's abuse of process claim was dismissed prior to trial on the ground that the statute_of_limitations on that claim had expired the remaining claims were tried before a jury between december and date the district court's instructions to the jury respecting libel in part stated that-- the words complained of by the plaintiff in the peterson letter specifically that he stole boxes of ibp documents and that bagley's version of ibp's quantity discount program is absolutely false and constitutes perjury are libelous per se in that the words themselves tend to disgrace and degrade him such words create a legal presumption of their falsity thus shifting to the defendant the burden of proving the truth of the statements by a preponderance_of_the_evidence with respect to punitive_damages for libel the district_court instructed the jury that-- if you find that plaintiff has established the essential elements of his libel claim and if you find on the basis of clear_and_convincing evidence that the defendant acted with actual malice in publishing the writing in question then you may award the plaintiff punitive_damages in addition to the actual damages assessed punitive_damages are designed to punish the offender and serve as an example to others whether or not to award such damages and the amount thereof are matters confided to you for decision the district_court judge instructed the jury respecting punitive_damages generally that-- in addition to the actual damages set out above plaintiff's complaint seeks to recover what is known in law as punitive_damages these damages are not compensatory in the ordinary sense but are allowed by way of punishment to restrain defendant or others from the commission of like acts in the future you are instructed that the law permits but does not require a jury to allow punitive_damages in certain cases if it is found by the jury that the act causing the injury complained of is malicious or wanton on date the jury returned verdicts in favor of petitioner on all four remaining claims and awarded petitioner actual and punitive_damages in the following amounts claim tortious interference with present employment tortious interference with future employment big_number libel invasion of privacy total big_number big_number big_number big_number big_number big_number big_number damages actual punitive dollar_figure dollar_figure on date ibp filed a motion for judgment notwithstanding the verdict or alternatively for a new trial ibp's motion contained a number of arguments including the argument that the damages awarded on the libel claim were duplicated by the awards on the other claims on date the district_court entered an order granting ibp's motion with respect to the invasion of privacy claim on the grounds that the award on that claim was duplicative of the award on the libel claim and dismissed that claim ibp appealed the judgment on the three remaining claims to the court_of_appeals for the eighth circuit the court_of_appeals for the eighth circuit sitting en_banc reversed the judgment on the libel claim and remanded it for a new trial with instructions affirmed the judgment on the tortious interference with present employment claim and affirmed the judgment on the tortious interference with future employment claim as to liability but reversed and remanded it as to damages on the ground that an award on that claim could be duplicative of any award on the libel claim the reversal of the judgment on the libel claim by the court_of_appeals was on the ground that the district_court erroneously instructed the jury that ibp had the burden of proving that the allegedly libelous statements were true the court_of_appeals in its opinion stated that petitioner must prove that ibp's statements that he stole documents and committed perjury were in fact false and that he must establish that ibp was at fault in publishing these statements the court_of_appeals held that to recover punitive_damages petitioner in addition to proving falsity must prove by clear_and_convincing evidence that ibp's actions in publishing the challenged statements constituted actual malice with respect to the tortious interference with future employment claims the court_of_appeals held that if petitioner failed to recover on his libel claim the award of damages should be reinstated but if petitioner recovered on his libel claim the district_court should then determine to what extent a recovery for tortious interference with future employment would duplicate his libel recovery to the extent of any duplication the court_of_appeals held that the award of damages on the tortious interference with future employment claim should not be reinstated on remand the district_court entered a judgment on the tortious interference with present employment claim in accordance with the opinion of the court_of_appeals for the eighth circuit and on date ibp paid petitioner dollar_figure on this claim this payment was composed of the following amounts compensatory_damages punitive_damages costs prejudgment_interest postjudgment interest total dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure on date petitioner filed a motion in the district_court to reinstate the award of dollar_figure in actual damages and dollar_figure million in punitive_damages which he had received from the jury on the invasion of privacy claim which the district_court had set_aside as duplicative of the libel award petitioner argued that since the judgment on the libel claim had been reversed and remanded the invasion of privacy award was no longer duplicative of the libel award and therefore should be reinstated by order dated date the district_court denied petitioner's motion as premature but stated in the order that if petitioner decided to forgo retrial of the libel claim the court would be disposed to reinstate the two damage awards and that petitioner also would be entitled to reinstatement of those two damage awards if on retrial he failed to establish ibp's liability for libel a new trial was scheduled to begin with respect to petitioner's libel claim on date in date the parties were required to meet for a settlement conference with a magistrate present at the conference were mr richard smith mr smith an attorney for ibp who had been retained after the remand of the case by a new vice president and general counsel of ibp mr lonny grigsby mr grigsby the magistrate petitioner's counsel mr william j rawlings mr rawlings and an associate of mr rawlings mr michael p jacobs for a brief time judge mcmanus was present at the conference at the settlement conference the parties agreed to an out-of- court settlement whereby ibp was to pay petitioner dollar_figure million and each party agreed to dismiss the suit against the other the settlement was agreed to on behalf of ibp by mr smith mr grigsby and mr robert peterson ibp's president in negotiating the settlement ibp's primary motivation was to resolve the litigation for the lowest possible payment ibp agreed to the settlement primarily to limit its monetary exposure resolve its dispute with petitioner with finality and avoid further publicity about the case given the hazards_of_litigation ibp's attorney thought the settlement was favorable for ibp the settlement was reached after some give and take by the parties over the amount to be paid to petitioner the dollar_figure million figure was not based on any formula or calculation during the course of the settlement conference mr rawlings stated that petitioner would receive punitive_damages if the case were retried and that the potential for punitive_damages had to be taken into consideration mr smith as a representative of ibp responded that ibp would not agree to pay punitive_damages and mr rawlings replied that that is what he would state if he were in mr smith's position it took the parties approximately weeks to agree on the wording of the settlement agreement and to execute the agreement during this period there were no further discussions between the parties with respect to the dollar_figure million to be paid to petitioner ibp's principal concern in the drafting of the settlement agreement was that the document clearly release ibp from any and all liability to petitioner and clearly provide that petitioner was to return the bagley documents to ibp and that the settlement remain confidential on date the parties executed a release and settlement agreement which provided this settlement agreement and release is entered into this 10th day of september between ibp inc ibp and hughes a and marilyn bagley bagley ibp and bagley each hereby release and forever discharge the other from all sums of money accounts actions suits proceedings claims and demands whatsoever which either of them at any time had or has up to the date hereof against the other for or by reason of or in respect of any act omission statement writing or cause whatsoever bagley hereby acknowledges payment and receipt in the sum of one million five hundred thousand dollars dollar_figure as damages for personal injuries including alleged damages for invasion of privacy injury to personal reputation including defamation emotional distress and pain and suffering bagley hereby agrees to return forthwith to ibp all documents previously in bagley's possession and generated by or at ibp in the course of its business except those which are identified as personal to bagley the parties will file forthwith a stipulation of dismissal of ibp's pending cause of action against bagley case number c in the united_states district_court for the northern district of iowa western division the parties will file forthwith a stipulation of dismissal of bagley's causes of action pending against ibp case number c in the united_states district_court for the northern district of iowa western division both parties agree to exercise their best efforts to avoid public disclosure of the settlement terms hereof including this document itself except as may be by law required this release is executed as a compromise settlement of disputed claims liability for which are expressly denied by the party and or parties released and this release does not constitute an admission of liability on the part of either party this release and settlement agreement contains the entire agreement between the parties and the terms hereof are contractual and not a mere recital pursuant to the settlement agreement ibp paid petitioner dollar_figure million by check dated date the invoice for the check indicated the check was issued for settlement the check was deposited into mr rawlings' firm's trust account and the funds were then distributed out of the trust account prior to the filing of the bagley suit mr rawlings had a flat hourly fee arrangement with petitioner for an hourly fee of dollar_figure for certain work and dollar_figure for other work with respect to the defense of the ibp suit after the bagley suit was commenced mr rawlings and petitioner changed the fee agreement arrangement to a hybrid basis whereby mr rawlings would receive a fee of dollar_figure per hour plu sec_25 percent of any judgment or settlement received in the litigation petitioner was to pay all expenses_incurred in the litigation during the year petitioner paid a total of dollar_figure in legal fees and costs in connection with the ibp litigation this amount was composed of dollar_figure paid in connection with the judgment petitioner received in the tortious interference with present employment claim and dollar_figure paid in connection with the settlement petitioner received from ibp of the dollar_figure in legal fees paid_by petitioner in connection with the tortious interference with present employment claim dollar_figure represented the 25-percent contingency fee and dollar_figure represented the dollar_figure-per hour fixed fee the fee agreement had been structured with a contingency fee as well as an hourly fee because of the difficulty in determining when the attorneys were defending against ibp's claims and when they were prosecuting petitioner's claims when they were working on the litigation on their federal_income_tax return petitioners reported dollar_figure of interest received from ibp on schedule b and deducted dollar_figure of legal and accounting fees as miscellaneous_itemized_deductions on schedule a petitioners showed the receipt of the dollar_figure of compensatory_damages from the tortious interference with present employment claim and the receipt of dollar_figure of punitive_damages from that claim but excluded both the compensatory_damages and punitive_damages from their taxable_income also petitioners showed the receipt of dollar_figure million paid in connection with the settlement but excluded the entire dollar_figure million from their taxable_income the amounts were shown on the tax returns on a form_8275 disclosure statement under sec_6661 respondent in her notice_of_deficiency increased petitioner's income as shown on petitioners' federal_income_tax return for the year by the amount of dollar_figure explained as a court-ordered award and by the amount of dollar_figure explained as an out-of-court settlement payment although the notice_of_deficiency does not state an explanation for the increases in income other than stating it is determined that petitioner received additional income in these amounts which was not reported respondent at the trial stated that these amounts represented the amounts of the awards which were punitive_damages which were not excludable from income under sec_104 as damages received on account of personal injuries or sickness respondent in the notice_of_deficiency reduced petitioner's income by the amount of dollar_figure which she computed as the amount of legal fees deductible the amount was computed by showing legal fees allowable for deduction as dollar_figure less legal fees claimed per return of dollar_figure leaving dollar_figure of deductible legal fees not claimed on the tax_return which after the adjustment for percent of adjusted_gross_income left a deduction of dollar_figure respondent in the notice_of_deficiency stated that these legal fees were applicable to the taxable_amount of the court-ordered award and the out-of-court settlement payment and were deductible as miscellaneous deductions subject_to reduction by an amount of percent of adjusted_gross_income opinion the first issue we have for decision is what portion if any of the dollar_figure million paid to petitioner by ibp in connection with the settlement of all claims other than the tortious interference with present employment claim which had been disposed of by an entry of judgment by the district_court pursuant to the opinion of the court_of_appeals for the eighth circuit prior to the time of settlement was paid in lieu of punitive_damages the parties are not in disagreement as to the law with respect to the allocation of an amount_paid in a settlement but have decided disagreements as to how the law should be applied to the facts of this case both parties agree that where an amount is paid in settlement of a case the critical question is in lieu of what was the settlement amount_paid 102_tc_465 102_tc_116 80_tc_1104 the parties agree also that all of the facts surrounding the settlement must be considered in determining in lieu of what was the settlement amount_paid mckay v commissioner supra where there is an express allocation contained in the agreement between the parties it will generally be followed in determining the allocation if the agreement is entered into by the parties in an adversarial context at arm's length and in good_faith robinson v commissioner supra however an express allocation set forth in the settlement is not necessarily determinative if other facts indicate that the payment was intended by the parties to be for a different purpose it is petitioners' position that the express language in the settlement agreement provides that the payment is a payment for the actual injuries in support of this position petitioners quote the provision of the agreement that petitioner acknowledges payment and receipt of the sum of dollar_figure million as damages for personal injuries including alleged damages for invasion of privacy injury to personal reputation including defamation emotional stress and pain and suffering it is petitioners' contention that this express language in the settlement shows that the entire payment of dollar_figure million was made for a tort type personal injury and therefore is excludable under sec_104 in support of this position petitioners cite the statement in 76_tc_116 affd without published opinion 676_f2d_683 1st cir that the most important fact in determining the purpose of the payment is express language in the agreement stating that the payment was made on account of personal injuries see also 88_tc_834 affd without published opinion 845_f2d_1013 3d cir petitioners state that the situation in petitioner's case is almost identical with that in mckay v commissioner supra and is distinguishable from the situation in robinson v commissioner supra relied on by respondent in both robinson v commissioner supra pincite and mckay v commissioner supra pincite we recognized that when a settlement agreement clearly allocates the settlement proceeds between tortlike personal injury damages and other damages the allocation is generally binding for tax purposes to the extent that the agreement is entered into by the parties in an adversarial context at arm's length and in good_faith where the taxpayer's claims are settled and the express allocations among the various claims are contained in the settlement agreement we carefully consider such allocations if these express allocations were negotiated at arm's length between the parties in robinson v commissioner supra the parties had made an allocation that was reflected in the final judgment as being percent in payment for mental anguish and percent for lost profits we held that the allocation in the final judgment did not control the tax effects because it was uncontested nonadversarial and entirely tax-motivated and did not accurately reflect the underlying claims in the mckay case we stated that the settlement was made by hostile parties who were in an adversarial position with respect to the allocations to be made in the settlement in that case we pointed out that the taxpayer wanted the settlement award to be as high an amount as possible to compensate him for his losses and wanted the other party to be punished for its behavior however the other party wanted to minimize the amount payable to the taxpayer as well as to avoid making any payment on account of the taxpayer's rico claim we pointed out that the party dealing with the taxpayer in that case had made it clear that he would not settle if any damages were allocated to rico claims because of the negative impact that payment of such damages would have on its reputation in the oil industry the settlement agreement stated affirmatively that no amount was being paid to the taxpayer to satisfy damages under rico in that case the settlement agreement provided mckay has necessarily acceded to ashland's demand that nothing be allocated to the rico claim punitive_damages claims or alleged intentional misconduct claims and ashland and mckay have both relied upon their appellate counsel's consensus estimate of mckay's probability of appellate success with respect to the two other claims mckay v commissioner t c pincite in the mckay case the record showed that the taxpayer was never given freedom to structure the settlement on his own in our view the instant case is distinguishable from the mckay case since there is no specific statement with respect to punitive_damages in the settlement agreement and the parties structured the settlement agreement by jointly participating in the drafting of the agreement although this case is not exactly comparable to robinson v commissioner supra there are some aspects of similarity to the robinson case here the record shows that a judgment had been entered by a jury with respect to the libel claim and the jury had allowed dollar_figurel million of compensatory_damages and dollar_figure million of punitive_damages the record shows that the court_of_appeals had held the claim with respect to tortious interference with future employment duplicative of the libel claim but did not reverse the jury award of dollar_figure of compensatory_damages and dollar_figure of punitive_damages if on retrial petitioner was unsuccessful in the libel suit the record further shows that the district_court had held that consideration would be given to reinstatement of the invasion of privacy award of dollar_figure in compensatory and dollar_figure million in punitive_damages if on retrial petitioner was unsuccessful in the libel suit therefore dollar_figure million was likely to be the total petitioner would receive as compensatory_damages if on retrial he succeeded on the libel claim the record shows that counsel for ibp was unwilling to have a statement made that a portion of the dollar_figure million was paid as punitive_damages and the parties agreed to a statement that the sum of dollar_figure million was paid as damages for personal injuries including alleged damages for invasion of privacy injury to personal reputation defamation emotional stress and pain and suffering however there is no specific statement as there was in 102_tc_465 that the damages referred to were not in consideration of any amount that might have been awarded as punitive_damages had the case gone to trial the overall picture here clearly shows that ibp would necessarily have considered the possibility in a retrial of having to pay punitive_damages in the libel suit and if ibp won the libel suit ibp would have to pay dollar_figure in punitive_damages under the tortious interference with future employment judgment and possibly dollar_figure million as punitive_damages on the invasion of privacy claim the record is also clear here that ibp's primary concern was that it pay as little as possible to dispose_of all claims of petitioner while providing for the return of the bagley documents and that the settlement remain confidential the evidence here shows that both parties worked on the wording of the settlement document and were aware that even if petitioner lost on the retrial of the libel claim the tortious interference with future employment judgment of dollar_figure compensatory_damages and dollar_figure punitive_damages and possibly the invasion of privacy award would be reinstated the parties in coming to their agreement were aware that the jury had previously awarded compensatory_damages in the libel suit of dollar_figure million and punitive_damages of dollar_figure million although the record supports the fact that counsel for ibp did not want to show an allocation to punitive_damages the record as a whole including the discussions and give-and-take between the parties as to the amount to be paid to petitioner shows that both parties considered the clear possibility of petitioner recovering punitive_damages in fact the testimony of the attorneys shows that this was in the minds of the attorneys when the negotiations were going on furthermore it was clearly in the interest of both parties not to show an amount allocated to punitive_damages petitioner's counsel testified that in the beginning of the negotiations he was not aware of whether it might make a difference if a portion were allocated to compensatory_damages and a portion to punitive_damages but that between the time of agreement to the total_payment of dollar_figure million and the completion of drafting the settlement agreement petitioner had consulted a tax attorney and was aware that there could possibly be a difference since an amount of compensatory_damages would clearly be excludable from income here we have a situation in which the jury award which was not reversed by the court because of its amount but rather because of an improper jury instruction as to burden_of_proof gave five times as much in punitive_damages to petitioner as in compensatory_damages and an award of two and one- half times as much in punitive as compensatory_damages that would be reinstated on the claim for tortious interference with future employment if the libel case of petitioner were unsuccessful also there existed the possibility that an additional dollar_figure million of punitive_damages might be reinstated on the invasion of privacy claim based on these facts we conclude that some of the dollar_figure million is properly allocable to punitive_damages however we do not agree with the amount respondent allocated the parties were negotiating for an amount in lieu of the overall amount petitioner might recover if the case went to trial they were considering the risk of trial as well as items unrelated to the money that petitioner might recover such as the return of the bagley documents and the confidentiality of the settlement all of these factors were important to ibp also it is clear that there would have been in any event a dollar_figure payment to petitioner for the tortious interference with future employment award of which dollar_figure were punitive_damages if petitioner was unsuccessful in the libel suit probably there would have been interest on that award however clearly ibp did not want to acknowledge a payment of punitive_damages under these circumstances it is reasonable to assume that ibp would have paid in settlement to petitioner the entire dollar_figure million that the jury had found he was due as compensatory_damages however in our view the remaining dollar_figure was in settlement of possible punitive_damages petitioner might have recovered we therefore hold that of the dollar_figure million settlement amount dollar_figure million was for compensatory_damages and dollar_figure was for punitive_damages petitioner argues that the amounts received by petitioner as punitive_damages which we have found total dollar_figure million are properly excludable from petitioner's income for under sec_104 in a fairly recent court-reviewed case 100_tc_93 affd 33_f3d_625 6th cir we held that the punitive_damages received by a taxpayer in a personal injury suit in a kentucky state court were excludable from the taxpayer's gross_income under sec_104 as damages received on account of personal injury our first basis for excluding punitive_damages from a taxpayer's income under sec_104 was a rejection of the concept that sec_104 excludes only amounts that restore lost capital as opposed to amounts that would otherwise constitute gains or accession to wealth we stated that in our view the beginning and end of the inquiry should be whether the damages were paid on account of 'personal injuries' we then stated that this inquiry should be answered by determining the nature of the underlying claim we concluded that once the nature of the underlying claim is established as one for personal injury any damages received on account of that claim including punitive_damages are excludable in the horton case we stated that the recent decision of the supreme court in 504_us_229 supported the analysis we had adopted we stated that the taxpayers in the burke case were claiming that a backpay award in a sex discrimination suit under title vii was excludable from income but the supreme court in holding to the contrary stated that in determining whether the sec_104 exclusion applies the nature of the claim underlying an award of damages is a critical factor in horton v commissioner supra we held that punitive_damages should be excluded from a taxpayer's income under sec_104 we held that we would follow our own opinion in 93_tc_330 rather than the reversal by the court_of_appeals 914_f2d_586 4th cir however we pointed out that the court_of_appeals for the fourth circuit in the miller case had concluded that under maryland law punitive_damages were not excludable since they were purely punitive and not compensatory to the injured party whereas under kentucky law punitive_damages served both to compensate the injured party and punish the wrongdoer therefore even though we held we would follow our position in the miller case we also distinguished the miller case from horton v commissioner supra on the basis of the difference in kentucky and maryland law the four circuits in addition to the fourth circuit in miller and the sixth circuit in horton which have addressed the deductibility of punitive_damages have come to the conclusion reached by the court_of_appeals for the fourth circuit in miller that damages which are compensatory in nature are excludable but damages which are noncompensatory in nature are not excludable under sec_104 the court_of_appeals for the ninth circuit held that punitive_damages were not excludable from gross_income where the punitive award was not a restoration of lost capital and was 'not intended to compensate the injured party but rather to punish the tort-feasor whose wrongful action was intentional or malicious and to deter him and others from similar extreme conduct ' 30_f3d_1077 9th cir citing 453_us_247 the court_of_appeals for the ninth circuit further found that punitive_damages were not awarded to a taxpayer on account of personal injury but rather were awarded on account of the tortfeasor's deplorable conduct hawkins v united_states supra pincite in 24_f3d_228 fed cir the court found that punitive_damages received by a taxpayer in an action under the district of columbia human rights act were not excludable since they were in the nature of noncompensatory damages the federal_circuit relying on a district of columbia case as well as the supreme court's language in city of newport v fact concerts inc supra and similar cases and on the legislative_history of sec_104 stated that it would be inconsistent with the legislative_history to treat punitive_damages as excludable from income since punitive_damages in no way resemble a return_of_capital reese v united_states supra pincite the court_of_appeals_for_the_federal_circuit rejected the taxpayer's argument that 504_us_229 was applicable to the issue it was considering on the ground that the burke case did not involve punitive_damages and was therefore not controlling or even relevant to the issue reese v united_states supra pincite the court_of_appeals for the fifth circuit has recently decided that noncompensatory punitive_damages are not excludable under sec_104 in 48_f3d_894 5th cir the court concluded as did the federal_circuit that the supreme court did not address whether punitive_damages are excludable from gross_income in united_states v burke supra the fifth circuit agreed with the opinions of the courts of appeals for the fourth ninth and federal circuits that congress did not intend that noncompensatory damages be excludable from a taxpayer's income since such damages did not restore lost capital wesson v united_states supra pincite since the fifth circuit concluded that under mississippi law punitive_damages were noncompensatory in nature it held punitive_damages not to be excludable from income under sec_104 wesson v united_states supra on date the court_of_appeals for the tenth circuit issued an opinion in 66_f3d_1550 10th cir concluding we thus join the majority of the circuits that have addressed this issue in holding that sec_104 does not exclude punitive_damages from income of the six courts of appeals which have decided the issue of exclusion from income of punitive_damages five have held that punitive_damages are not in 53_f3d_712 5th cir revg tcmemo_1994_4 the court_of_appeals for the fifth circuit also held that punitive_damages were noncompensatory under texas law and therefore were not excludable from gross_income under sec_104 excludable the court_of_appeals for the sixth circuit in affirming our horton case primarily relied on the language of united_states v burke supra pincite which indicated that in order to determine whether an award is excludable under sec_104 we should focus 'on the nature of the claim underlying the taxpayer's damages award ' 33_f3d_625 6th cir affg 100_tc_93 the court_of_appeals for the fourth and fifth circuits have looked to state law to determine the nature of punitive_damages while the federal_circuit has interpreted opinions of the supreme court as well as an opinion of the district of columbia court_of_appeals to determine whether punitive_damages were compensatory in nature commissioner v miller supra pincite moore v commissioner 53_f3d_712 5th cir reese v united_states supra pincite however most important to a consideration of whether in this case we should follow our holding in horton v commissioner supra is whether our holding in the horton case has effectively been overruled by the decision of while the court_of_appeals for the seventh circuit has yet to address this issue it has favorably quoted 914_f2d_586 4th cir revg 93_tc_330 stating in 917_f2d_1033 7th cir affg t c memo sec_104 of the internal_revenue_code 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 the rationale of the exemption is to free a taxpayer from liability for an amount received as compensation_for a loss of that nature t he recovery does not generate a gain or profit but only makes the taxpayer whole by compensating for a loss 914_f2d_586 4th cir citing b bittker federal taxation of income estates and gifts para while 33_f3d_625 6th cir affg 100_tc_93 held that the nature of the claim underlying the taxpayer's damages award decided whether punitive_damages were excludable the court_of_appeals stated after its conclusion that punitive_damages under kentucky state law were partly compensatory in nature this case is distinguishable both from miller in which the fourth circuit noted that under maryland defamation law punitive_damages served no compensatory purpose and from hawkins in which the arizona taxpayers 'concede d that the punitive damage award bears no relationship to their injuries and represents pure gain ' quoting hawkins v united_states 30_f2d_1077 9th cir the supreme court in commissioner v schleier u s ____ 115_sct_2159 in the schleier case the taxpayer included as gross_income the backpay portion but not the liquidated_damages portion of a settlement award received under the age discrimination in employment act of adea the commissioner sent the taxpayer a notice_of_deficiency determining that the taxpayer should have included the liquidated_damages portion of his settlement as gross_income we found for the taxpayer holding that the entire settlement was damages received on account of personal injuries or sickness within the meaning of sec_104 and was therefore excludable from gross_income and the court_of_appeals for the fifth circuit affirmed commissioner v schleier 26_f3d_1119 5th cir the supreme court reversed the court_of_appeals the supreme court stated that the taxpayer argued that his damages were excluded from gross_income since they were damages received on account of personal injuries or sickness commissioner v schleier supra pincite the supreme court rejected this argument stating that the plain language of sec_104 undermines the taxpayer's contention commissioner v schleier supra pincite the supreme court concluded that each element of the settlement must satisfy the requirement under sec_104 that the damages were received on account of personal injuries or sickness commissioner v schleier supra pincite since the backpay was not directly caused by the injury sec_104 did not apply the court reasoned in short sec_104 does not permit the exclusion of the taxpayer's back wages because the recovery_of back wages was not on account of any personal injury and because no personal injury affected the amount of back wages recovered commissioner v schleier supra pincite the taxpayer argued that liquidated_damages fit within sec_104 citing 316_us_572 which held that liquidated_damages under the fair labor standards act flsa were compensation not a penalty or punishment the court however distinguished liquidated_damages recovered under the flsa from those recovered under the adea in finding that sec_104 did not apply to liquidated_damages under the adea the court stated 'congress intended for liquidated_damages under the adea to be punitive in nature ' commissioner v schleier u s s ct pincite quoting 469_us_111 the taxpayer in the schleier case made essentially the same argument as the taxpayer in 100_tc_93 with regard to 504_us_229 see horton v commissioner supra pincite the taxpayer argued that the burke case stood for the proposition that a taxpayer need only prove that the underlying claim was based on a tort or tort type rights to be excludable under sec_104 in addressing the taxpayer's argument that the burke case limited the analysis under sec_104 to determining whether recovery is based on tort or tort type rights the supreme court stated pincite u s s ct pincite second and more importantly the holding of burke is narrower than the taxpayer suggests in burke following the framework established in the irs regulations we noted that sec_104 requires a determination whether the underlying action is based upon tort or tort type rights united_states v burke u s pincite s ct pincite in so doing however we did not hold that the inquiry into tort or tort type rights constituted the beginning and end of the analysis in particular though burke relied on title vii's failure to qualify as an action based upon tort type rights we did not intend to eliminate the basic requirement found in both the statute and the regulation that only amounts received on account of personal injuries or sickness come within sec_104's exclusion thus though satisfaction of burke's tort or tort type inquiry is a necessary condition for excludability under sec_104 it is not a sufficient condition fn ref omitted in our view the supreme court in the schleier case adopted a position contrary to our holding in the horton case that the underlying claim is the beginning and end of the analysis under the holding in the schleier case once it is determined that the nature of the claim is based on a tort or tort type right it is necessary to further determine whether the amounts received were on account of personal injuries or sickness the supreme court has made it clear in the schleier case that damages which are not compensatory but punitive in nature are not excludable from gross_income under sec_104 the supreme court stated we agree with the taxpayer that if congress had intended the adea's liquidated_damages to compensate plaintiffs for personal injuries those damages might well come within sec_104's exclusion there are however two weaknesses in the taxpayer's argument first even if we assume that congress was aware of the court's observation in overnight motor that the liquidated_damages authorized by the flsa might provide compensation_for some obscure injuries it does not necessarily follow that congress would have understood that observation as referring to injuries that were personal rather than economic second and more importantly we have previously rejected the taxpayer's argument we have already concluded that the liquidated_damages provisions of the adea were a significant departure from those in the flsa see lorillard v pons u s pincite s ct pincite trans world airlines inc v thurston u s pincite s ct pincite and we explicitly held in thurston congress intended for liquidated_damages to be punitive in nature id pincite s ct pincite our holding in thurston disposes of the taxpayer's argument and requires the conclusion that liquidated_damages under the adea like back wages under the adea are not received on account of personal_injury_or_sickness fn refs omitted commissioner v schleier u s s ct pincite it is clear from this paragraph that if punitive_damages are not of a compensatory nature they are not excludable under sec_104 the supreme court in the schleier case left open when punitive or exemplary damages under a particular federal or state law are intended to be compensatory we therefore look to the state law to determine whether the punitive_damages petitioner received were compensatory in nature the present case involves iowa law see 797_f2d_632 8th cir under iowa law it is clear that punitive_damages are to punish the person who is liable for injury and set an example to deter future malicious actions in team cent inc v teamco inc n w 2d iowa the iowa supreme court stated that the purpose of punitive_damages is to punish the wrongdoer rather than to compensate the victim this case is in line with previous cases by the supreme court of iowa in meyer v nottger n w 2d iowa the court stated exemplary damages are not intended to be compensatory an award of exemplary damages is never made as a matter of right but depends upon whether under the facts in a particular case such award is appropriate in order to punish an offending party or discourage others from similar wrongful conduct citations omitted the court in meyer v nottger supra concluded that the noncompensatory nature of punitive_damages is well established under iowa law the supreme court stated in commissioner v schleier supra pincite-- we have already concluded that the liquidated_damages provisions of the adea were a significant departure from those in the flsa and we explicitly held in thurston congress intended for liquidated_damages to be punitive in nature id pincite s ct pincite citations and fn ref omitted we conclude that in commissioner v schleier supra the supreme court effectively overruled the part of our holding and that of the court_of_appeals for the sixth circuit in horton v commissioner supra that since the claim as originally made was one for a personal injury or a tortlike claim even if the punitive_damages received were as punishment for malicious actions and an example to deter others from such malicious action they are excludable from income under sec_104 we will therefore no longer follow our opinion in horton v commissioner supra to the extent that it holds that punitive_damages which are not compensatory in nature are excludable from income under sec_104 we therefore hold that the dollar_figure million received by petitioner in composed of dollar_figure received on date pursuant to the judgment entered by the district_court and the dollar_figure received on date as part of the settlement of the remaining issues in the ibp litigation which we have held to be for punitive_damages is not excludable from his income under sec_104 petitioner contends that the contingent legal fees paid to his attorney in connection with his litigation with ibp should be a reduction of the amount he received pursuant to judgment or in settlement of the ibp litigation respondent contends that these fees to the extent deductible should be considered miscellaneous_itemized_deductions subject_to reduction by percent of petitioner's adjusted_gross_income under sec_67 the basis of petitioner's contention is that the contingent_fee arrangement created a joint_venture or partnership between him and the law firm petitioner argues that the portions of the judgment and settlement paid over to the law firm pursuant to that contingency fee were not income to petitioner sec_7701 defines a partnership as a syndicate group pool joint_venture or other unincorporated organization through or by means of which any business financial operation or venture is carried on whether a partnership exists is a question of fact to be a partnership the parties in good_faith and acting with a business_purpose must intend to join together in the present conduct of an enterprise 337_us_733 see estate of 313_f2d_724 8th cir affg in part revg in part and remanding 33_tc_465 in determining whether a partnership exists for purposes of federal tax we have looked at such factors as the agreement of the parties and their conduct in executing its terms the contributions which each party has made to the venture each party's control_over income and capital and the right of each to make withdrawals and most relevant to the issue here before us whether each party was a principal and coproprietor sharing a mutual proprietary interest in the net profits and having an obligation to share the net losses this is distinguished from a relationship where one party receives contingent_compensation in the form of a percentage of income for his services rendered to the other party based on the record we find that there is nothing to indicate that the parties intended the contingency fee arrangement to be a joint_venture or partnership mr rawlings testified that he regarded the agreement between himself and petitioner as nothing more than an arrangement for the payment for his services petitioner did not testify with respect to the fee agreement there is therefore no testimony whatsoever that either party intended to form a partnership petitioner did not report any profit or loss from any partnership with mr rawlings but instead claimed a miscellaneous itemized_deduction for attorney's_fees paid we therefore find petitioner's argument to be without merit petitioner also argues that the dollar_figure-per-hour portion of the legal fees he paid is deductible as a schedule c expense under sec_162 since petitioner was defending his professional name and attempting to protect his occupation as a consultant to the meat packing industry there is no schedule c attached to petitioner's return there is attached a form_2106 employee business_expenses petitioner has made no showing of any connection of the ibp litigation with a consulting business if any in which he was engaged in or any other year therefore to the extent the ibp litigation costs are deductible they are deductible either as employee business_expenses or expenses_incurred for the production_of_income a deduction for either such expense is a miscellaneous itemized_deduction allowable only to the extent that the total of such deductions exceed sec_2 percent of adjusted_gross_income see 102_tc_465 petitioner contends that the statutorily-imposed interest received on the amount of the judgment he received on account of the personal injury he suffered should be excludable from income this issue has been before us on other occasions and we have held that interest_paid on damages awarded in connection with personal injury claims is taxable and not excludable from income but that the amount of the attorney's_fees paid in connection with the interest award is deductible from income 100_tc_124 affd without published opinion 25_f3d_1048 6th cir 94_tc_189 27_bta_1339 we therefore hold that the interest received by petitioner on the amount of the judgment in the ibp case is taxable_income that is not excludable under sec_104 decision will be entered under rule reviewed by the court hamblen chabot cohen swift jacobs gerber wright parr wells ruwe whalen colvin halpern beghe chiechi laro and foley jj agree with this opinion vasquez j did not participate in the consideration of this opinion


number release date id office uilc cca_2009082112103937 -------------- from ------------------- sent friday date pm to -------------------- cc ----------- subject re k-1 discrepancies yes we can issue a valid stat_notice if the taxpayer filed a notice of inconsistent treatment but only after sending a notice of conversion under sec_6231 under those circumstances a subsequent notice_of_deficiency would suspend the period for assessment because it would be a valid notice under section a a ii and a first parenthetical