The opinion
T.C. Memo. 2005-177
UNITED STATES TAX COURT
ROBERT L. ALLUM, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 2424-03. Filed July 20, 2005.
Robert L. Allum, pro se.
Richard D. D’Estrada, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
MARVEL, Judge: Respondent determined a deficiency of
$185,491 in petitioner’s Federal income tax for 1999. The issues
for decision1 are: (1) Whether settlement proceeds petitioner
1
Petitioner also raised several constitutional and
jurisdictional issues regarding the validity of this Court and
the Internal Revenue Code in general, including whether this
Court, as an Art. I court exercising jurisdiction over this case,
(continued...)
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received may be excluded from his gross income under section
104(a)(2);2 and (2) if the total settlement proceeds are not
excluded under section 104(a)(2), whether a portion of the
settlement proceeds that petitioner paid to his attorney as a
contingent fee3 may be excluded from petitioner’s gross income.4
1
(...continued)
violates Amends. V, VI, and VII of the U.S. Constitution.
Petitioner’s arguments are specious and frivolous, resembling in
tone the type of tax-protester arguments with which we are
sometimes presented. We shall not address petitioner’s
“constitutional” arguments “with somber reasoning and copious
citation of precedent; to do so might suggest these arguments
have some colorable merit.” Crain v. Commissioner, 737 F.2d
1417, 1417 (5th Cir. 1984). We simply point out that this Court
is a court of law, Freytag v. Commissioner, 501 U.S. 868, 890-891
(1991), with jurisdiction to decide income tax issues of the type
raised in this case, secs. 6211-6214, I.R.C. 1986.
2
Unless otherwise indicated, 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.
3
In this case, the attorney’s fee was a fixed fee that was
contingent upon the successful settlement of petitioner’s claims.
Although the amount of the fee was not dependent on the amount of
the settlement, the fee nevertheless was a contingent fee in that
it was payable only if a settlement was successfully negotiated
and consummated. See Black’s Law Dictionary 338 (8th ed. 2004)
(a contingent fee is “A fee charged for a lawyer’s services only
if the lawsuit is successful or is favorably settled out of
court”).
4
Respondent concedes that the $75,000 fee paid to
petitioner’s attorney is deductible, but only “as a miscellaneous
itemized deduction, subject to the restrictions of sections 67
and 68 and, if appropriate, the application of the Alternative
Minimum Tax provisions, sections 55 and 56.” In his reply brief,
petitioner argues for the first time that the attorney’s fee is
deductible or excludable as a Schedule C, Profit or Loss From
Business, expense but did not offer any evidence at trial that
(continued...)
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FINDINGS OF FACT
Some of the facts have been stipulated and are so found.
The stipulation of facts and supplemental stipulation of facts
are incorporated herein by this reference. Petitioner resided in
Bozeman, Montana, when his petition in this case was filed.
During the 1980s, petitioner was employed as a Federal
Housing Administration (FHA) underwriter with the Valley Mortgage
Company (Valley). Valley engaged in an illegal loan scheme,
which petitioner reported to both Valley’s head underwriter and
the FHA. In 1989, Valley terminated petitioner’s employment.
In 1991, petitioner brought suit against Valley in the
Washoe County District Court of Nevada, alleging wrongful
termination, defamation, and violations of Nevada’s Racketeer
Influenced and Corrupt Organizations Act (RICO). A jury decided
against petitioner on the wrongful termination and defamation
claims. The Washoe County District Court dismissed the RICO
claim, which dismissal the Supreme Court of Nevada affirmed. See
Allum v. Valley Bank, 849 P.2d 297 (Nev. 1993).
4
(...continued)
the fee was deductible under sec. 162. Moreover, petitioner did
not give respondent any notice in his amended petition, his
pretrial memorandum, or at trial that he was claiming the fee was
deductible under sec. 162. We conclude, therefore, that
petitioner did not timely raise the sec. 162 issue, and we
decline to decide it. DiLeo v. Commissioner, 96 T.C. 858, 891
(1991), affd. 959 F.2d 16 (2d Cir. 1992); Foil v. Commissioner,
92 T.C. 376, 418 (1989), affd. 920 F.2d 1196 (5th Cir. 1990);
Markwardt v. Commissioner, 64 T.C. 989, 997 (1975).
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In 1994, petitioner brought suit against Valley’s successor,
Bank of America (the bank), a Nevada Supreme Court justice who
participated in the 1993 decision, and others (together,
defendants) in the U.S. District Court for the District of Nevada
(District Court) in case No. CV-N-94-455. Petitioner’s complaint
alleged that the defendants violated his civil rights under 42
U.S.C. sec. 1983 during the State court proceedings and conspired
to violate Federal and State RICO statutes.
Petitioner’s civil rights complaint in case No. CV-N-94-455
(complaint) consisted of alleged violations of his rights to
procedural and substantive due process. Petitioner alleged that
his procedural due process rights were violated by certain of the
defendants, including the bank, providing financial support to
“lawyer politicians” seeking elected judicial office in Nevada,
so as to create an
atmosphere of “obligation” on the part of the lawyer
politician who is elected to the position of district
court judge or Nevada Supreme Court Justice to
facilitate obtaining “legal protection” from said
elected lawyer politician * * * for any of the conduct
or actions of these Defendants which result in legal
action being taken against them.
Petitioner claimed that, as a result of this atmosphere of
obligation, his procedural due process rights were further
violated through misconduct of the Nevada judiciary that
included:
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1. Accepting perjured documents and testimony from the
defendants;
2. denying petitioner a full and fair opportunity to
access the discovery process;
3. generally failing to comply with the Canons of
Judicial Conduct;
4. applying improper standards of adjudication to
petitioner’s motions and complaints;
5. fabricating the fact that petitioner “participated
in the illegal [RICO] scheme by virtue of his underwriting”,
see Allum v. Valley Bank, 849 P.2d 297, 301-302 (Nev. 1993);
and
6. advocating on behalf of the defendants.
Correspondingly, petitioner claimed that the defendants, in
furtherance of Nevada’s “‘good ole boy network’”, violated his
substantive due process right by using him as “an example” to
promote the protection afforded to the lawyer politicians’
contributors and coerce the contributors’ employees into
submitting to abuse and hostile working conditions.
Petitioner also alleged in his complaint that he suffered
unspecified physical and emotional damages as the result of the
civil rights violations, and he sought both punitive and
compensatory damages. In regard to his RICO claims, petitioner
alleged that he lost income and incurred the costs of prosecuting
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and defending various lawsuits with the defendants as a result of
their alleged racketeering activities, and he sought treble
damages.
The District Court dismissed petitioner’s claims of judicial
errors in the State court for lack of jurisdiction, granted
summary judgment against him on his remaining claims, and denied
his discovery-related motions as moot. On March 31, 1998, the
Court of Appeals for the Ninth Circuit reversed the District
Court’s order denying petitioner’s discovery motions and that
part of the District Court’s decision granting summary judgment
on petitioner’s due process claims, and remanded the case back to
the District Court.5
In 1999, petitioner filed another suit in the District
Court, this time against the State of Nevada, members of the
office of the attorney general of the State of Nevada, and a
former Nevada Supreme Court justice, alleging violations of his
civil rights under 42 U.S.C. sec. 1983 and a conspiracy to
5
In all other respects, the Court of Appeals for the Ninth
Circuit affirmed the District Court’s decision. In disposing of
petitioner’s RICO claims, the Court of Appeals for the Ninth
Circuit noted that petitioner had alleged that he suffered
“emotional and physical distress, lost income and litigation
expenses related to prosecuting and defending lawsuits, wrongful
termination, libel, and loss of his professional license.” The
Court of Appeals found, however, that although only the loss of
the professional license could constitute injury to “business or
property” for purposes of the RICO claims, petitioner had not
shown he had been deprived of his professional license, “much
less that such deprivation was the result of racketeering
activities on the part of the * * * [defendants]”.
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violate his civil rights in connection with case No. CV-N-94-455.
During 1999, petitioner also entered into negotiations to settle
case No. CV-N-94-455 with the bank and certain other defendants.
Petitioner hired an attorney, Kenneth McKenna, to represent him
in the negotiations. Petitioner and Mr. McKenna agreed that
petitioner would pay him a fee of $75,000 for his services if the
negotiations were successful.
In approximately November 1999, petitioner and the bank
signed a “GENERAL RELEASE AND SETTLEMENT AGREEMENT” (the
agreement). The agreement provided:
3.a. Payment to be Made. In consideration of the
settlement of Allum’s claims alleging violation of his
civil rights as asserted in Case No. CV-N-94-445 ECR[6]
and without any other obligation to do so, the Bank
will pay Allum the gross sum of five hundred thousand
dollars ($500,000). * * *
The agreement also stated that “As further consideration and
inducement” petitioner would request dismissal of ongoing Nevada
State litigation and Federal litigation between petitioner and
the defendants7 and that “In exchange for the promises contained
in this Agreement” petitioner would generally release all other
6
The parties stipulated that the agreement erroneously
refers to case No. CV-N-94-445 ECR and that the correct case
reference is to case No. CV-N-94-455.
7
The Nevada litigation consisted of seven “claims and civil
litigation between Allum, the bank, and others before the courts
of the State of Nevada”. The Federal litigation consisted of
nine “claims and civil litigation between Allum, the bank, and
others before the courts of the United States”, in addition to
case No. CV-N-94-455.
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known and unknown claims against the defendants arising out of or
related to his employment relationship with the bank and the
Nevada and Federal litigation.8
The agreement specifically provided that the bank took no
position on the tax effect of the $500,000 payment to petitioner
and would issue a Form 1099 regarding the payment. The agreement
also provided that if any governmental authority determined the
payment constituted income, petitioner would be solely
responsible for the payment of all taxes arising from the
determination. Furthermore, the agreement provided, in regard to
attorney’s fees, that--
As further mutual consideration of the promises set
forth herein, the Bank and Allum agree that they are
each responsible for their own attorneys’ fees and
costs, and each agrees that they will not seek from the
other reimbursement for attorneys’ fees and/or costs
incurred in this action or relating to any matter
addressed in this Agreement.
8
The release of claims provision consisted of both
boilerplate language and, in pertinent part, the following:
This agreement includes, but is not limited to, (i)
release, waiver and discharge of any claims, * * *
damages, or injuries that Allum has pled or otherwise
claimed, or which Allum could have pled or otherwise
claimed, in any of the * * * [Nevada and Federal
litigation], (ii) release, waiver and discharge of any
claims arising from any statements * * * made or
distributed or published by any and all of the Released
Parties, prior to signing of this Agreement by Allum,
including any statements by Allum himself, and (ii)
[sic] release of any claims for any type of wages,
commissions, bonus, separation or severance benefits,
or any other form of compensation. * * *
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By the end of 1999, the bank had paid petitioner $500,000, and
petitioner had paid Mr. McKenna $75,000 from the amount received.
Sometime during 1999, petitioner contacted a Nevada
Congressman’s office to inquire about the taxability of the
settlement proceeds and received a response from a representative
of a local Taxpayer Advocate Service office in return.
Petitioner was dissatisfied with the clarity of that office’s
response, and he sent a letter dated January 20, 2000, to the
District Director of the Internal Revenue Service (IRS) in
Phoenix, Arizona, again inquiring about the taxability of the
proceeds he received for violation of his “civil rights to a full
and impartial tribunal”. On or about February 11, 2000, the
District Director responded by letter to petitioner’s inquiry.
The letter informed petitioner of the rules generally governing
the taxation of court awards and settlements, and stated:
If this information is insufficient for your needs,
there are other avenues you can follow to receive a
more formal opinion on the taxability of the funds
received in the settlement. You can request an opinion
letter, private letter ruling, or a determination
letter. * * * The user fee for a ruling or letter * *
* would be * * * $2,500, if your total income is over
$150,000.
Petitioner did not request a ruling or letter.
On or about April 17, 2000, petitioner filed a Form 1040,
U.S. Individual Income Tax Return, for 1999. Petitioner did not
include the $500,000 of settlement proceeds in the gross income
he reported on his 1999 return. Petitioner attached a statement
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to his return, however, in which he stated: “I received $500,000
* * * as settlement of a lawsuit for violation of my civil
rights.”
On January 28, 2003, respondent mailed to petitioner a
notice of deficiency in which respondent increased petitioner’s
gross income for 1999 by the full amount of the settlement
proceeds, including the amount petitioner paid to his attorney.
On February 7, 2003, petitioner’s letter to the Court was filed
as his imperfect petition. The Court ordered petitioner to file
an amended petition by May 16, 2003. On May 13, 2003,
petitioner’s amended petition contesting the notice of deficiency
was filed.
OPINION
In general, the Commissioner’s determination of a deficiency
is presumed correct, and the taxpayer bears the burden of proving
otherwise. Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115
(1933). In this case, petitioner does not contend that section
7491(a), which shifts the burden of proof to the Commissioner if
its requirements are met, applies, and petitioner has not
produced evidence to show he meets the requirements of section
7491(a). The burden of proof, therefore, remains on petitioner.
A. Section 104(a)(2)
Section 61(a) includes in gross income “all income from
whatever source derived” unless excluded by a specific provision
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of the Code. This statute is construed broadly, whereas
exclusions from gross income are construed narrowly.
Commissioner v. Schleier, 515 U.S. 323, 328 (1995); United States
v. Burke, 504 U.S. 229, 233 (1992); Commissioner v. Glenshaw
Glass Co., 348 U.S. 426, 431 (1955). Section 104(a)(2) excludes
from gross income “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”.9
To be eligible for the section 104(a)(2) exclusion, a
taxpayer must demonstrate that (1) the underlying cause of action
giving rise to the recovery is based in tort or tort type rights,
and (2) the damages were received on account of personal physical
injuries or physical sickness. Commissioner v. Schleier, supra
at 337; Prasil v. Commissioner, T.C. Memo. 2003-100. In the
context of section 104(a)(2), the terms “physical injury” and
“physical sickness” do not include emotional distress, except to
9
The Small Business Job Protection Act of 1996 (SBJPA), Pub.
L. 104-188, sec. 1605, 110 Stat. 1838, amended sec. 104(a)(2) to
narrow the exclusion for damages received for personal injuries
or sickness to damages for personal injury or sickness that is
physical in nature, effective for amounts received after Aug. 20,
1996. See United States v. Burke, 504 U.S. 229, 236 n.6 (1992)
(preamendment personal injuries or sickness did not include
damages pursuant to the settlement of purely economic rights, but
did include “nonphysical injuries to the individual, such as
those affecting emotion, reputation, or character”). SBJPA also
amended sec. 104(a)(2) to except punitive damages from the
exclusion irrespective of whether they derived from a case
involving physical or nonphysical injury.
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the extent of damages not in excess of the amount paid for
medical care described in section 213(d)(1)(A) and (B)
attributable to emotional distress. See sec. 104(a) (flush
language).
When damages are received pursuant to a settlement
agreement, the nature of the claim that was the actual basis for
settlement, and not the validity of the claim, controls whether
such amount is excludable under section 104(a)(2). United States
v. Burke, supra at 237; see also Bagley v. Commissioner, 105 T.C.
396, 406 (1995) (“[T]he critical question is, in lieu of what was
the settlement amount paid?”), affd. 121 F.3d 393 (8th Cir.
1997). The determination of the nature of the claim is a factual
inquiry and is generally made by reference to the settlement
agreement. Robinson v. Commissioner, 102 T.C. 116, 126 (1994),
affd. in part and revd. in part on another issue 70 F.3d 34 (5th
Cir. 1995). An express allocation in the settlement agreement of
a portion of the proceeds to tort or tortlike claims is generally
binding for tax purposes if the agreement was entered into by the
parties in an adversarial relationship at arm’s length and in
good faith. Bagley v. Commissioner, supra at 406; Robinson v.
Commissioner, supra at 126-127. If the settlement agreement
lacks express language stating what the settlement amount was
paid to settle, we look to the intent of the payor, based on all
the facts and circumstances of the case, including the complaint
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that was filed and the details surrounding the litigation.
Knuckles v. Commissioner, 349 F.2d 610, 613 (10th Cir. 1965),
affg. T.C. Memo. 1964-33; Robinson v. Commissioner, supra at 127.
1. The Parties’ Contentions
Respondent concedes that petitioner satisfies the first
requirement for exclusion under section 104(a)(2). Respondent
contends, however, that petitioner does not satisfy the second
requirement for exclusion because the settlement proceeds were
not received on account of personal physical injury or physical
sickness, regardless of whether “petitioner’s reporting his
suspicions to banking authorities, his termination or the alleged
violation of his procedural and substantive due process rights
gave rise to the recovery of the settlement proceeds”.
Petitioner contends that although the “crux of the cases,
which were settled, was that the Nevada Supreme Court, through
its members, utilized it [sic] power * * * to violate Allum’s
constitutional rights to a fair and impartial tribunal and to
violate the Nevada and Federal Rules of Civil Procedure”, he
received the settlement funds because he had been labeled a RICO
scheme participant by the Nevada Supreme Court and had lost his
FHA underwriting license (license). Petitioner further contends
that because he has a property interest in his license, the
alleged loss of the license constitutes a personal physical
injury for purposes of section 104(a)(2).
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2. Analysis
Because the settlement payment was made pursuant to the
agreement between petitioner and the bank, we look first to the
agreement’s terms in order to determine whether the payment is
attributable to a personal physical injury. The agreement
provided that the settlement amount is payable to petitioner in
consideration of the settlement of petitioner’s “civil rights
claims” in case No. CV-N-94-455. The agreement also required
petitioner to release or request dismissal of all of his known
and unknown claims against the defendants arising out of both his
employment relationship with the bank and his State and Federal
court claims and litigation as additional consideration for the
settlement. The agreement, however, did not allocate any part of
the settlement amount to a personal physical injury or refer to a
personal physical injury resulting from any civil rights
violations or generally released claims. Rather, the agreement
expressly provided that the settlement amount was to be reported
to the IRS on a Form 1099 and was potentially taxable.
Because we cannot clearly discern from the agreement why the
settlement amount was paid, we must also look to the allegations
in petitioner’s complaint to determine whether the “civil rights
claims” to which the proceeds are allocated are claims for
personal physical injuries. See Robinson v. Commissioner, supra
at 127 (when payments are received pursuant to a settlement
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agreement from which we cannot clearly discern why the payments
were made, the underlying complaint is normally examined as an
indicator of the payor’s intent). Petitioner alleges in his
complaint that his civil rights were violated because his
procedural and substantive due process rights were infringed. In
essence, he claims his due process rights were violated through
judicial misconduct done in furtherance of Nevada’s “good ole
boy” network. Although the complaint also includes general
allegations that he suffered emotional and physical damage as a
result of the alleged violations and seeks compensatory and
punitive damages, it contains no specific allegations of personal
physical injury or physical sickness.10
Neither the settlement agreement nor the complaint
establishes that the bank made any portion of the settlement
payment to petitioner on account of a personal physical injury or
physical sickness. The agreement and complaint only indicate
that the bank made the payment on account of civil rights
violations and for a general release from all of petitioner’s
claims.
10
The mere mention of “personal physical injury” in a
complaint does not, by itself, serve to exclude the recovery from
gross income under sec. 104(a)(2) because the “personal physical
injury” language could easily be included in every complaint,
even if such claim were only a “throwaway” claim. See
Kightlinger v. Commissioner, T.C. Memo. 1998-357.
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Petitioner nevertheless argues that the bank made the
settlement payment as a result of the alleged loss of his license
and that such loss is a personal physical injury under section
104(a)(2) so that the settlement proceeds are excludable in their
entirety. This argument, however, is unsupported by the record
in this case for several reasons. First, the agreement makes no
specific allocation of proceeds to the alleged loss of the
license. Second, although petitioner’s complaint alleges that
petitioner was falsely labeled a participant in a RICO scheme,
the complaint does not allege petitioner lost his license as a
result. Third, in March 1998, the Court of Appeals for the Ninth
Circuit found that petitioner had not proved that he had been
deprived of his license by the defendants, making it highly
unlikely that the bank would offer petitioner $500,000 for the
alleged loss of the license more than a year later.
Even if we assumed, for purposes of argument, that the bank
made the settlement payment on account of the alleged loss of
petitioner’s license, this fact would not support petitioner’s
argument. Petitioner’s interest in his license is a property
interest, and recovery for “business or property” is separate and
distinct from recovery for personal injury. Berg v. First State
Ins. Co., 915 F.2d 460, 464 (9th Cir. 1990); Mishler v. Nev.
State Bd. of Med. Examrs., 896 F.2d 408, 409-410 (9th Cir. 1990);
Rylewicz v. Beaton Servs., Ltd., 888 F.2d 1175, 1180 (7th Cir.
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1989); Kightlinger v. Commissioner, T.C. Memo. 1998-357 (citing
Genty v. Resolution Trust Corporation, 937 F.2d 899, 918 (3d Cir.
1991)).
3. Conclusion
The agreement did not allocate any part of the settlement
payment to any personal physical injury or physical sickness
involving petitioner, and the other evidence in the record does
not support such an allocation. Accordingly, we conclude that no
portion of the $500,000 settlement payment was compensation for a
personal physical injury or physical sickness and that petitioner
is not entitled to exclude the payment from gross income under
section 104(a)(2).
4. Petitioner’s Additional Arguments
a. Constitutionality of Section 104(a)(2)
Alternatively, petitioner contends that section 104(a)(2)
does not apply to his settlement proceeds because it is
unconstitutionally vague. Petitioner argues that the local
Taxpayer Advocate Service office’s inability to give a
“definitive answer” to his initial inquiry regarding the
applicability of section 104(a)(2) provides “prima facia evidence
that the IRS, the agency to enforce the statute, does not know
what is included or excluded as taxable or non-taxable income.”
Section 104(a)(2) provides that the amount of any damages,
other than punitive damages, received by suit or agreement “on
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account of personal physical injuries or physical sickness” is
excludable from gross income. The language of the statute is not
vague or ambiguous such that “men of common intelligence must
necessarily guess at its meaning”. Baggett v. Bullitt, 377 U.S.
360, 367 (1964); Connally v. Gen. Constr. Co., 269 U.S. 385, 391
(1926); see also Retired Teachers Legal Def. Fund, Inc. v.
Commissioner, 78 T.C. 280, 285 (1982). Moreover, the IRS
specifically offered petitioner a more formal opinion on the
taxability of his settlement, which petitioner refused, and
postamendment section 104(a)(2) has been applied in numerous
opinions with no mention of any concern about vagueness.11 See,
e.g., Ndirika v. Commissioner, T.C. Memo. 2004-250; Lindsey v.
Commissioner, T.C. Memo. 2004-113; Tamberella v. Commissioner,
T.C. Memo. 2004-47; Amos v. Commissioner, T.C. Memo. 2003-329;
Shaltz v. Commissioner, T.C. Memo. 2003-173. Although the
standard established in section 104(a)(2) may be difficult to
apply to particular factual circumstances, this fact does not
render the statute vague or ambiguous and does not persuade us to
11
When other constitutional challenges have been raised
against sec. 104(a)(2), the statute consistently has been upheld.
See, e.g., Polone v. Commissioner, T.C. Memo. 2003-339
(postamendment sec. 104 is not unconstitutionally retroactive);
Venable v. Commissioner, T.C. Memo. 2003-240 (postamendment sec.
104 is neither retroactive nor unconstitutional), affd. 110 Fed.
Appx. 421 (5th Cir. 2004); see also Young v. United States, 332
F.3d 893 (6th Cir. 2003) (the distinction in postamendment sec.
104(a)(2) between physical and nonphysical injury does not
violate the Equal Protection Clause of the Fifth Amend.).
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find section 104(a)(2) unconstitutional. See Cottrell v.
Commissioner, T.C. Memo. 1970-218.
b. Capital Investment
Petitioner argues that the settlement proceeds are “not only
for ‘personal physical injury’” but are also a nontaxable return
on capital because they are allocable to the loss of his license
as the source of his business and to the loss of goodwill he
generated in being known for his honesty and trustworthiness.
See, e.g., OKC Corp. & Subs. v. Commissioner, 82 T.C. 638, 650
(1984) (settlement proceeds may be received as a replacement for
capital destroyed or for the sale or exchange of a capital asset
so that they are treated as a nontaxable return of capital or a
taxable capital gain, respectively).
The record contains no credible evidence that the bank made
any portion of the settlement payment for petitioner’s alleged
loss of license or goodwill, and petitioner has otherwise failed
to show that the settlement proceeds, in whole or in part, are
attributable to the damage of any capital asset. Consequently,
we reject petitioner’s argument.
B. Attorney’s Fees and Costs
1. Commissioner v. Banks
In Commissioner v. Banks, 543 U.S. ___, 125 S. Ct. 826
(2005), the U.S. Supreme Court addressed whether the portion of a
money judgment or settlement paid to a plaintiff’s attorney under
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a contingent fee agreement was includable in the plaintiff’s
gross income. The Supreme Court held that a contingent fee
agreement between an attorney and a client should be viewed as an
anticipatory assignment to the attorney of a portion of the
client’s income from any litigation recovery12 and that, “as a
general rule, when a litigant’s recovery constitutes income, the
litigant’s income includes the portion of the recovery paid to
the attorney as a contingent fee.” Id. at ___, ___, 125 S. Ct.
at 829, 831. The Supreme Court’s holding is consistent with
prior opinions of this Court holding that the portion of a
recovery paid to an attorney as a contingent fee is includable in
the litigant’s income. See Kenseth v. Commissioner, 114 T.C. 399
(2000), affd. 259 F.3d 881 (7th Cir. 2001); O’Brien v.
Commissioner, 38 T.C. 707, 712 (1962), affd. per curiam 319 F.2d
532 (3d Cir. 1963).
2. The Parties’ Contentions
Petitioner argues that the portion of the settlement amount
used to pay his attorney’s fees is not includable in his gross
12
Under the anticipatory assignment of income doctrine, a
taxpayer cannot exclude an economic gain from gross income by
assigning the gain in advance to another party. Commissioner v.
Banks, 543 U.S. ___, ___, 125 S. Ct. 826, 831 (2005). The
rationale for this doctrine is that “gains should be taxed ‘to
those who earn them’, a maxim we have called ‘the first principle
of income taxation’”. Id. at ___, 125 S. Ct. at 831 (citations
omitted). In order to preserve this principle, when income is
anticipatorily assigned it is attributed to the taxpayer who
retains dominion over the income-generating asset. Id. at ___,
125 S. Ct. at 831-832.
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income because the nature of his relationship with the
defendants, the nature of his underlying claims, and the
retention of his attorney “for the sole purpose of culminating
the settlement agreement” distinguish his case from Commissioner
v. Banks, supra; and his relationship with his attorney
constituted a “de facto subchapter K partnership”.13 Respondent
contends that Banks is controlling and that the portion of the
settlement amount used to pay petitioner’s attorney’s fees must
be included in petitioner’s gross income. Respondent concedes
that petitioner may deduct the amount of the attorney’s fees as a
miscellaneous itemized deduction subject to the restrictions of
sections 67 and 68 and the alternative minimum tax provisions.
We agree with respondent.
13
Petitioner also contends that “If any tax is determined to
be due”, the filing fees, discovery fees, and supply costs he
allegedly incurred in pursuing his claims against the bank
“should be excluded as costs of producing the taxable income.”
We interpret this as petitioner’s argument that the fees and
costs are deductible as expenses paid or incurred for the
production of income under sec. 212(1). Deductions are strictly
a matter of legislative grace, and petitioner must show that his
deductions are allowed by the Internal Revenue Code. Rule
142(a); New Colonial Ice Co. v. Helvering, 292 U.S. 435, 440
(1934). Petitioner must also keep sufficient records to
substantiate any deductions otherwise allowed by the Internal
Revenue Code. Sec. 6001; see New Colonial Ice Co. v. Helvering,
supra at 440. Petitioner provided no evidence regarding any of
the alleged fees and costs other than his own vague testimony.
In the absence of corroborating evidence, we are not required to
accept petitioner’s self-serving testimony. See Tokarski v.
Commissioner, 87 T.C. 74, 77 (1986). Because petitioner has
failed to substantiate the fees and costs, he is not entitled to
deduct them.
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3. Analysis
In Commissioner v. Banks, supra, the Supreme Court
consolidated the cases of taxpayers John W. Banks II and Sigitas
J. Banaitis. Mr. Banks had retained an attorney on a contingent
fee basis and had filed a civil suit against his employer
alleging employment discrimination under Federal and State law.
Id. at ___, 125 S. Ct. at 829. Mr. Banaitis had retained an
attorney on a contingent fee basis and had filed a civil suit
against his employer alleging willful interference with his
employment contract and wrongful termination. Id. at ___, 125 S.
Ct. at 830. Both taxpayers settled their claims, and neither
taxpayer included the amount of settlement proceeds paid to his
attorney in his gross income. Id. at ___, 125 S. Ct. at 829-830.
The Commissioner issued to each taxpayer a notice of deficiency
in which the Commissioner determined that the amount paid to the
taxpayer’s attorney as a contingent fee was includable in the
taxpayer’s income, and each taxpayer contested the determination.
Id. Relying on the facts that the taxpayers retained control
over their legal claims (income-generating assets), diverted some
of the settlement amount to their attorneys through their
respective contingent fee agreements, and realized a consequent
benefit, the Supreme Court decided that each taxpayer must
include in his gross income the portion of the settlement amount
-23-
paid to his attorney under the contingent fee agreement. Id. at
___, ___, ___, 125 S. Ct. at 828-829, 832, 834.
In arriving at its decision, the Supreme Court rejected the
taxpayers’ argument that a contingent fee agreement establishes,
for tax purposes, a joint venture or partnership “in which the
client and attorney combine their respective assets--the client’s
claim and the attorney’s skill--and apportion any resulting
profits.” Id. at ___, 125 S. Ct. at 832-833. In rejecting this
argument, the Supreme Court reasoned that “regardless of the
variations in particular compensation agreements or the amount of
skill and effort the attorney contributes,” the relationship
between a client and his attorney is a “quintessential principal-
agent relationship” because the client retains ultimate dominion
and control over the underlying claim, and the attorney is
dutybound to act only in the interests of the client. Id. at
___, ___, 125 S. Ct. at 832, 833. The Supreme Court further held
that the client may not exclude litigation proceeds used to pay
attorney’s fees from his gross income, even when the attorney-
client contract or State law confers special rights or
protections on the attorney, including providing the attorney
with an “ownership interest” in his fees, so long as these
protections do not alter the fundamental principal-agent
character of the relationship. Id. at ___, 125 S. Ct. at 833.
The Supreme Court declined to address whether a contingent fee
-24-
agreement established a “Subchapter K partnership”, however,
because the “novel [proposition] of law with broad implications
for the tax system” was not advanced at an earlier stage of the
litigation. Commissioner v. Banks, 543 U.S. at ___, 125 S. Ct.
at 833.
a. Petitioner’s Argument That Banks Is
Distinguishable
In this case, petitioner hired an attorney to represent him
in the settlement of his legal claims against the defendants on a
contingent fee basis, received a settlement amount from the
defendants, failed to include the settlement amount, including
the portion paid to his attorney, in his gross income, and was
issued a notice of deficiency by respondent. This is precisely
the type of situation the Supreme Court considered in Banks. We
therefore reject petitioner’s contention that Banks is not
controlling because the type of facts on which he relies to
distinguish his case--the nature of his relationship with the
defendants and his underlying claims,14 and what he terms his
14
The Supreme Court did consider the fact that Mr. Banks
brought his legal claims under Federal statutes authorizing fee
awards to prevailing plaintiff’s attorneys due to Mr. Banks’
contention that the application of the anticipatory assignment of
income principle would be inconsistent with the purpose of
statutory fee-shifting provisions. Commissioner v. Banks, 543
U.S. at ___, 125 S. Ct. at 834. Because Mr. Banks ultimately
settled his claims and his attorney received his fee pursuant to
their contingent fee arrangement rather than a statutory fee-
shifting provision, however, the Supreme Court did not address
this contention. Id. Petitioner has not asserted a similar
(continued...)
-25-
“one event relationship” with his attorney--provide no meaningful
distinction from Banks.
b. Petitioner’s Subchapter K Partnership Argument
Petitioner also contends that the portion of the settlement
amount used to pay his attorney’s fees is not includable in his
gross income because a de facto subchapter K partnership existed
between petitioner and his attorney. Petitioner argues that he
combined his rights in his settlement recovery with his
attorney’s professional license, that “The gross income produced
by the partnership (settlement monies from the defendants) could
not have occurred without the partnership”, and that the
relationship between petitioner and his attorney “is analogous to
the horse owner and trainer in McDougal v. Commissioner, 62 T.C.
720 (1974) in which the court determined that a joint venture
resulted.” We reject petitioner’s attempt to avoid Federal
income taxation of the portion of the settlement amount he paid
to his attorney by labeling his relationship with his attorney a
subchapter K partnership.
14
(...continued)
contention in this case.
-26-
The substantive law governing the Federal income taxation of
partners and partnerships is found in subchapter K (sections 701
through 777) of the Code.15 See Rhone-Poulenc Surfactants &
Specialties, L.P. v. Commissioner, 114 T.C. 533, 539 (2000). An
entity that meets the definition of partnership provided by
section 761(a)--“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, and
which is not * * * a corporation or a trust or estate”--is thus
subject to the provisions of subchapter K.16 See sec. 1.761-1,
15
A joint venture or other contractual arrangement may
create a separate entity for Federal tax purposes if the
participants carry on a trade, business, financial operation, or
joint venture and divide the profits therefrom. Sec. 301.7701-
1(a)(2), Proced. & Admin. Regs. An eligible domestic business
entity with two or more members will be classified for Federal
tax purposes as a partnership unless it elects to be classified
as a corporation. See sec. 301.7701-2(a), Proced. & Admin. Regs.
(defining “business entity” as “any entity recognized for federal
tax purposes * * * that is not properly classified as a trust
under §301.7701-4 or otherwise subject to special treatment under
the Internal Revenue Code”); see also sec. 301.7701-3(a) and (b),
Proced. & Admin. Regs. Whether an organization is an entity
separate from its owners for Federal tax purposes is a matter of
Federal tax law and does not depend on whether the organization
is recognized as an entity under local law. Sec. 301.7701-
1(a)(1), Proced. & Admin. Regs.
16
Sec. 761(a) also provides that the members of an
unincorporated organization may elect to exclude such
organization from the application of all or part of subch. K if
it is availed of (1) for investment purposes only and not for the
active conduct of a business, (2) for the joint production,
extraction, or use of property, but not for the purpose of
selling services or property produced or extracted, or (3) by
dealers in securities for a short period for the purpose of
(continued...)
-27-
Income Tax Regs.; see also sec. 7701(a)(2) (providing the same
definition of “partnership” as section 761(a) for purposes of the
Code); secs. 301.7701-1, 301.7701-2, and 301.7701-3, Proced. &
Admin. Regs.
In order to determine whether a partnership exists for
Federal income tax purposes, and is thereby subject to the
provisions of subchapter K, the Court must consider whether, in
light of all the facts, the parties in good faith and acting with
a business purpose intended to join together in the present
conduct of an enterprise. Commissioner v. Culbertson, 337 U.S.
733, 743 (1949). Factors the Court may consider in making this
determination include the agreement, the conduct of the parties
in execution of its provisions, their statements, the testimony
of disinterested persons, the relationship of the parties, their
respective abilities and capital contributions, the actual
16
(...continued)
underwriting, selling, or distributing a particular issue of
securities, if the income of the members of the organization may
be adequately determined without computation of partnership
income. Such electing organizations are still considered
partnerships for purposes of the other sections of the Code,
however. Bryant v. Commissioner, 46 T.C. 848, 864 (1966) (“The
election under section 761(a) does not operate to change the
nature of the entity. * * * The partnership remains intact and
other sections of the Code are applicable as if no exclusion
existed.”), affd. 399 F.2d 800 (5th Cir. 1968). Subch. K,
therefore, governs the Federal income tax treatment of an entity
qualifying as a partnership under secs. 761(a) and 7701(a)(2),
and their accompanying regulations, unless it is an entity
specifically enumerated in sec. 761(a) that is eligible to elect
out of subch. K treatment and does so.
-28-
control of income and the purposes for which it is used, and any
other facts throwing light on their true intent. Id. at 742; see
also Luna v. Commissioner, 42 T.C. 1067, 1077-1078 (1964) (other
factors to consider include whether each party was a principal
and coproprietor, or whether one party was the agent or employee
of the other, receiving for his services contingent compensation
in the form of a percentage of income; whether the parties filed
Federal partnership returns or otherwise represented to
respondent or to persons with whom they dealt that they were
joint venturers; and whether the parties exercised mutual control
over and assumed mutual responsibilities for the enterprise).
The record in this case does not support petitioner’s
contention that a subchapter K partnership existed, for several
reasons. First, petitioner produced no evidence that he intended
to form a partnership with his attorney. The record contains
only an argument, made for the first time on brief, that a de
facto subchapter K partnership “existed” because of the
combination of his interest in his legal claims and his
attorney’s professional license. Second, contrary to the
position he advocated on brief, petitioner both testified at
trial and submitted to the Court as a stipulation of fact that he
“hired” his attorney “to represent him” in the settlement of his
legal claims and paid him for “services he rendered”,
demonstrating that petitioner did not view his attorney as a
-29-
coowner of his legal claims, but as a legal representative
receiving compensation for his services. See Kessler v.
Commissioner, T.C. Memo. 1982-432 (merely providing compensation
to an employee or independent contractor on a contingent fee
basis, as is common among attorneys, does not convert the
relationship to a partnership for Federal tax purposes); see also
Smith v. Commissioner, 33 T.C. 465, 487 (1959), affd. in part,
revd. in part and remanded on another issue 313 F.2d 724 (8th
Cir. 1963); Comtek Expositions, Inc. v. Commissioner, T.C. Memo.
2003-135, affd. 99 Fed. Appx. 343 (2d Cir. 2004). Third,
petitioner produced no evidence regarding whether the attorney
intended to form a partnership with him. It is well established
that the failure of a party to introduce evidence which, if true,
would be favorable to him, gives rise to the presumption that the
evidence would be unfavorable if produced. Wichita Terminal
Elevator Co. v. Commissioner, 6 T.C. 1158, 1165 (1946), affd. 162
F.2d 513 (10th Cir. 1947).
Furthermore, the record demonstrates that petitioner’s
reliance on McDougal v. Commissioner, 62 T.C. 720 (1974), is
misplaced. In McDougal, we determined whether the taxpayer’s
transfer of a one-half interest in a racehorse to a horse trainer
constituted a contribution to a partnership or joint venture
formed by the taxpayer and trainer. Id. The taxpayer had
purchased the horse on the trainer’s advice, and he promised the
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trainer a one-half interest in the animal once he had recovered
acquisition costs and expenses. Id. at 721. The taxpayer did
not make the promise in lieu of payment of the standard trainer’s
fee, however, and continued to compensate the trainer for the
services he provided in relation to the horse until the time of
the transfer. After the transfer, the taxpayer and the trainer
made joint decisions regarding the horse, created a partnership
agreement, agreed to share profits equally, computed what the
partnership’s tax return would show (although they did not file a
partnership return for the year in issue), and reported the
results of the computation on their individual returns. Id. at
722, 723. Because of the presence of all of these factors, we
found that the taxpayer and the trainer had formed a joint
venture. Id. at 725. McDougal, therefore, is distinguishable
from this case because there is no evidence petitioner and his
attorney agreed to form a partnership, shared control over
petitioner’s legal claims, considered their relationship a
separate entity for tax purposes or treated it as such, or
considered the attorney’s fees to be anything other than
compensation for services. Consequently, we reject petitioner’s
contention.
C. Conclusion
Because the Supreme Court’s opinion in Commissioner v.
Banks, 543 U.S. ___, 125 S. Ct. 826 (2005), is controlling, we
-31-
hold that the entire settlement amount, including the portion
petitioner paid to his attorney pursuant to a contingent fee
agreement, must be included in petitioner’s gross income. See
Helvering v. Horst, 311 U.S. 112 (1940); Lucas v. Earl, 281 U.S.
111 (1930). We have carefully considered all remaining arguments
made by the parties for results contrary to those expressed
herein and, to the extent not discussed above, conclude that
those arguments are without merit.
To reflect the foregoing,
Decision will be entered
under Rule 155.