KEVIN F . AND ANN M . HENNESSEY, Petitioners v .

T .C . Memo . 200 9

UNITED STATES TA X

KEVIN F . AND ANN M . HENNESSEY, Petitioners v .

COMMISSIONER OF INTERNAL REVENUE, Responden t

Docket No . 20484-07 .

Kevin F . and Ann M . Hennessey,

pr sese .

Michael W . Bitner , for respondent .

MEMORANDUM OPII O N

MARVEL,

Judge : Respondent determined an $8,688 deficiency

in petitioners' 2004 Federal income ta~ . Petitioners filed a

timely petition contesting respondent' determination . The issue

for decision is whether $27,9001 Mr . Hennessey received in 2 00 4

'Kevin F . Hennessey (Mr . Hennesse~) received $30,000

(continued . . .)

2 pursuant to a class action settlement agreement is excludable

,from gross income under section 104(a)(2)•2 We hold it is not .

Background

The parties submitted this case fully stipulated under Rule

122 . We incorporate the stipulated facts into our findings by

this"reference . Petitioners resided in Missouri when they filed

their petition .

Before 1993 Mr . Hennessey was a commissioned officer serving

active duty with the U .S . Air Force . In 1992, because o f

,congressionally mandated personnel reductions in the Arme d

I!

FForces,

the Secretary of the U .S . . Air Force established th e

!Fiscal Year 1993 Reduction-in-Force Board (Board) . The purpose

of the Board was to select U .S . Air Force officers for

involuntary separation .

The Secretary of the U .S . .Air Force issued a memorandum of

instruction (memorandum) that provided guidance on screenin g

1 ( . • . continued )

pursuant to a class action settlement agreement, $2,100 of which

represented attorney's fees, costs, and expenses . In the notice

of deficiency respondent stated that petitioners reported $2,100

of the $30,000 payment and allowed a deduction for this lega l

' ;expense . Although in his brief respondent states that it was

!I questionable whether petitioners were entitled to the $2,100

,deduction, he doe's not assert an increased deficiency . Other .

!adjustments proposed in the notice of deficiency are .

;,computational .

2Unless otherwise indicated, all section references are-to

,the Internal Revenue Code, and all Rule references are to the Tax

h Court Rules of Practice and Procedure .

3 officers for involuntary separation . Paragraph 7_of the

memorandum stated that the Board's "evaluation of minority and

women officers must clearly afford them fair and equitabl e

consideration ." The memorandum also s tated that in co n'side'ring

women and minority officers, the Boar d should be sensitive to th e

fact that such officers might have-be e n disadvantaged from a .

career perspective because of past inddividual and societall

attitudes,-policies, and practices .

I t allowed the Boardt o

of

consider these factors in ensuring that t minority and femal e

officers received fair and equitable

t reatment .

In 1993, pursuant to the Board's recommendation ,

Hennessey was removed from active duty status with the U .SIIAi r

Force and transferred to the U .S . Air Force Reserve .

reviewing records the Board considered the memorandum regarding

I

.selection rates for minority and female officers .

Mr . . Hennesse y

is now a commissioned officer in the U .S . Air Force Reserve

On or . about December 28, 1998, M

Hennessey and :oth e

officers whom the Board selected for i nvoluntary separatio n file d

a complaint in the U .S . Court of Fede ial Claims-in the case o f

Berkley v .- United States , case N

98- 943C . The plaintiffs

claimed that the Board violated their equal protection right s

under the Fifth Amendment to the

U .S .

Constitution because l', t

improperly considered race and gender in selecting officer s fo r

involuntary separation . The court ce tified plaintiffs as a

i

4

-

4

(.class under rule 23 of the Rules of the United States Court of

Federal Claims . See Berkley v . United States , 45 Fed .

Cl .

224,

1.235 (1999) .

The class action case was settled,3 and each member of the

ti~class had an option of (1) receiving a $30,000 lump-sum payment

less attorney's fees,costs, and expenses of $2,100 or (2 )

requesting another retention review . Mr . Hennessey received the

lump-;sum payment in October 2004 . . The lump-sum payment-was not

compensation for physical injuries or,physical sickness that Mr .

Hennessey might have suffered as a consequence of any action s

taken by employees oft the U .S . Air Force .

Petitioners jointly filed their 2004 return . On their 200 4

return petitioners did not include in income . the $30,000 lump-su m

,payment ..

Discussion

The Commissioner's determinations generally are presume d

correct, and the taxpayer bears the burden of proving thos e

,determinations are erroneous . Rule 142(a) ;

Welch v . Helvering ,

3The Court of Federal Claims first issued a decision i n

favor of the Government . See Berkley v . United States, 48 Fed .

1 C1 . 361, 379 (2000), revd . 287 F .3d 1076 (Fed . Cir . 2002) .

Afte r

the Court of Appeal s fo r the Federal Circuit reverse d th e

Judgment and remanded the case to the Court of Federal Claims for

',furthe'r proceedings, see Berkley v . United States , 287 F .3d

107 6

,',(Fed . Cir . 2002), the parties entered into settlement

negotiations . The'settlement agreement is not part of the

record, but the parties stipulated the opinion of the Court of

Federal 'Claims, see Berkley v . United States, 59 Fed . Cl . 675

~I(2004), approving the settlement agreement .

- 5 290 U .S . 111, 115 (1933) . Petitioners do not contend tha t

section 7491 (a) -(1•) which shifts the b rden of proof to th e

I

Commissioner if the requirements of section 7491(a)(2)`are

met ,

applies . Moreover, because this case is fully stipulated,'lthere

are no disputed issues of fact that wo ld be affected by a r

allocation of the burden of proof under section 7491(a) .

I

Section 61(a) includes in,gross income "all income fro m

whatever source derived" unless exclud d by a specifics. provision

of the Code . This section is construe broadly, whereas

exclusions from gross income are construed narrowly .

Commissioner v . Schleier , 515 U .S . 323

327-328

States v . Burke , 504 U .S . 229, 233 (1 9 92) ;

( 1995 )

Commissioner v .

Glenshaw Glass Co . , 348 U .S . 426, 43 0

(1955) .

excludes from gross income "the amount

of any damages

punitive damages )

received

United

Section 104 :(a) (2)

( ot h

tha n

(whether b y

whether as lump sums .or as periodic p

personal physical injuries or physical sickness "

In Commissioner v . Schleier ,

supra at 337, the SupremelCour t

stated that to be eligible for the section 104 (a ) (2) exclusion,

taxpayer must demonstrate that (1) the underlying cause of,,

a

action

giving rise to the recovery is based i tort or tort type 'rights

and (2) the damages were received on account of personal inurie s

or sickness . After the Supreme Court issued its opinion in

Schleier , Congress amended section 1041(a)(2) (amendment),

I

- 6 -

effective for amounts,, received after August 20, 1996, by adding a

!requirement that in order to be excluded from gross income, any .

amount received must be on account of :;personal injuries that ar e

,Iphysical or sickness that is physical .4 See Small Business Job

Protection Act of 1996, Pub . L . .104-188, sec . 1605, 110~Stat .

1838 . Accordingly, the amendment imposed an additional .

(requirement of physical . injury or sickness to the test under

F Commissioner v . Schleier ,

supra at 337 . Where damages are-

received pursuant to a settlement agreement , the nature, of th e

,claim that was the basis for the settlement determines whether

the damages are excludable . under section 104(a)(2) .

, States v . Burke ,

United

supra at 237 .

Petitioners stipulated that the lump-sum payment Mr .

11

-

Hennessey received was not compensation for physical injuries o r

physical sickness . Accordingly, under section 104(a)(2)

petitioners may not exclude the lump-sum payment from gross

income . However, petitioners raise several constitutional

objections to section 104 (a) (2) .

Petitioners contend that the lump-sum payment is not income

because there was no accession to wealth and, accordingly, no

gain within the meaning of section 61(a) . Rather, they, argue ,

4Preamendment personal injuries or sickness included

"nonphysical injuries to the individual, such as those affecting

emotions, reputation, or character" .

United States v . Burke , 504

U .S . 229, 236 n .6 (1992) .

6

the payment was intended to•makeMr . H nnessey "whole" ;for hi s

losses, which, in addition to the loss of wages, consisted

of

lost promotional opportunities, lost military pension,'~dama4et o

reputation, and stigma of involuntary separation . A'simil a

argument was raised by the taxpayer in- Murphy v . IRS ,'493F .3 d

170, 176-177 (D .C . Cir .' 2007) .5 The Court of Appeals for th e

District of Columbia Circuit held-that taxation of award s

received for personal, nonphysical injuries was within the

of Congress .

Id .

at 173, : 186 . We!agree with the Court

Appeals, and we reject petitioners', a gument .

Petitioners also argue . that section 104(a)(2) violates th e

Equal Protection Clause of the 14th Amendment as applicabl 16 t o

the Federal Government` through the-Duel Process Clause

;of- t h

Fifth Amendment under Bolling v . Sharpe, . 347 U .S . 497,'50 0

(1954) . . Petitioners argue that the Code-treats taxpayers wh o

receive compensatory damages as a res It of physical injurie s

differently from those who suffer and are paid for nonphys i c al

injuries, with no rational basis for such a distinction . I h

Young v . United States , 332 F . 3d 893, 895-896 (6th Cir . ' 20 0 3

'The Court of Appeals for the Dis riot of Columbia Circuit

first agreed with the taxpayer and held that compensation for

mental distress and loss of reputatio wasnot income withi th e

meaning of the 16th Amendment . Murph v . IRS, 460 F .3 ;d 79 (D .C .

Cir . 2006) . However, the Court of Appeals then vacated it s

decision, Murphy v . IRS , 99 AFTR 2d 2 07-39,6, 2007-1 USTC par . .

50,228 (D .C . Cir . 2006), and heard ad itional arguments befor e

1, 493

-ion, Murphy v .

F .3d 170 (D .C . Cir . 2007) .

t

- 8 the Court of Appeals for the Sixth Circuit reviewed a similar

challenge to section 104(a)(2) on the ground of violation of

equalpr .otection and held the statute ; constitutional . We agre e

with the Court of Appeals, and we .reject petitioners' argument .

Petitioners also argue that taxation of the lump-sum paymen t

violates the Due Process and Takings Clauses of the Fift h

Amendment to the U .S . .Constitution . According to petitioners,

sunder Missouri State law reputational ;damage is damage to

!property and Mr . Henn'essey's property interest in his employmen t

and reputation would not have-been taxable in the absence of the

Board'.,s discriminatory actions . Petitioners contend that taxing

such previously untaxable property interest amounts to an unjust

taking of petitioners' property and forced conversion of their

assets,for the public use .

u

This, constitutional challenge has no merit . Generally, th e

Fifth Amendment is not a limitation upon Congress's taxing power .

.,jSee Regan v . Taxation With Representation , 461 U .S . 540 (1983) ;

A . Magnano Co . v . Hamilton , 292 U .S . 40, 44 (1934) ;

Brushaber v .

Union Pac . R .R . Co . , 240 U .S . 1, 24 (1916) . The Constitution

,simply does not conflict with itself by conferring upon Congress

on the one hand the "power to lay and'collect taxes on incomes",

it

1 U .S .!,Const . amend . XVI, while taking away this power under the

Due Process Clause of :the Fifth Amendment,

Brushaber v .'Union

N

:Pac . R .R . Co . , .'4 u

supra

at 24 . In some limited circumstances a tax

- 9 may be so arbitrary and capricious tha it is not a permissible

I

exercise of the power to tax but rather a . constitutionally !

impermissible taking . See id .

Section 104(a)(2), however,, i s

not arbitrary and capricious . Congres 's purpose in enacting

H

section 104(a)(2) was to clarify the lw and decrease litigatio

n

for cases that do not involve physical injury or physical

sickness . H . Conf . Rept . 104-737, at 300-301 (1996), 1996741, 1040-1041 ; H . Rept . .104-586, at 12-143 (1996), 1996-

C .B .

C .B .

339, 480-481 . Section 104(a)(2) reflects a reasonable exercise

of Congress's power to tax, and it does not violate the Fift h

Amendment . Accordingly, petitioners' challenge to section

104(a)(2) under the Fifth Amendment fa' ls .

For reasons discussed above, we hold that the $27,90 0

payment Mr . Hennessey received in 200 4

is not . excludable fro m

income :<under section 104(a)(2) .

We have considered the parties' remaining arguments and to

the extent not discussed above, conclude those arguments a r

irrelevant, moot, or without merit .

To reflect the foregoing,

Dec ision will be entered for

responde