Fabry v. Comm'r of Internal Revenue

• Decision Date: 16 December 1998
• Docket Number: No. 9126–96.,9126–96.
• Citation: 111 T.C. 305,111 T.C. No. 17
• Parties: Carl J. FABRY and Patricia P. Fabry, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent.
• Court: U.S. Tax Court

111 T.C. 305

111 T.C. No. 17

Carl J. FABRY and Patricia P. Fabry, Petitioners

v.COMMISSIONER OF INTERNAL REVENUE, Respondent.

No. 9126–96.

United States Tax Court.

Dec. 16, 1998.

Robert S. MacDonald and Brian J. Moran, for petitioners.

Stephen R. Takeuchi, for respondent.

OPINION

HALPERN, Judge:I. Introduction

By notice of deficiency dated February 14, 1996, respondent determined a deficiency in petitioners' 1992 Federal income tax of $201,054 and an accuracy-related penalty of $40,211.

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.

After concessions, the sole issue for decision is whether $500,000 received by petitioners in settlement of a lawsuit alleging injury to business reputation is excludable from petitioners' gross income under section 104(a)(2) as damages received on account of personal injuries.¹

Certain facts have been stipulated. The stipulation of facts filed by the parties, with attached exhibits, is incorporated herein by this reference. We have need to find few facts in addition to those stipulated and, accordingly, shall not separately set forth those findings. We include our additional findings of fact in the discussion that follows. Petitioners bear the burden.of proof. Rule 142(a).

II. BackgroundA. Residence

Petitioners resided in Orlando, Florida, at the time the petition was filed.

B. Patsy's Nursery; Petitioners' Reputations

In 1976, petitioners started a business known as Patsy's Nursery, an unincorporated proprietorship located in Orange County, Florida. In their nursery, petitioners grew Hoya Carnosa (Hoyas), ornamental plants commonly known as wax plants, and citrus trees.

Petitioner Patricia P. Fabry.quickly developed a reputation for growing quality plants and, because of the high quality and vivid color of her Hoyas, became known as the “Hoya Lady”. Petitioner Carl J. Fabry also enjoyed a good reputation in the agricultural field. C. Benlate Damage

In connection with the,operation of Patsy's Nursery, petitioners used a fungicide, Benlate, manufactured by E.I. du Pont de Nemours and Co. (du Pont). From 1988 to 1991, petitioners suffered extensive damage to their stock of plants, which they claim was a result of their use of Benlate.

D. The Lawsuit

In 1991, on account of the claimed Benlate damage, petitioners began a lawsuit against du Pont in the Circuit Court of the Ninth Judicial Circuit in and for Orange County, Florida (the lawsuit). Petitioners averred that du Pont had allowed the Benlate used by petitioners to become contaminated so as to cause the damage in question. Petitioners demanded a judgment for monetary damages from du Pont under theories of strict liability in tort and negligence. Under both theories, petitioners claimed: “[T]he Fabrys have sustained damages in the form of the lost value of destroyed or injured plants, damage to their business reputation, lost income and lost value for their business, the amount of which exceeds $10,000.” Du Pont answered the lawsuit, denying knowledge or information sufficient to form a belief as to the truth of many of petitioners' allegations and asserting affirmative defenses.

After mediation, the lawsuit was concluded pursuant to a stipulation of the parties, under which, among other things, du Pont agreed to pay to petitioners the sum of $3,800;000. Petitioners executed a general release and received the stipulated payment. Five hundred thousand dollars of the stipulated payment (the $500,000 payment) is allocable to business reputation damages.

E. Income Tax Return

In reporting the proceeds of the lawsuit in their 1992 Federal income tax return, petitioners excluded the $500,000 payment. III. DiscussionA. Introduction

Petitioners brought the lawsuit against du Pont, claiming tortious injury to petitioners' nursery business as the result of their use of an agricultural chemical (Benlate) manufactured by du Pont. Petitioners received $3,800,000 from du Pont in settlement of the lawsuit, of which $500,000 is allocable to damages on account of petitioners' claim of injury to their business reputation (the $500,000 payment). We must decide whether petitioners properly excluded the $500,000 payment from gross income.

Petitioners bear the burden of proof. Rule 142(a).

B. General Rules

Section 61(a) provides that, except as otherwise provided, “gross income” means “all income from whatever source derived”. Sec. 61(a). With an exception not here relevant, section 104(a)(2) provides that “the amount of any damages received (whether by suit or agreement * * * ) on account of personal injuries or sickness” is excludable from gross income. The regulations promulgated under section 104(a)(2) provide: “The term ‘damages received (whether by suit or agreement)’ means an amount received (other than workmen's compensation) through prosecution of a legal suit or action based upon tort or tort type rights, or through a settlement agreement entered into in lieu of such prosecution.” Sec. 1.104–1(c), Income Tax Regs. To determine whether any payment received in settlement of a lawsuit is excludable under section 104(a)(2), we consider the nature of the claim that was the basis for the settlement, not the validity of the claim. E.g., Metzger v. Commissioner, 88 T.C. 834, 847 (1987), affd. without published opinion 845 F.2d 1013 (1988). “If the settlement agreement lacks express language stating that the payment was (or was not) made on account of personal injury, then the most important fact in determining how section 104(a)(2) is to be applied is the intent of the payor' as to the purpose in making the payment.” Id. at 847–848 (citing Knuckles v. Commissioner, 349 F.2d. 610, 613 (10th Cir.1965), affg. T.C. Memo.1964–33).

Neither the text nor the legislative history of section 104(a)(2) offers any explanation of the term “personal injuries”.² Both the courts and the Commissioner long have recognized, however, that the section 104(a)(2) reference to “personal injuries” is not restricted to physical injuries but encompasses nonphysical injuries to the individual, as well, such as those affecting emotions, reputation, or character. See United States v. Burke, 504 U.S. 229, 235 n. 6 (1992). For instance, we have on occasion found that damages received on account of damage to a taxpayer's business reputation were excludable damages received on account of personal injury. E.g., Threlkeld v, Commissioner, 87 T.C. 1294, 1308 (1986) (based on the nature of an action for malicious prosecution as an action for personal injuries under Tennessee law, settlement payment allocable to injury to professional reputation excludable from gross income under section 104(a) (2)), affd. 848 F.2d 81 (6th Cir.1988). Nevertheless, as the Supreme Court recently made clear in Commissioner v. Schleier, 515 U.S. 323, 329–330 (1995), although it is necessary condition of exclusion under section 104(a): (2) that the damages (or settlement amount) in question be received on account of the prosecution (or settlement) of a suit or action based on tort or tort type rights, that is not a sufficient condition for exclusion under section 104(a)(2). The damages or settlement must be received both on account of a violation of tort or torts type rights and for personal injuries or sickness. Id. at 330. The parties here disagree as to whether the $500,000 payment was received on account of personal injuries.

C. Arguments of the parties

The arguments of the parties are straightforward. Respondent, while conceding that the $500,000 payment was received in settlement of a claim for tortious injury to business reputation, argues that it was not received on account of a personal injury. Petitioners argue that injury to business reputation is, as a matter of law, a personal injury. D. Discussion1. Nature of the Inquiry

We do not agree with petitioners that injury to business reputation is, as a matter of law, a personal injury. In Threlkeld v. Commissioner, supra, we decided not to follow our decision in Roemer v. Commissioner, 79 T.C. 398 (1982), revd. 716 F.2d 693 (9th Cir.1983), in which we distinguished between injury to personal reputation and injury to business reputation and held that damages awarded on account of defamation resulting in injury to business reputation did not give rise to damages received on account of personal injuries within the meaning of section 104(a)(2). We did not, in Threlkeld, adopt a per se rule that damages received on account of injury to an individual's business reputation are excludable under section 104(a)(2). We described the necessary determination as presenting a question of fact. Threlkeld v. Commissioner, supra at 1305. We said that the determination depended on the nature of the claim presented, and we looked to all the facts and circumstances of the case, including the State law characterization of the claim in question (a claim for malicious prosecution) to determine the nature of that claim. Id. at 1307–1308. We found that an action for malicious prosecution is similar to an action for defamation and concluded that it would be classified as an action for personal injuries under Tennessee law. Id. at 1307. We concluded that the payment received for the release of the taxpayer's claims against the defendant for damage to the taxpayer's professional reputation was excludable under section 104(a)(2).

Petitioners direct our attention to two recent memorandum opinions, Knevelbaard v. Commissioner, T.C. Memo.1997–330, and Noel v. Commissioner, T.C. Memo.1997–113, for the proposition that “business reputation damages arising in tort actions are excludable under [section 104(a)(2) ]”. Petitioners state: “No special causation analysis was utilized in the Noel and Knevelbaard decisions nor was one necessary.” In the Noel case, the taxpayer had sued PepsiCo, Inc. (PepsiCo), claiming both breach of...