Horton v. C.I.R.

• Decision Date: 29 August 1994
• Docket Number: No. 93-1928,93-1928
• Citation: 33 F.3d 625
• Parties: -5934, 63 USLW 2142, 94-2 USTC P 50,440 Ernest and Mary C. HORTON, Petitioners-Appellees, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellant.
• Court: U.S. Court of Appeals — Sixth Circuit

Page 625

33 F.3d 625

74 A.F.T.R.2d 94-5934, 63 USLW 2142,

94-2 USTC P 50,440

Ernest and Mary C. HORTON, Petitioners-Appellees, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellant.

No. 93-1928.

United States Court of Appeals, Sixth Circuit.

Argued June 14, 1994.

Decided Aug. 29, 1994.

Thomas J. Utaski (briefed), Cincinnati, OH, Ljubomir Nacev (argued and briefed), Ft. Thomas, KY, for petitioners-appellees.

David L. Jordan, I.R.S., Office of Chief Counsel, Michael L. Paup, Kenneth L. Greene, Edward T. Perelmuter (argued), Gary R. Allen, Acting Chief (briefed), U.S. Dept. of Justice, Appellate Section Tax Div., Washington, DC, for respondent-appellant.

Before: KENNEDY and SILER, Circuit Judges; and BROWN, Senior Circuit Judge.

BAILEY BROWN, Senior Circuit Judge, delivered the opinion of the court, in which SILER, Circuit Judge, joined. KENNEDY, Circuit Judge (pp. 632-33), delivered a separate dissenting opinion.

BAILEY BROWN, Senior Circuit Judge.

Appellant Commissioner of Internal Revenue ("the Commissioner") appeals from a Tax Court decision in favor of Appellees Ernest and Mary C. Horton ("the Hortons" or "the Taxpayers") which held that the Hortons were entitled to exclude from their gross income punitive damages received in 1985 under pre-revision section 104(a)(2) of the Internal Revenue Code. ¹ We conclude that the Tax Court did not err and therefore affirm.

I.

The Tax Court summarized the facts of the case, to which the parties stipulated, as follows:

Petitioners resided in Florence, Kentucky, when they filed their petition in this case.

On December 1, 1981, a Boone County [Kentucky] circuit court jury found Union Light, Heat and Power Co. (Union) liable for failing to detect a gas leak in petitioners' residence. This leak resulted in an explosion and resulting fire that destroyed petitioners' residence causing them personal injury.

The jury found that petitioner Ernest Horton was entitled to compensatory damages in the amount of $62,265 and also awarded punitive damages in the amount of $100,000. The jury found that petitioner Mary C. Horton was entitled to compensatory damages in the amount of $41,287 and also awarded punitive damages in the amount of $400,000. The punitive damages awards were based on a finding of gross negligence on the part of Union.

Upon entry of the judgment, Union paid the compensatory damages and appealed the issue of punitive damages to the Kentucky Court of Appeals, which reversed the circuit court on that issue. Petitioners appealed the reversal to the Kentucky Supreme Court. On April 11, 1985, that court reversed the court of appeals and reinstated the punitive damage awards. See Horton v. Union Light, Heat & Power Co., 690 S.W.2d 382 (Ky.1985). During 1985, Union paid $100,000 in punitive damages to petitioner Ernest Horton, and $400,000 in punitive damages to petitioner Mary C. Horton.

Petitioners excluded the punitive damage amounts from income on their 1985 Federal income tax return. Respondent determined that petitioners should have included these amounts in income, and therefore determined a deficiency. Petitioners timely filed a petition with this Court seeking a redetermination of that deficiency.

Horton v. Commissioner, 100 T.C. 93, 93-94, 1993 WL 28557 (1993).

The Tax Court, with sixteen judges concurring and three dissenting, held that the Hortons had properly excluded the punitive damages awards from their 1985 gross income, stating:

[P]unitive damages received as a result of a personal injury claim are excludable under section 104(a)(2). The beginning and end of the inquiry should be whether the damages were paid on account of "personal injuries." This inquiry is answered by determining the nature of the underlying claim. 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.

Id. at 96 (footnote omitted).

II.

We address only one issue in this case: whether the Tax Court erred in holding that punitive damages received by taxpayers in state court litigation, where the taxpayers also received compensatory damages for personal injuries, are excludable from gross income under pre-revision Internal Revenue Code section 104(a)(2) as "damages received ... on account of personal injuries." ²

III.

The Commissioner first argues that the punitive damages were not excludable because they were not awarded "on account of" the taxpayers' personal injuries within the meaning of section 104(a)(2), but instead were received "on account of" the utility's gross negligence; punitive damages are recoverable in Kentucky only if defendant's conduct is grossly negligent. Second, the Commissioner asserts that including punitive damages in gross income comports with the underlying purpose of the statute, which is to exclude those damages which make a taxpayer "whole" from a loss of personal rights, but to include mere accessions to wealth. The Commissioner notes that the other subsections of section 104 exclude only payments that compensate for injury or sickness. Third, the Commissioner urges us to follow the Federal Circuit's decision in Reese v. United States, 24 F.3d 228 (Fed. Cir.1994), aff'g 28 Fed.Cl. 702 (1993), the Fourth Circuit's opinion in Commissioner v. Miller, 914 F.2d 586 (4th Cir.1990), rev'g 93 T.C. 330, 1989 WL 104238 (1989), and the Ninth Circuit's opinion in Hawkins v. United States, 30 F.3d 1077 (9th Cir.1994) (2-1 decision), ³ discussed infra, each of which holds that punitive damages are includable in gross income. Fourth, the Commissioner contends that the Supreme Court's decision in United States v. Burke, --- U.S. ----, 112 S.Ct. 1867, 119 L.Ed.2d 34 (1992), infra, is distinguishable as it did not focus on punitive damages, and did not interpret the phrase "on account of" in the statute. Fifth, the Commissioner suggests that punitive damages in Kentucky, and in general, serve no compensatory purpose, but rather are accessions to wealth.

Citing the opinion of the Supreme Court of Kentucky in this very matter, the Taxpayers respond that under Kentucky law, punitive damages in part serve a compensatory function, and therefore, if serving such function were necessary to exclusion from gross income, such damages are excludable as damages received on account of personal injuries. Even if the damages are considered noncompensatory, according to the Taxpayers, they should still be excluded under a literal reading of the statute, particularly in the light of Burke, as would be any damages received in a tort claim for personal injuries. Finally, the Taxpayers cite the 1989 amendment of the statute, ⁴ which they contend, by expressly providing that punitive damages are to be included in gross income when recovered in a case "not involving physical injury," strongly implies that punitive damages recovered in a personal injury case have been and continue to be excludable.

IV.

We review the Tax Court's conclusions of law de novo, and the Tax Court's findings of fact for clear error. North American Rayon Corp. v. Commissioner, 12 F.3d 583, 586 (6th Cir.1993). The parties have stipulated to all of the facts in this case, and thus we proceed to address the legal issue, one of first impression in this circuit. We proceed knowing that "[a] consensus on this issue within the federal judiciary is nonexistent." Estate of Wesson v. United States, 843 F.Supp. 1119, 1121 (S.D. Miss.1994). ⁵

Taxpayers must generally include in their gross income "all income from whatever source derived." 26 U.S.C. Sec. 61(a). Exclusions from gross income are generally construed narrowly. United States v. Centennial Sav. Bank FSB, 499 U.S. 573, 583, 111 S.Ct. 1512, 1518-19, 113 L.Ed.2d 608 (1991); Weingarden v. Commissioner, 825 F.2d 1027, 1029 (6th Cir.1987). However, section 104, entitled "Compensation for injuries or sickness," excludes from gross income "the amount of any damages received ... on account of personal injuries or sickness[.]" 26 U.S.C. Sec. 104(a)(2). The burden is on the taxpayer to show that an exclusion applies under the Internal Revenue Code. Burke v. United States, 929 F.2d 1119, 1121 (6th Cir.1991), rev'd on other grounds, --- U.S. ----, 112 S.Ct. 1867, 119 L.Ed.2d 34 (1992).

Three circuits have addressed the issue at hand, two very recently. The Federal Circuit has held that "punitive damages received in settlement of civil litigation are not excludable from a taxpayer's 'gross income' " under pre-revision section 104(a)(2). Reese, 24 F.3d at 229. The court first noted that the language "on account of" in section 104(a)(2) is ambiguous, mandating an examination of the design, object, and policy of the whole statute. Id. at 230-31. Entitled "Compensation for injuries or sickness," section 104's other subsections--which exclude workers' compensation payments, accident or health insurance payments, certain pension or annuity payments, and certain disability payments--"encompass only the replacement of losses resulting from injury or sickness," according to the court. Id. at 231. The court next cited as support the principle that "all realized accessions to wealth are presumed to be taxable income, unless a taxpayer can demonstrate that an acquisition is specifically exempted." Id. In addition, the Federal Circuit panel found that the legislative history of section 104 supported its holding that punitive damages are not excludable from gross income. Id. at 232-33. The panel also believed that the Supreme Court's opinion in Burke, upon which we rely in part, was not "even relevant" because it did not involve punitive damages. Id. at 234.

The Fourth Circuit has determined "that punitive damages [received as settlement proceeds] in a Maryland defamation action do not fall within Sec. 104(a)(2), and they are, therefore, included in [the taxpayer's] gross income." Miller, 914 F.2d at 590. Examining Maryland law, the court agreed that a...