87 F.3d 682 (5th Cir. 1996), 95-40289, Dotson v. United States

Docket Nº:95-40289.
Citation:87 F.3d 682
Party Name:Elton E. DOTSON and Alrethia Dotson, Plaintiffs-Appellants, v. UNITED STATES of America, Defendant-Appellee.
Case Date:June 27, 1996
Court:United States Courts of Appeals, Court of Appeals for the Fifth Circuit

Page 682

87 F.3d 682 (5th Cir. 1996)

Elton E. DOTSON and Alrethia Dotson, Plaintiffs-Appellants,


UNITED STATES of America, Defendant-Appellee.

No. 95-40289.

United States Court of Appeals, Fifth Circuit

June 27, 1996

Page 683

        Stephen L. Hester, Washington, DC, K. Peter Schmidt, Arnold & Porter, Washington, DC, Roslyn M. Litman, Litman, Litman, Harris and Brown, Pittsburg, PA, John G. Jacobs, Plotkin and Jacobs, Chicago, IL, for Plaintiffs-Appellants.

        Gregory Scott Garland, Dallas, TX, Michael D. Powell, U.S. Department of Justice, Tax Division, Dallas, TX, Kenneth W. Rosenberg, Gary R. Allen, U.S. Department of Justice, Tax Division, Appellate Section, Washington, DC, for Defendant-Appellee.

        Appeal from the United States District Court for the Southern District of Texas.

        Before: GARWOOD, SMITH and DENNIS, Circuit Judges.

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        DENNIS, Circuit Judge:

        The Dotsons brought this action seeking a refund from income and wage taxes paid on a class action settlement award. They appeal the denial of their motion for summary judgment and the grant of the United States' cross-motion for summary judgment. The district court held that damages received pursuant to § 502(a) and § 510 of the Employee Retirement Income Security Act (29 U.S.C. § 1132(a) and § 1140) do not meet the "personal injury" exclusion from income under § 104(a)(2) of the Internal Revenue Code (26 U.S.C. § 104(a)(2)). While the Special Master and the parties to the 1990 settlement clearly intended a tort-like compensatory remedy, which appeared to be available under reasonable interpretations of extant jurisprudence, later judicial decisions interpreting ERISA have cast doubt on the availability of such excludable compensatory remedies. This appeal raises the question of whether subsequent legal decisions more narrowly interpreting the availability of personal injury damages as statutory remedies affect the classification for tax purposes of a good faith, arm's length settlement based upon the reasonable potential for recovery of such damages under the then extant jurisprudence. The district court held that they do. We reverse.

        The case arises out of a settlement made in a consolidated class action lawsuit brought against Continental Can Company (Continental). Two separate classes of plaintiffs brought actions against Continental for violation of § 510 of ERISA, which makes provides that:

It shall be unlawful for any person to discharge, fine, suspend, expel, discipline, or discriminate against a participant or beneficiary for exercising any right to which he is entitled under the provisions of an employe benefit plan ... or for the purpose of interfering with the attainment of any right to which such participant may become entitled under the plan ...

        29 U.S.C. § 1140. Plaintiffs claimed that defendants, through the implementation of a nation-wide scheme to avoid pension liabilities, prevented them from obtaining benefits under the pension plan in violation of § 510. Gavalik v. Continental Can Co., 812 F.2d 834, 838 (3rd Cir.), cert. denied, 484 U.S. 979, 108 S.Ct. 495, 98 L.Ed.2d 492 (1987); see also, McLendon v. Continental Group, Inc., 749 F.Supp. 582, 583 (D.N.J.1989). After two bifurcated trials, Continental was found liable for violating § 510. See Gavalik, supra (reversing trial court judgment for Continental); McLendon, supra.

        In order to litigate the remaining issue of damages, the Gavalik case was consolidated with the second case under the name McLendon. McLendon v. Continental Group, Inc., 802 F.Supp. 1216 (D.N.J.1992). The New Jersey district court appointed Yale Law Professor George Priest as Special Master in order to help the court fashion an appropriate remedy.

        In December of 1990 the parties settled for $415 million to be distributed to the consolidated class by the Special Master. The court approved the settlement and Professor Priest's Plan for Distribution. The Dotsons received $89,754, of which $19,877 went directly to a qualified pension fund. Of the remaining $64,872.35, $15,361.93 was withheld for income taxes, and $4,381.65 was withheld for FICA. The Dotsons filed an amended income tax return in December of 1993 which excluded the $64,872.35 from wages. They seek the resulting refund of $19,485 from income taxes, and a $1,107.65 from FICA taxes for the year 1992. After the IRS denied these claims, the Dotsons brought this action in the federal district court for the Southern District of Texas. The parties filed cross-motions for summary judgment. The district court granted the government's motion, and the Dotsons filed this appeal.


        We review summary judgment rulings de novo. Wesson v. United States, 48 F.3d 894, 896 (5th Cir.1995).

        Section 61(a) of the Internal Revenue Code defines gross income broadly as "all income from whatever source derived" not expressly excluded by the Code. 26 U.S.C. § 61(a). Courts give effect to that broad definition by interpreting the statutory exclusions from

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gross income narrowly. U.S. v. Burke, 504 U.S. 229, 233, 112 S.Ct. 1867, 1870, 119 L.Ed.2d 34 (1992).

        The appellants claim that their ERISA settlement meets the exception for personal injury compensation. Section 104(a)(2) of the Code excludes "the amount of any damages received (whether by suit or agreement and whether as lump sums or periodic payments) on account of personal injuries or sickness." The Code itself does not define the term "damages received ... on account of personal injuries," but Treasury Regulation 26 CFR § 1.104-1(c) (1994) states that it "means an amount received (other than workers' 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." The Supreme Court has held that this Regulation links the definition of personal injury compensation with the requirement of a tort or tort-like suit. U.S. v. Burke, supra.

        Congress first enacted the personal injury compensation exclusion in 1918 at a time when such payments were considered the return of human capital, and thus not constitutionally taxable "income" under the 16th amendment. See H.R.Rep. No. 767, 65th Cong., 2nd Sess. 9-10 (1918). The concept of a return of human capital lost through injury continues to support the exclusion. Commissioner v. Miller, 914 F.2d 586, 590 (4th Cir.1990), 1 B. Bittker, Federal Taxation of Income, Estates and Gifts, para. 13.1.4 (1981). The recipient of personal injury damages is in effect forced to sell some part of her physical or emotional well-being in return for money. 1

        The return of human capital theory does not serve to explain, however, why § 104(a)(2) exclusion also applies to back wages received as part of a personal injury award, Rev.Rul. 85-97, 1985-2 C.B. 50. and U.S. v. Burke, supra. These wages would ordinarily be taxable when received. Courts and commentators speculate that Congress' purpose in maintaining the § 104(a)(2) exclusion can perhaps best be explained as "intended to relieve a taxpayer who has the misfortune to become ill or injured." Epmeier v. U.S., 199 F.2d 508, 511 (7th Cir.1952). See also Bertram Harnett, Tort and Taxes, 27 N.Y.U.L.Rev. 614, 627 (1952); Laurie Malman, Lewis Solomon, Jerome Hesch, Federal Income Taxation 102-3 (1994).

        The Supreme Court has recently decided two cases on the application of § 104(a)(2) to different anti-discrimination statutes, Commissioner of Internal Revenue v. Schleier, --- U.S. ----, 115 S.Ct. 2159, 132 L.Ed.2d 294 (1995) and U.S. v. Burke, supra. The Court clarified the requirements of § 104(a)(2) exclusion: damages received must be both "on account of personal injury" and stem from a "tort or tort-like" claim. Schleier, supra at ----, 115 S.Ct. at 2166. The first requirement tests whether the damages received were due to a personal injury rather than mere economic loss. The second examines the legal basis of the claim for tort-like characteristics, focusing on the scope of remedies available under the statutory scheme. Id.


        The district court concluded that Mr. Dotson failed the requirement that damages be recovered for a tort-like claim. The civil enforcement clause of ERISA, § 502(a) (29 U.S.C. § 1132(a)), gives beneficiaries the right to bring civil suits to recover benefits or "(A) to enjoin any act or practice which violates any provision of this subchapter, or (B) to obtain other appropriate equitable relief (i) to redress such violations or (ii) to enforce any provisions of this subchapter or the terms of the plan." The district court acknowledged that the parties and the Special Master interpreted the law governing ERISA at the time of the settlement to allow for extra-contractual damages.

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The record in this case is absolutely clear that Special Master Priest unequivocally thought that the settlement award included significant "tort-like" elements. Indeed, there is evidence that a settlement was reached in the underlying class action only because the Defendants in that case feared that they would be liable for punitive damages if they failed to settle.

        Applying hindsight, the district court instead relied on cases decided after the settlement which interpret the statute to limit the remedies available under ERISA. Mertens v. Hewitt Assocs., 508 U.S. 248, 262, 113 S.Ct. 2063, 2072, 124 L.Ed.2d 161, 174 (1993); Medina v. Anthem Life Insurance Co., 983 F.2d 29, 32 (5th Cir.) cert. denied, 510 U.S. 816, 114 S.Ct. 66, 126 L.Ed.2d 35 (1993). As a result of these later cases, the district court concluded, the statutory remedy is not tort-like as defined by the Supreme Court in Burke.

        The appellants argue...

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