C.I.R. v. Miller

• Citation: 914 F.2d 586
• Decision Date: 21 September 1990
• Docket Number: No. 89-1851,89-1851
• Parties: -5620, 90-2 USTC P 50,511 COMMISSIONER OF INTERNAL REVENUE, Plaintiff-Appellant, v. Bonnie A. MILLER, Defendant-Appellee.
• Court: United States Courts of Appeals. United States Court of Appeals (4th Circuit)

Page 586

914 F.2d 586

66 A.F.T.R.2d 90-5620, 90-2 USTC P 50,511

COMMISSIONER OF INTERNAL REVENUE, Plaintiff-Appellant, v. Bonnie A. MILLER, Defendant-Appellee.

No. 89-1851.

United States Court of Appeals Fourth Circuit.

Argued June 8, 1990.

Decided Sept. 21, 1990.

Ann Belanger Durney, Tax Div., U.S. Dept. of Justice, Washington, D.C., argued (Shirley D. Peterson, Asst. Atty. Gen., Gary R. Allen, Laura Marie Conley O'Hanlon, Tax Div., U.S. Dept. of Justice, Washington, D.C., on brief) for plaintiff-appellant.

S. Ronald Ellison, Fedder and Garten, P.A., Baltimore, Md., argued (Kenneth D. Pack, Fedder and Garten, P.A., Baltimore, Md., on brief), for defendant-appellee.

Before RUSSELL and MURNAGHAN, Circuit Judges, and TILLEY, United States District Judge for the Middle District of North Carolina, sitting by designation.

MURNAGHAN, Circuit Judge:

The question presented in the case before us is whether the portion of a defamation action settlement properly attributed to punitive damages is excludable from gross income pursuant to 26 U.S.C. Sec. 104(a)(2).

I

Bonnie A. Miller succeeded in obtaining a large settlement of two lawsuits brought for defamation and intentional infliction of emotional distress. The ad damnum for the first of the two suits, which Miller brought in the Superior Court of (now the Circuit Court for) Baltimore City, was $10,000,000, with an additional claim of $10,000,000 in punitive damages. The ad damnum in the second suit, which was brought in the Circuit Court for Baltimore County, was $15,000,000, with a $15,000,000 claim in punitive damages. The jury returned a verdict in the first suit of $950,000 made up of $500,000 in compensatory damages and $450,000 in punitive damages, with no portion of the award attributable to intentional infliction of emotional distress. Following the jury verdict, Miller entered into settlement negotiations with the defendants in both suits. The negotiations produced a general release discharging all defendants from liability, with Miller accepting therefor a payment of $900,000. That payment did not provide for any allocation of the settlement proceeds between the two cases, or between the claims for compensatory damages and the claims for punitive damages. After payment of legal fees and costs from the settlement amount totaling $375,000, Miller received as net settlement proceeds $525,000.

Miller's legal complications were, however, not ended. She, regarding the settlement proceeds as excludable from her federal income tax, did not include on her tax return any part of the $525,000 in settlement. The Internal Revenue Service took the position that all of the settlement proceeds were taxable, leading to a deficiency of $249,106, plus an addition under Internal Revenue Code Sec. 6661 of $62,254. ¹

The case was tried in the Tax Court. Miller argued that the settlement proceeds were not subject to tax by relying upon Sec. 104(a)(2) of the Internal Revenue Code. See 26 U.S.C. Sec. 104(a)(2). That section excludes from income "the amount of any damages received whether by suit or agreement ... on account of personal injuries or sickness." The Government challenged Miller's position on two grounds. First, the Government asked the court to read into Sec. 104(a)(2) distinctions based on the kinds of injuries that result from a given tortious action. Although the record is not free from doubt, it appears from the Tax Court's opinion that the Government argued either that only damages to personal, as opposed to professional, reputation should be excluded from gross income or that only damages for physical, as opposed to nonphysical, injury should be compensated. The second argument advanced by the Government was that Sec. 104(a)(2) should be read to exclude from gross income only compensatory, as opposed to punitive, damages. Thus, the Government argued, to the extent that some portion of the settlement proceeds represented punitive damages, that portion was to be included in Miller's gross income. ²

The Tax Court rejected, though not unanimously, both of the Government's arguments. Miller v. Commissioner, 93 T.C. 330 (1989). The court rejected the Government's first argument by reviewing the Tax Court and appellate court opinions that had rejected the drawing of distinctions, for Sec. 104(a)(2) purposes, among kinds of personal injuries or kinds of harm flowing from those injuries. Id. at 334-37. The court saw no reason to depart from those holdings. Id. at 337.

The court rejected the Government's second argument by examining the phrase "any damages received ... on account of personal injuries." Id. at 337-41. Giving the words "any" and "on account of" what it considered to be their ordinary meaning, the court concluded that the "plain meaning" of Sec. 104(a)(2) indicated that punitive damages were within the section's ambit and, therefore, were to be excluded from gross income. The court noted that "Webster's defines the phrase 'on account of' as: 'For the sake of,' 'by reason of,' or 'because of.' These phrases suggest causation." Id. at 339 (citation omitted). The court further relied upon Burford v. United States, 642 F.Supp. 635 (N.D.Ala.1986), which held that proceeds received as settlement of an action brought pursuant to Alabama's wrongful death statute were within Sec. 104(a)(2) and, therefore, excluded from gross income, even though Alabama law labels wrongful death proceeds as "punitive." 93 T.C. at 338-39. The court recognized the canon of statutory interpretation requiring that exclusions from income be narrowly construed, id. at 340; however, the court declined to apply the canon, applying instead the canon that a court "should not disregard the plain meaning of a statute except to prevent an absurd result or one that is contrary to legislative intent." Id. at 340-41. Finding no absurdity in its result or contradiction in the legislative history, the court held for Miller. ³ Two judges dissented. Id. at 345-52.

The Government has appealed. On appeal, the Government no longer asserts its argument regarding distinctions among various forms of injuries or various forms of compensatory damages. Instead, the Government argues only the second point it argued below, namely, that punitive damages are not within Sec. 104(a)(2), and, therefore, are not excluded from gross income. ⁴

II

A

We begin with the proposition that gross income includes "all income from whatever source derived." 26 U.S.C. Sec. 61(a). Section 104(a)(2) excludes from gross income settlement proceeds received "on account of personal injuries or sickness." To determine whether Miller's settlement award may be excluded pursuant to Sec. 104(a)(2), "the nature of the cause of action and the injury to be remedied must be identified." Thompson v. Commissioner, 866 F.2d 709, 711 (4th Cir.1989); see generally id. (analyzing separately claim for back pay and claim for liquidated damages). That inquiry requires consideration of the Maryland law that created Miller's entitlement to relief. See Roemer v. Commissioner, 716 F.2d 693, 697 (9th Cir.1983) ("we must look to state law to analyze the nature of the claim litigated").

Under Maryland law, a defamation action such as Miller's is an action for personal injuries. See New York, Philadelphia and Norfolk R.R. Co. v. Waldron, 116 Md. 441, 453, 82 A. 709, 714 (1911). However, it must also be recognized that, under Maryland law, "[p]unitive damages are inherently different from compensatory damages and the reasons for the award of each differ sharply." Exxon Corp. v. Yarema, 69 Md.App. 124, 137, 516 A.2d 990, 997 (1986), cert. denied, 309 Md. 47, 522 A.2d 392 (1987). A punitive damages award "does not attempt to compensate the plaintiff for harm suffered by him, but rather is exemplary in nature and is over and above any award of compensatory damages." Id. In the context of a defamation action, the Maryland Court of Special Appeals has commented that "[e]xemplary or punitive damages, as the name connotes, are rather a punishment for and deterrent to wrongdoing than a means of recompensing the victim. To the victim they are a windfall not necessarily related to the injury he has suffered." Cheek v. J.B.G. Properties, Inc., 28 Md.App. 29, 34, 344 A.2d 180, 184 (1975). ⁵

Against that doctrinal background, we now review the Tax Court's conclusion that even those portions of Miller's settlement proceeds properly attributable to punitive damages are to be excluded from gross income pursuant to Sec. 104(a)(2).

B

At the outset, we reject the conclusion of the Tax Court that the plain meaning of Sec. 104(a)(2) compels exclusion of punitive damages from gross income. We do not quarrel with the court's observation that "on account of" suggests "causation." However, in our view, that observation blithely smooths over the distinction between "but-for" causation and "sufficient" causation. Under a but-for causation approach, the fact that a plaintiff has to sustain a personal injury as a prerequisite to an award of punitive damages leads to the conclusion that the punitive damages were "on account of" the plaintiff's injury, even though a punitive damage award requires the additional showing of, and is responsive only to, egregious conduct by the defendant. ⁶ However, under a sufficient causation approach, the fact that personal injury is a prerequisite to punitive damages does not lead to the conclusion that the punitive damages were "on account of" the plaintiff's injuries because even if the other elements of the tort are present, personal injury alone does not sustain a punitive damage award. The fact that a plaintiff seeking punitive damages has to show egregious conduct by the defendant indicates that the plaintiff's injury was not a sufficient cause of the punitive damages. Thus, the mere fact that "on account of" suggests "causation" does not answer the question of whether "on account of" suggests but-for causation or sufficient...