Brabson v. U.S., 94-1591

Citation73 F.3d 1040
Decision Date11 January 1996
Docket NumberNo. 94-1591,94-1591
Parties-572, 64 USLW 2461, 96-1 USTC P 50,038 Mary BRABSON, et al., Plaintiffs-Appellees, v. UNITED STATES of America, Defendant-Appellant.
CourtUnited States Courts of Appeals. United States Court of Appeals (10th Circuit)

Kenneth W. Rosenberg, Attorney, Tax Division, Department of Justice (Ann B. Durney, Attorney, Department of Justice, with him on brief), Washington, DC, for Defendant-Appellant.

W. Thomas Beltz (H. William Mahaffey with him on the brief, of Rothgerber, Appel, Powers & Johnson), Colorado Springs, Colorado, for Plaintiffs-Appellees.

Before SEYMOUR, COFFIN 1 and McKAY, Circuit Judges.

COFFIN, Senior Circuit Judge.

In this case, we must determine whether statutorily mandated prejudgment interest awarded in a personal injury suit is "damages received ... on account of personal injuries or sickness" within the meaning of Sec. 104(a)(2) of the Internal Revenue Code. The district court, on the United States' motion to dismiss, found for the taxpayer-appellees, Mary, Helen, and William Brabson (collectively the "Taxpayers" or "Brabsons"), and held that under Colorado law, prejudgment interest is an element of compensatory damages excludable from income under Sec. 104(a)(2). See Brabson v. United States, 859 F.Supp. 1360 (D.Colo.1994). We conclude, however, that considerations of federal law require reversal.

I. BACKGROUND

On July 15, 1981, Mary Brabson and her children, Helen and William, were injured in an explosion caused by a gas leak in their home. Mary Brabson, on behalf of herself and her children, sued the City of Colorado Springs, Stratmoor Hills Water District, and Stratmoor Hills Sanitation District. On October 29, 1983, after a jury trial, the court entered judgment for the Brabsons awarding damages for personal and property injuries, and statutory prejudgment interest on this amount dating from the time of the explosion.

The defendants appealed, the Stratmoor Hills parties subsequently settled, and in November 1986, the Colorado Court of Appeals affirmed the judgment. The City of Colorado Springs filed a petition for a writ of certiorari in the Colorado Supreme Court that was initially granted but then, following oral argument on April 25, 1988, denied.

In June 1988, the City of Colorado Springs satisfied the judgment. The Brabsons did not include the amount characterized as prejudgment interest on their 1988 federal income tax returns, and were assessed deficiencies for the excluded amount. After paying the deficiencies, the Brabsons brought suit to recover the amounts paid, plus interest and attorney's fees. The district court found for the Brabsons, holding that prejudgment interest awarded pursuant to Colo.Rev.Stat. Sec. 13-21-101(1) (1979) is an element of damages excludable from income within the meaning of Sec. 104(a)(2) of the Internal Revenue Code. 859 F.Supp. at 1370. This appeal by the government followed.

II. DISCUSSION

The facts are not in dispute. We review de novo the legal question of whether prejudgment interest is properly excludable under Sec. 104(a)(2). See O'Gilvie v. United States, 66 F.3d 1550, 1555 (10th Cir.1995). We shall review relevant statutory provisions, set out the competing positions as reflected in the caselaw on point, then turn to our own analysis of the issue.

A. Introduction
1. The Relevant Code Provisions

"Gross income" is defined in Sec. 61(a) of the Internal Revenue Code: "Except as otherwise provided in this subtitle, gross income means all income from whatever source derived." 26 U.S.C. Sec. 61(a). Since its enactment, the "sweeping scope" of this section and its predecessors has been repeatedly emphasized by the Supreme Court. Commissioner v. Schleier, --- U.S. ----, ----, 115 S.Ct. 2159, 2163, 132 L.Ed.2d 294 (1995); O'Gilvie, 66 F.3d at 1555. Thus, any gain constitutes gross income unless the taxpayer demonstrates that it falls within a specific exemption. Wesson v. United States, 48 F.3d 894, 898 (5th Cir.1995); see Schleier, --- U.S. at ----, 115 S.Ct. at 2163; Commissioner v. Glenshaw Glass Co., 348 U.S. 426, 430, 75 S.Ct. 473, 476, 99 L.Ed. 483 (1955).

The exclusion at issue here, Sec. 104(a) of the Code, provides, in relevant part,

gross income does not include--

(2) the amount of any damages received (whether by suit or agreement and whether as lump sums or as periodic payments) on account of personal injuries or sickness....

26 U.S.C. Sec. 104(a)(2). In interpreting the breadth of Sec. 104(a)(2), we are guided by the corollary to Sec. 61(a)'s broad construction, the "default rule of statutory interpretation that exclusions from income must be narrowly construed." Schleier, --- U.S. at ----, 115 S.Ct. at 2163; O'Gilvie, 66 F.3d at 1560.

The tension between Secs. 61(a) and 104(a) is the nub of this dispute. The Taxpayers contend that prejudgment interest, as provided for by Colorado law, falls within the specific exclusion of Sec. 104(a)(2). In contrast, the government argues that interest is not an element of Sec. 104(a)(2) damages but rather is expressly defined as income under Sec. 61(a)(4).

2. Relevant Caselaw

The parties' contrary positions are a reflection of the cases that have addressed this issue. Beginning with Kovacs v. Commissioner, 100 T.C. 124, 1993 WL 46512 (1993), aff'd without published opinion, 25 F.3d 1048 (6th Cir.1994), the Tax Court uniformly has held that prejudgment interest is taxable.

Kovacs involved the statutory assessment of prejudgment interest under Michigan law on a wrongful death claim. Relying on the principle that "the words of statutes--including revenue acts--should be interpreted where possible in their ordinary, everyday senses," id. at 128 (quoting Crane v. Commissioner, 331 U.S. 1, 6, 67 S.Ct. 1047, 1051, 91 L.Ed. 1301 (1947)), the court found a clear demarcation between "damages" and "interest" and emphasized that Sec. 104(a)(2) referred only to "damages." In addition, the court stressed the usual practice of taxing interest, noting in particular that it had found no cases that supported the taxpayer's position. Finally, the court noted that its decision was consistent with Michigan law, which clearly distinguished between "damages" and "interest." The Tax Court's subsequent decisions, relying on Kovacs, consistently have held that prejudgment interest is taxable, regardless of how the state characterizes its prejudgment statute or whether the final disposition is judgment or settlement. See Burns v. Commissioner, 67 T.C.M. (CCH) 3116, 1994 WL 273928 (1994); Robinson v. Commissioner, 102 T.C. 116, 126, 1994 WL 26303 (1994), aff'd in part and rev'd in part, 70 F.3d 34 (5th Cir.1995); Delaney v. Commissioner, 70 T.C.M. (CCH) 353, 1995 WL 468429 (1995); Forest v. Commissioner, 70 T.C.M. (CCH) 349, 1995 WL 468428 (1995).

The district court forthrightly attacked the reasoning of Kovacs. See 859 F.Supp. at 1366-70. Discarding the "interest is interest" equation as "tautology," id. at 1368, the court undertook a thorough analysis of the concept of interest and damages and arrived at a contrary conclusion. The crux of the court's decision was that under Colorado law, prejudgment interest is characterized as damages. Id. at 1363-66. 2

We see merit in each position. As, apparently, this is the first published opinion from a court of appeals reviewing Kovacs and its progeny, we embark on a thorough exploration of this difficult question.

B. Our Analysis

The task before us is to determine whether prejudgment interest on tort damages is excludable as "damages" under Sec. 104(a)(2). We begin by reviewing the Supreme Court's most recent discussion of the provision in Schleier, and then consider the nature of the prejudgment interest award under Colorado law. Having thus set the framework, we reexamine the statutory language, and because we determine that it is ambiguous, we turn to consider legislative intent.

1. Schleier

In holding that a plaintiff's recovery under the ADEA is not excludable from gross income under Sec. 104(a)(2), 115 S.Ct. at 2163, the Supreme Court enunciated the proper approach to be followed in applying the provision:

In sum, the plain language of Sec. 104(a)(2), the text of the applicable regulation [26 C.F.R. Sec. 1.104-1(c) ], and our decision in [U.S. v.] Burke [504 U.S. 229, 112 S.Ct. 1867, 119 L.Ed.2d 34 (1992) ] establish two independent requirements that a taxpayer must meet before a recovery may be excluded under Sec. 104(a)(2). First, the taxpayer must demonstrate that the underlying cause of action giving rise to the recovery is "based upon tort or tort type rights"; and second, the taxpayer must show that the damages were received "on account of personal injuries or sickness."

Id. at ----, 115 S.Ct. at 2167.

Schleier makes clear that all elements of a damage award received by a taxpayer must satisfy these two prongs. Justice Stevens for the Court described a hypothetical car accident that caused the victim to suffer medical expenses, lost wages, and pain, suffering and emotional distress. The resulting settlement is excludable in full, he explained, not simply because the taxpayer received a tort settlement, but because each element of the tort award was "damages ... received 'on account of injuries or sickness.' " Id. at ----, 115 S.Ct. at 2164. In other words, each element of damages was linked to the injury itself.

In this case, there is no dispute that the Taxpayers satisfy the first prong: the award of prejudgment interest was based upon a tort. However, for the Taxpayers to prevail they must demonstrate that the interest here is "damages," and further, that recovery of such "damages" was "on account of injuries"--i.e., attributable to the injuries suffered in the explosion. We therefore look to Colorado law to determine how, if at all, it plays a part in deciding these issues.

2. Colorado Law

We note at the outset that state law determines the nature of the legal interests and rights created by state law, but...

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