Brabson v. US

• Citation: 859 F. Supp. 1360
• Decision Date: 15 August 1994
• Docket Number: Civ. A. No. 93-K-2288.
• Parties: Mary BRABSON, Plaintiff, v. UNITED STATES of America, Defendant.
• Court: U.S. District Court — District of Colorado

859 F. Supp. 1360

Mary BRABSON, Plaintiff, v. UNITED STATES of America, Defendant.

Civ. A. No. 93-K-2288.

United States District Court, D. Colorado.

August 15, 1994.

H. William Mahaffey, W. Thomas Beltz, Hecox, Tolley, Keene & Beltz, Colorado Springs, CO, for plaintiff.

Joel R. Roessner, Tax Div., Dept. of Justice, Washington, DC, Wm. G. Pharo, Ass't U.S. Atty., for defendant.

MEMORANDUM OPINION AND ORDER

KANE, Senior District Judge.

Before me on defendant United States' motion to dismiss is the complex question of what constitutes "damages received on account of personal injuries or sickness" under the exclusion from gross income stated in Internal Revenue Code § 104(a)(2). In particular I must determine whether mandatory statutory prejudgment interest, added by operation of law to Colorado personal injury awards under C.R.S. § 13-21-101(1), is an element of "damages" excludable from income within the meaning of § 104(a)(2) or whether it is taxable "interest" within the meaning of § 61(a)(4).

Plaintiffs Mary, Helen, and William Brabson initiated this action against the United States alleging overpayment of their 1988 federal income taxes. The Brabsons claim they were erroneously taxed on the prejudgment interest portion of a personal injury award Mary Brabson obtained against the City of Colorado Springs and others as a result of a gas explosion at the Brabsons' home in 1981. They seek recovery of the $371,000 in taxes assessed and paid on the portion of their damages award attributable to prejudgment interest, plus interest and attorney fees.

The United States moves to dismiss the Brabsons' complaint, asserting prejudgment interest is separate from damages and fully taxable as interest income. I disagree. Based on my review of the Code and caselaw interpreting it, I conclude mandatory statutory prejudgment interest is an element of compensatory "damages" available to plaintiffs pursuing personal injury actions under Colorado law. To the extent this conclusion conflicts with the Tax Court's recent ruling in Kovacs v. Comm'r, 100 T.C. 124, 1993 WL 46512 (1993), aff'd in unpublished disposition, 1994 WL 253035 (June 9, 1994), I decline to follow the majority's analysis, and adopt instead the dissent of Judge Beghe.

I. Facts

The following facts are undisputed:

On July 15, 1981, an explosion damaged Mary Brabson's home, injuring Mary and her children, William and Helen. The explosion was linked to a gas leak. Mary Brabson filed suit in El Paso County District Court, naming the City of Colorado Springs, Stratmoor Hills Water District, and Stratmoor Hills Sanitation District as defendants. The case was tried to a jury and a verdict rendered in favor of the Brabsons. On October 29, 1983, the trial court signed a judgment awarding Mary Brabson $1,502,150.02 for personal injuries, $97,840.98 for property damage, and $341,159.10 in prejudgment interest from the date of the explosion to the date of judgment.

The defendants appealed. Before determination of the case by the Colorado Court of Appeals, the Stratmoor Hills defendants settled with Mary Brabson for $155,948.87. On November 26, 1986, the Court of Appeals issued an opinion affirming the trial court's judgment.

On February 17, 1987, the City of Colorado Springs filed a petition for writ of certiorari with the Colorado Supreme Court, seeking review of the Court of Appeals' decision. The petition was granted on May 11, 1987. On October 30, 1987, the Brabsons sought leave to execute partially on the judgment. The request was denied by the Colorado Supreme Court on November 10, 1987.

After oral argument on April 25, 1988, the Colorado Supreme Court ordered the petition for writ of certiorari denied as having been improvidently granted. On June 28, 1988, the parties filed a satisfaction of judgment in the El Paso County District Court indicating Mary Brabson received $2,888,414.06 in connection with her action against the City of Colorado Springs. Of this, $370,723.12 was attributed to mandatory statutory prejudgment interest on the personal injury award.

The Brabsons did not include the prejudgment interest as income on their 1988 federal income tax returns on grounds it constituted damages received on account of personal injuries under 26 U.S.C. § 104(a)(2). The Internal Revenue Service assessed income tax deficiencies against each of the Brabsons for the excluded prejudgment interest, which deficiencies the Brabsons paid. The Brabsons now seek to recover the amounts paid, plus interest and attorney fees.

II. Discussion

As a general rule, "gross income means all income from whatever source derived." 26 U.S.C. § 61(a). All realized accessions to wealth are presumed to be taxable income, unless the taxpayer can demonstrate an acquisition is specifically exempt. See Comm'r v. Glenshaw Glass Co., 348 U.S. 426, 430, 75 S.Ct. 473, 476, 99 L.Ed. 483 (1955); Wulf v. City of Wichita, 883 F.2d 842, 871 (10th Cir.1989).

Since 1918 Congress has expressly excluded from gross income tort damages received on account of personal injuries. Revenue Act of 1918, § 213(b)(6), 40 Stat. 1066, discussed in Roemer v. C.I.R., 716 F.2d 693, 696 (9th Cir.1983) (footnote omitted). In its present form at 26 U.S.C. § 104(a)(2), the personal injury damages exclusion provides:

§ 104. Compensation for injuries and sickness.

(a) In general. — Except in the case of amounts attributable to (and not in excess of) deductions allowed under section 213 (relating to medical, etc., expenses) for any prior taxable, year, 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. § 104 (emphasis added).¹

Treasury Regulation 1.104-1(c) defines "damages" in this context as "an amount received ... 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." 26 C.F.R. § 1.104-1(c) (1991). With the exception of punitive damage awards,² excludability under § 104(a)(2) and Treasury Regulation 1.104-1(c) turns solely on the nature of the underlying claim, not the nature of the injury. United States v. Burke, ___ U.S. ___, 112 S.Ct. 1867, 119 L.Ed.2d 34, 44 (1992), approving analysis in Burke v. United States, 929 F.2d 1119, 1121 (6th Cir.1991). If the underlying claim sounds in tort, that is "`the beginning and the end of the inquiry.'" Burke, 929 F.2d at 1121 (quoting Threlkeld v. Comm'r, 87 T.C. 1294, 1299, 1986 WL 22061 (1986), aff'd, 848 F.2d 81 (6th Cir.1988)); Horton v. Comm'r, 100 T.C. 93, 96, 1993 WL 28557 (1993) (citing Burke). The entire "amount received" through prosecution of that claim is excludable, regardless of whether it includes compensation for nonphysical or economic losses, and regardless of whether it includes elements of damages otherwise taxable.³

The exclusion from income under § 104(a)(2) thus is broad, as are the other exclusions in § 104 for "compensation for injuries or sickness." For example, the exemption for "amounts received" through accident or health insurance for personal injuries or sickness (26 U.S.C. § 104(a)(3)) excludes from income all amounts received under accident or health insurance policies, even if they are in excess of the insured's actual medical expenses (Rev.Rul. 58-602, 1958-2 C.B. 109), and even if they include items otherwise taxable, such as replacement income (Rev. Rul. 58-90, 1958-1 C.B. 88). See 4 U.S. Tax Rep. ¶ 1044.03.⁴

The Tenth Circuit recognizes the breadth of the exclusion in § 104(a)(2). Once it is determined an underlying claim sounds in tort, the Tenth Circuit has ruled the entire amount awarded as damages for personal injuries is excluded under § 104(a)(2). Wulf v. City of Wichita, 883 F.2d 842, 873 (10th Cir.1989). In Wulf, the court of appeals reversed the trial court's addition of $80,821.97 to a damages award for "taxes due," finding the trial court had erroneously assumed the damages award, which represented back pay, was taxable. Because the underlying claim — i.e. termination of plaintiff's employment deprived him of his First Amendment rights in contravention of 42 U.S.C. § 1983 — sounded in tort, the Tenth Circuit found the entire damages award excludable from income under § 104(a)(2). Id.

The award of back pay compensated plaintiff for the economic injury resulting from the denial of his constitutional rights. It is still an award of damages `on account of personal injuries,' and is therefore not taxable.

Id. (citing Bent v. Comm'r, 835 F.2d 67, 71 (3d Cir.1987) (rejecting Commissioner's argument that portion of settlement based on lost wages not excludable from income under § 104(a)(2) because wages otherwise taxable)).

Applying this analysis to the case before me, I first look to the nature of the underlying claim. There is no dispute the Brabsons' suit against the City of Colorado Springs and the Stratmoor water and sanitation districts was a legal action based upon tort. Nor is there a dispute that the prejudgment interest at issue was part of the "amount received" by the Brabsons through prosecution of that action. See Treasury Reg. 1.104-1(c).

This alone should be the end of the inquiry. Kovacs v. Comm'r, 100 T.C. 124, 145-46, 1993 WL 46512 (1993) (Beghe, J. dissenting) (citing Burke, supra, ___ U.S. ___, 112 S.Ct. 1867, 119 L.Ed.2d 34; Downey, supra, 97 T.C. at 160-63; Horton, supra, 100 T.C. at 96). The United States, however, argues the relevant inquiry is not whether the prejudgment interest was an "amount received" by the Brabsons through prosecution of Mrs. Brabson's personal injury action, but whether it constitutes "damages" as contemplated in § 104(a)(2). Def.'s Mot. Dismiss at 7. The answer to this question, I find, requires consideration of Colorado personal injury law and a determination of how Colorado views prejudgment interest...