Delaney v. C.I.R.

• Citation: 99 F.3d 20
• Decision Date: 08 February 1996
• Docket Number: No. 95-2066,95-2066
• Parties: -6968, 65 USLW 2331, 96-2 USTC P 50,576 Joseph P. DELANEY and Jane H. Delaney, Petitioners, Appellants, v. COMMISSIONER OF INTERNAL REVENUE, Respondent, Appellee. . Heard
• Court: United States Courts of Appeals. United States Court of Appeals (1st Circuit)

Page 20

99 F.3d 20

78 A.F.T.R.2d 96-6968, 65 USLW 2331,

96-2 USTC P 50,576

Joseph P. DELANEY and Jane H. Delaney, Petitioners, Appellants, v. COMMISSIONER OF INTERNAL REVENUE, Respondent, Appellee.

No. 95-2066.

United States Court of Appeals,

First Circuit.

Heard Feb. 8, 1996.

Decided Nov. 1, 1996.

Kimberly L. O'Brien, with whom Justin S. Holden and Justin S. Holden & Associates, Inc., Providence, RI, were on brief for petitioners, appellants.

Kevin M. Brown, Attorney, Tax Division, Department of Justice, with whom Loretta C. Argrett, Assistant Attorney General, and Gary R. Allen and Bruce R. Ellisen, Attorneys, Tax Division, Department of Justice, Washington, DC, were on brief for respondent, appellee.

Before TORRUELLA, Chief Judge, CYR and LYNCH, Circuit Judges.

CYR, Circuit Judge.

Joseph J. and Jane H. Delaney ("appellants" or "the Delaneys") challenge a United States Tax Court ruling upholding a determination by the Commissioner of Internal Revenue that a portion of their $250,000 settlement recovery in a tort-based action for personal injuries is subject to federal income tax as statutory prejudgment interest. We affirm the Tax Court ruling, without deciding whether prejudgment interest is ever excludable as "damages received on account of personal injuries" under Section 104(a)(2) of the Internal Revenue Code.

I BACKGROUND

In 1988, the Delaneys commenced a tort action in Rhode Island Superior Court, demanding damages for personal injuries sustained by Mr. Delaney in a fall from the second-floor porch of their Apple Valley condominium in Smithfield, Rhode Island. Apple On October 12, 1990, a jury awarded $150,000 to Mr. Delaney for personal injuries and $25,000 to Mrs. Delaney for loss of consortium, assigning fault among the three defendants as follows: Apple Valley Associates 25%; Apple Valley Condominium Association and Apple Valley Condominium Management, jointly, 75%. As required under Rhode Island law, the clerk of court added $112,000 in statutory prejudgment interest to the jury award, bringing the total judgment to $287,000. The defendants appealed the judgment to the Rhode Island Supreme Court.

Valley Associates, Inc., the condominium developer; Apple Valley Condominium Association, Inc., the condominium owners association; and Condominium Management, Inc., the management firm responsible for maintaining the condominium properties, were named as defendants.

In 1991, while their appeal was still pending, Apple Valley Condominium Association, Inc. and Condominium Management, Inc. entered into a settlement agreement to pay the Delaneys $250,000 for a release of "any and all past, present, or future ... claims ... arising out of bodily injuries sustained by Joseph P. Delaney...." ¹ The agreement itself mentioned neither prejudgment nor postjudgment interest; furthermore, it failed to indicate what, if any, understanding the settling parties had reached regarding any apportionment of the settlement amount as between prejudgment interest and compensatory damages. Subsequently, however, the settling parties filed a stipulation of dismissal with the Rhode Island Superior Court, which stated: "No interest. No costs." ² The stipulation was silent as to whether the term "interest" meant prejudgment interest, postjudgment interest, or both.

The Delaneys did not declare the $250,000 on their 1991 federal income tax return. Ultimately, the Commissioner assessed a $20,580 deficiency for tax year 1991, which was calculated by allocating 39 percent--or $97,561--of the settlement proceeds to prejudgment interest. The IRS based its 39 percent allocation on the fact that 39 percent (or $112,000) of the $287,000 superior court judgment constituted prejudgment interest.

The Delaneys initiated proceedings in the Tax Court, alleging that the entire $250,000 settlement had been properly excluded from gross income as "damages received ... on account of personal injuries or sickness" pursuant to Section 104(a)(2) of the Internal Revenue Code. The Commissioner has conceded that the settlement amount attributable to compensatory damages for personal injuries is excludable, but not the statutory prejudgment interest. Through the testimony of their counsel in the underlying tort action, their letter proposing settlement to the defendants, the settlement agreement itself, and the stipulation of dismissal, the Delaneys attempted to show the Tax Court at trial that none of the settlement amount had been intended as prejudgment interest. After determining that the Delaneys had not met their burden of proving the Commissioner's assessment incorrect, the Tax Court ruled that the settlement included a prejudgment interest component amounting to $97,561, or 39% of the $250,000 settlement. Delaney v. Commissioner of Internal Revenue, 70 T.C.M. (CCH) 353 (1995).

II DISCUSSION

This case concerns the inherent tension between two sections of the Internal Revenue Code governing exclusions from gross income. Section 61(a) of the Internal Revenue Code states: "[e]xcept as otherwise provided in this subtitle, gross income means all income from whatever source derived." 26 U.S.C. § 61(a) (emphasis added). On the other hand, section 104(a)(2) of the Internal Revenue Code provides that "damages received Thus, gain constitutes gross income under section 61(a) unless the taxpayer can demonstrate a specific exclusion. Brabson, 73 F.3d at 1042 (citing Schleier, --- U.S. at ----, 115 S.Ct. at 2163 (1995); Commissioner v. Glenshaw Glass Co., 348 U.S. 426, 430, 75 S.Ct. 473, 476, 99 L.Ed. 483 (1955); Wesson v. United States, 48 F.3d 894, 898 (5th Cir.1995)). In determining exclusions under 104(a)(2), courts are "guided by the corollary to § 61(a)'s broad construction, the 'default rule of statutory interpretation that exclusions from income must be narrowly construed.' " Id. (quoting Schleier, --- U.S. at ----, 115 S.Ct. at 2163).

                ... on account of personal injuries or sickness" are excludable from gross income.  26 U.S.C. § 104(a)(2).  The courts have accorded section 61(a) wide sweep.   Commissioner v. Schleier,  --- U.S. ----, ----, 115 S.Ct. 2159, 2167, 132 L.Ed.2d 294 (1995);  Brabson v. United States, 73 F.3d 1040, 1042 (10th Cir.1996);  O'Gilvie v. United States, 66 F.3d 1550, 1555 (10th Cir.1995), cert. granted, --- U.S. ----, 116 S.Ct. 1316, 134 L.Ed.2d 469 (1996);  see also 26 U.S.C. § 61(a)(4) (including "interest" within definition of "gross income")
                

The present appeal revolves around two principal claims. First, the Delaneys claim that the Tax Court improperly second-guessed their settlement agreement with the defendants in the tort action by treating a portion of the $250,000 settlement as statutory prejudgment interest despite the explicit language in their subsequent stipulation of dismissal: "No interest. No costs." The Delaneys insist that the stipulated settlement term "no interest" unambiguously provides that the settlement amount included no interest component of any type. Second, appellants maintain that any prejudgment interest in a settlement recovery for personal injuries comes within the section 104(a)(2) exclusion for "damages" resulting from personal injuries. We find neither claim availing.

A. Settlement Agreement

It is settled law that taxpayers bear the burden of proving that a tax deficiency assessment is erroneous. United States v. Rexach, 482 F.2d 10, 16 (1st Cir.), cert. denied, 414 U.S. 1039, 94 S.Ct. 540, 38 L.Ed.2d 330 (1973); Tax Court Rule 142(a). The Supreme Court has held that the Commissioner's "ruling has the support of a presumption of correctness, and the petitioner has the burden of proving it to be wrong." Welch v. Helvering, 290 U.S. 111, 115, 54 S.Ct. 8, 9, 78 L.Ed. 212 (1933); see also United States v. Janis, 428 U.S. 433, 439, 96 S.Ct. 3021, 3025, 49 L.Ed.2d 1046 (1976); Estate of Todisco v. Commissioner, 757 F.2d 1, 6 (1st Cir.1985) (the basic rule in all tax cases places the burden of proof with the taxpayer). The rationale for this rule is more deeply rooted than the conventional regimen that places the burden of proof on the moving party. See Rexach, 482 F.2d at 16. Thus, in a tax deficiency suit "the burdens of going forward and of ultimate persuasion are always on the taxpayer and never shift to the Commissioner." Id. at 16-17. Ultimately, of course, a tax deficiency assessment is subject to reversal if the taxpayer establishes by a preponderance of the evidence that it was erroneous. Estate of Whitt v. Commissioner, 751 F.2d 1548, 1556 (11th Cir.), cert. denied, 474 U.S. 1005, 106 S.Ct. 523, 88 L.Ed.2d 456 (1985).

Viewed simply as a linguistic exercise, appellants' interpretation has a certain appeal. Since the settlement agreement language itself suggests no differentiation between damages and prejudgment interest, its silence plainly permits the interpretation that the entire $250,000 constituted recompense for personal injury. Moreover, the subsequent stipulation of dismissal executed by the parties to the tort action purports to fill the void by precluding--with the language "No interest. No costs."--the interpretation urged by the Commissioner.

The difficulty with appellants' approach lies in the fact that the required inquiry encompasses much more than the mere language subscribed to by the parties, whether in the settlement agreement proper, the stipulation of dismissal, or both, because under established precedent the Tax Court must determine "in lieu of what were damages Accordingly, confronted with a $250,000 postjudgment settlement literally allocating nothing to statutory prejudgment interest notwithstanding the $112,000 prejudgment interest component concededly included in the $287,000 superior court judgment, the Tax Court reasonably considered, inter alia, the intent of the parties in context. The Tax Court's approach seems especially apt in these circumstances, where a relevant indicator extrinsic to the settlement documentation suggested that their...