Hawkins v. U.S., 93-15828

• Decision Date: 19 July 1994
• Docket Number: No. 93-15828,93-15828
• Citation: 30 F.3d 1077
• Parties: -5363, 63 USLW 2076, 94-2 USTC P 50,386 Jack R. HAWKINS, Cynthia J. Hawkins, husband & wife, Plaintiffs-Appellees, v. UNITED STATES of America, Defendant-Appellant.
• Court: U.S. Court of Appeals — Ninth Circuit

Page 1077

30 F.3d 1077

74 A.F.T.R.2d 94-5363, 63 USLW 2076,

94-2 USTC P 50,386

Jack R. HAWKINS, Cynthia J. Hawkins, husband & wife Plaintiffs-Appellees, v. UNITED STATES of America, Defendant-Appellant.

No. 93-15828.

United States Court of Appeals Ninth Circuit.

Argued and Submitted April 11, 1994.

Decided July 19, 1994.

Gary R. Allen, Edward T. Perelmuter, Tax Div., U.S. Dept. of Justice, Washington, DC, for defendant-appellant.

Kenneth J. Whitehead, Phoenix, AZ, for plaintiffs-appellees.

Before GOODWIN, FERGUSON and TROTT, Circuit Judges.

Opinion by Judge GOODWIN; Dissent by Judge TROTT.

GOODWIN, Circuit Judge:

The government appeals a summary judgment granted in favor of Jack and Cynthia Hawkins ("the taxpayers"). The district court concluded that the taxpayers' punitive damage award was excludable from gross income as "damages received ... on account of personal injury." 26 U.S.C. Sec. 104(a)(2). We reverse.

I.

The facts are undisputed. In 1979, Cynthia Hawkins crashed the taxpayers' $8,000 car, totaling it. Ms. Hawkins and her husband ("the Hawkinses") filed a claim with their insurer, Allstate Insurance Company ("Allstate"), requesting a replacement car. Allstate agents allegedly pressured the couple into buying an inferior, less expensive replacement car for $6,741, and then failed to equip the new car with certain options. The Hawkinses sued Allstate for breach of good faith and fair dealing (insurance bad faith), ultimately recovering $15,000 in compensatory damages and $3.5 million in punitive damages. Hawkins v. Allstate Insurance Co., 152 Ariz. 490, 733 P.2d 1073, cert. denied, 484 U.S. 874, 108 S.Ct. 212, 98 L.Ed.2d 177 (1987).

On their 1988 federal income tax return, the Hawkinses initially reported $2,937,406 of the lawsuit proceeds as gross income, contending that the punitive damages (less attorneys' fees and costs) were taxable, but that the $15,000 compensatory damages were excludable "damages received on account of personal injury or sickness." 26 U.S.C. Sec. 104(a)(2). They then filed an amended return, claiming that the punitive damages were also excludable under Sec. 104(a)(2) and requesting a refund of $793,277. The IRS disallowed the refund, and the Hawkinses filed this refund action in the district court. On cross-motions for summary judgment, the district court found for the Hawkinses, ruling that the punitive damages were excludable. The government timely appealed.

II.

Viewing the evidence in the light most favorable to the non-moving party, we review de novo to determine whether there are any genuine issues of material fact and whether the district court correctly applied the relevant substantive law. Stevens v. Moore Business Forms, Inc., 18 F.3d 1443, 1446 (9th Cir.1994). The case presents no genuine issues of material fact and summary judgment was appropriate. However, we disagree with the district court's interpretation of the relevant law, and hold that the taxpayers' punitive damages were not excludable under Sec. 104(a)(2) (1988).

III.

For taxation purposes, gross income includes "all income from whatever source derived." 26 U.S.C. Sec. 61(a). An accession to wealth, such as the Hawkinses' punitive damage award, is presumed to be taxable income, unless the taxpayer can demonstrate that it fits into one of the Tax Code's specific exemptions. Commissioner v. Glenshaw Glass Co., 348 U.S. 426, 430, 75 S.Ct. 473, 476, 99 L.Ed. 483 (1985). The Hawkinses contend that their punitive damage award fits into Sec. 104(a)(2), which provides:

Sec. 104. Compensation for injuries or sickness

... [G]ross 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) (1988) (emphasis added). ¹ IRS implementing regulations define "damages" as amounts received "through prosecution of a legal suit or action based upon tort or tort-type rights." 26 C.F.R. Sec. 1.104-1(c) (1993) (emphasis added).

The parties agree that, under Arizona law, the Hawkinses' bad faith lawsuit was a tort-type action, Rawlings v. Apodaca, 151 Ariz. 149, 726 P.2d 565, 567 (1986); Noble v. National American Life Insurance Co., 128 Ariz. 188, 624 P.2d 866, 868 (1981), and that the Hawkinses suffered "personal injuries" as a result of Allstate's conduct. Bates v. The Superior Court of the State of Arizona, In and For the County of Maricopa, 156 Ariz. 46, 749 P.2d 1367, 1370 (1988) (mental distress suffered as a result of an insurance company's bad faith refusal to pay a legitimate claim can qualify as a personal injury); Lange v. Penn Mutual Life Ins. Co., 843 F.2d 1175, 1178 (9th Cir.1988). The government therefore concedes that the Hawkinses' compensatory damages are excludable "damages received ... on account of personal injury." Sec. 104(a)(2).

The parties also agree that the Hawkinses' compensatory damages completely covers the Hawkinses' actual injuries, including their two-week loss of the family car, out-of-pocket losses of less than $1,000, and attendant emotional distress. The Hawkinses concede that the punitive damage award bears no relationship to their injuries and represents pure gain.

Thus, the only dispute is whether the punitive damages, despite their tangential relationship to any actual injury, are excludable from gross income under Sec. 104(a). We must decide whether Sec. 104(a) excludes all damages received in a tort-like lawsuit, or only those damages which have some compensatory purpose. The government contends that noncompensatory, punitive damage awards such as the Hawkinses' are not received "on account of personal injuries," but on account of the tortfeasor's egregious conduct. In the government's view, Sec. 104(a)(2) excludes only those damages which purport to compensate the taxpayer for her injuries. The Hawkinses, in contrast, contend that, under the 1988 version of Sec. 104(a)(2), all damages received in a tort-like lawsuit are excludable, regardless of their purpose.

While the Hawkinses' position draws some support from the IRS's vacillation on the issue, ² we believe the government's current interpretation is more consistent with Sec. 104(a)'s title and purpose, as well as with the rule that exemptions must be narrowly construed in favor of taxation. We therefore join several other courts in concluding that Sec. 104(a)(2) does not exclude noncompensatory punitive damages. See Reese v. Commissioner, 24 F.3d 228, (Fed.Cir.1994); Commissioner v. Miller, 914 F.2d 586 (4th Cir.1990); Estate of Wesson v. United States, 843 F.Supp. 1119 (S.D.Miss.1994); Kemp v. Commissioner, 771 F.Supp. 357, 359 (N.D.Ga.1991).

A.

Unlike the district court, we are not convinced that the "plain meaning" of Sec. 104(a)(2) compels exclusion of punitive damages. Rather, as the Fourth and Federal Circuits have noted, Sec. 104(a)(2) is "ambiguous." Reese, 24 F.3d at 230; Miller, 914 F.2d at 589-90. "Damages received on account of personal injury" could mean all damages recovered in a personal injury lawsuit, or, it could mean only those damages which purport to compensate the taxpayer for her personal injuries. Id. Punitive damages such as the Hawkinses, which do not purport to compensate the taxpayer for personal injuries and which bear no relation to the severity of the taxpayer's injuries, are not necessarily awarded "on account of" personal injury; rather, they are awarded "on account of" the tortfeasor's egregious conduct. Id. ³ We also disagree with the Hawkinses' characterization of the case law as "consistently h[olding] that the inquiry under Sec. 104(a)(2) is limited to an examination of the nature of the taxpayer's claim or injury." Appellees Br. at 15 (citing United States v. Burke, --- U.S. ----, ----, 112 S.Ct. 1867, 1870, 119 L.Ed.2d 34 (1992); Redfield v. Insurance Co. of North America, 940 F.2d 542 (9th Cir.1991); Threlkeld v. Commissioner, 848 F.2d 81 (6th Cir.1988)). While these cases did examine the nature of the taxpayers' claim or injury to determine whether or not the damages at issue were recovered for personal injury, they did not hold that whenever the underlying claim is tort-like, all damages are excludable.

In fact, the Federal Circuit recently rejected the Hawkinses' exact argument and distinguished precisely these cases. Reese, 24 F.3d at 234. As the Reese court noted, Burke held only that damages awarded under the 1991 version of Title VII were not excludable from gross income because the statute did not "evidence[ ] a tort-like conception of injury and remedy." --- U.S. at ----, 112 S.Ct. at 1873. The Burke taxpayers had not received punitive damages, and the Court did not address the excludability of punitive damages. Rather, the Court mentioned punitive damages only because the Court felt that the availability of punitive damages indicates the nature of the underlying cause of action: Since punitive damages are traditionally available only in personal injury-type actions, the availability of punitives suggests that the underlying cause of action is "tort-like" within the meaning of Sec. 104(a). Contrary to the dissent's arguments, however, nothing about this comment implies that punitive damages themselves are excludable from gross income. Punitive damages may be an indicia of a tort-like cause of action without themselves being damages received on account of personal injury.

Nor did the Court indicate that, if the underlying cause of action is tort-like, all damages, regardless of their purpose, are excludable. While the Court "agree[d] with the Court of Appeals' analysis insofar as it focused, for purposes of Sec. 104(a)(2), on the nature of the claim underlying ... [the taxpayers'] damages award," Burke, --- U.S. at ----, 112 S.Ct. at 1872, the Court did not state that courts should look exclusively at the nature of the claim underlying the damage award. The Court's alleged failure to "mention any...