Hemelt v. U.S., s. 96-2827

• Decision Date: 07 August 1997
• Docket Number: Nos. 96-2827,96-2828,s. 96-2827
• Citation: 122 F.3d 204
• Parties: -5937, 97-2 USTC P 50,596, Pens. Plan Guide (CCH) P 23937V George J. HEMELT; Theresa G. Hemelt, Plaintiffs-Appellants, v. UNITED STATES of America, Defendant-Appellee. William W. SCHELL; Laverne C. Schell, Plaintiffs-Appellants, v. UNITED STATES of America, Defendant-Appellee.
• Court: U.S. Court of Appeals — Fourth Circuit

Page 204

122 F.3d 204

80 A.F.T.R.2d 97-5937, 97-2 USTC P 50,596,

Pens. Plan Guide (CCH) P 23937V

George J. HEMELT; Theresa G. Hemelt, Plaintiffs-Appellants, v. UNITED STATES of America, Defendant-Appellee.

William W. SCHELL; Laverne C. Schell, Plaintiffs-Appellants, v. UNITED STATES of America, Defendant-Appellee.

Nos. 96-2827, 96-2828.

United States Court of Appeals, Fourth Circuit.

Argued July 9, 1997.

Decided Aug. 7, 1997.

ARGUED: Stephen Liddon Hester, Washington, DC, for Appellants. Kenneth W. Rosenberg, Tax Division, United States Department of Justice, Washington, DC, for Appellee. ON BRIEF: K. Peter Schmidt, Arnold & Porter, Washington, DC, for Appellants. Loretta C. Argrett, Assistant Attorney General, Kenneth L. Greene, Lynne A. Battaglia, United States Attorney, Tax Division, United States Department of Justice, Washington, DC, for Appellee.

Before WILKINSON, Chief Judge, LUTTIG, Circuit Judge, and BOYLE, United States District Judge for the Eastern District of North Carolina, sitting by designation.

Affirmed by published opinion. Chief Judge WILKINSON wrote the opinion, in which Judge LUTTIG and Judge BOYLE joined.

OPINION

WILKINSON, Chief Judge:

George Hemelt, William Schell and their spouses brought actions seeking to recover federal income and FICA taxes withheld from their portions of a settlement in a class-action ERISA lawsuit. The district court denied both claims, ruling that the settlement proceeds did not fall within the Internal Revenue Code's exception for "damages received ... on account of personal injuries or sickness," I.R.C. § 104(a)(2), and that they were "wages" subject to FICA taxation.

Taxpayers' challenges to these rulings are without merit. In Mertens v. Hewitt Associates, 508 U.S. 248, 113 S.Ct. 2063, 124 L.Ed.2d 161 (1993), the Supreme Court held that ERISA section 502(a)(3) cannot be the source of the sort of compensatory damages excluded from income by section 104(a)(2). As a result, and in light of FICA's broad definition of "wages" and the close relationship between the settlement awards and taxpayers' employment with Continental, the claims for FICA refunds must also fail. Accordingly, we affirm the judgment of the district court.

I.

In 1983, a class of employees laid off by Continental Can Company filed suit against their former employer under section 502 of the Employee Retirement Income Security Act of 1974 (ERISA), 29 U.S.C. § 1132. Plaintiffs alleged that Continental fired them to avoid incurring liability for their pensions in violation of section 510 of ERISA, 29 U.S.C. § 1140. McLendon v. Continental Group, Inc., 660 F.Supp. 1553, 1556 (D.N.J.1987), aff'd, 908 F.2d 1171 (3d Cir.1990). The district court in McLendon granted partial summary judgment to the plaintiffs on the issue of Continental's liability for violating ERISA. 660 F.Supp. at 1564-65. To facilitate settlement of the outstanding damages issues, the court appointed a Special Master. McLendon v. Continental Group, Inc., 749 F.Supp. 582, 612 (D.N.J.1989), aff'd, 908 F.2d 1171 (3d Cir.1990).

With the assistance of the Special Master, the parties to the class action negotiated a Settlement and Plan of Distribution that required Continental to pay a total of $415 million to approximately five thousand former employees. McLendon v. Continental Group, Inc., 802 F.Supp. 1216, 1220-21 (D.N.J.1992). The Special Master concluded that individualized determinations of the losses suffered by each class member would be too difficult and time-consuming. Thus, to allocate the $415 million, the Master devised formulas for two categories of recovery: the Basic Award and the Earnings Impairment Additur. The Basic Award was determined by factoring together each class member's age and years of service as of the time he was laid off. The Earnings Impairment Additur sought to approximate lost earnings capacity by comparing each class member's earnings after leaving Continental to the amount that class member would have earned at Continental had he not been laid off. Every member of the class received some amount as a Basic Award, and most members also received an Earnings Impairment Additur.

Applying the two formulas, Mr. Hemelt received a total award of $31,480, the combination of a $24,500 Basic Award and a $6,980 Earnings Impairment Additur. Continental withheld a portion of this award to cover its share of FICA and FUTA taxes. Continental also withheld federal and state income taxes and the employee's share of FICA taxes totaling $8,083.62, making the Hemelts' net proceeds from the settlement $20,613.09. Mr. Schell received a $58,124 Basic Award and a $16,744 Earnings Impairment Additur for a total award of $74,868. This amount was reduced by Continental's share of FICA and FUTA taxes, a contribution to a qualified pension plan, and a $15,502.20 deduction for federal and state income taxes and the employee's share of FICA taxes, resulting in a net award of $42,068.03.

In December 1993, the Hemelts and the Schells both sought refunds of the federal income taxes and FICA taxes they had paid on the settlement award in the 1992 tax year. They argued that since the settlement payments aimed to compensate them for personal injuries, including the anxiety and stress caused by their illegal layoff, the amounts should be excluded from income for tax purposes and should not be considered wages under FICA. The IRS disallowed the claims. Taxpayers then sued for refunds, maintaining that the settlement awards should be excluded from their gross income under section 104(a)(2) of the I.R.C. because they were received as settlement of claims for personal injury damages. As such, taxpayers further contended, the awards were not "wages" for the purpose of FICA taxation.

The district court determined that the settlement awards did not fit within the section 104(a)(2) exclusion of "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." See Hemelt v. United States, 951 F.Supp. 562, 568 (D.Md.1996). The court found that the Supreme Court's decision in Mertens foreclosed a ruling that the McLendon suit was an "action based upon tort or tort type rights," which is a necessary element of the test for excluding the awards from income under I.R.C. section 104(a)(2). 26 C.F.R. § 1.104-1(c); see also Commissioner v. Schleier, 515 U.S. 323, 335-36, 115 S.Ct. 2159, 2167, 132 L.Ed.2d 294 (1995). Granting the United States' motion for summary judgment in full, the district court also held, without discussion, that FICA wage taxes were properly withheld from the awards. Taxpayers now appeal.

II.

In order to claim the exemption from federal income taxation provided in I.R.C. section 104(a)(2), taxpayers seek to characterize the awards they received as satisfaction of tort-like claims for personal injury. The Supreme Court has squarely rejected this characterization by interpreting section 502(a) of ERISA to provide only for equitable relief, not for tort-like compensatory damages. Mertens, 508 U.S. at 258-59, 113 S.Ct. at 2069-70. Taxpayers deny that Mertens controls this case. They further argue that the parties' and the Special Master's belief that the McLendon settlement would provide damages for personal injuries controls the characterization of the awards. ^* We reject these attempts to avoid the Mertens decision.

A.

Taxpayers are right to insist that the tax treatment of the settlement payments at issue in these cases turns on the nature of the claims at issue in McLendon. What they fail to recognize is that Mertens is dispositive of that question.

The McLendon plaintiffs alleged that Continental's layoff practices violated section 510 of ERISA, which makes it "unlawful for any person to discharge ... a participant ... for the purpose of interfering with the attainment of any right to which such participant may become entitled under the plan." 29 U.S.C. § 1140. Thus, they sued under section 502(a), the civil enforcement provision of ERISA. Section 502(a) provides, in relevant part:

A civil action may be brought--

...

(3) by a participant, beneficiary, or fiduciary (A) to enjoin any act or practice which violates any provision of this subchapter or the terms of the plan, or (B) to obtain other appropriate equitable relief (i) to redress such violations or (ii) to enforce any provisions of this subchapter or the terms of the plan....

29 U.S.C. § 1132(a)(3).

In Mertens the Supreme Court plainly held that personal injury damages are not contemplated by section 502(a)(3) of ERISA, which authorizes suits only for injunctive relief and"other appropriate equitable relief" (emphasis added). The Court noted that compensatory damages are "the classic form of legal relief," and are not traditionally denominated "equitable." 508 U.S. at 255, 113 S.Ct. at 2068 (citations omitted). The Court also relied on the interpretation of virtually identical language in Title VII of the Civil Rights Act of 1964 in United States v. Burke, where the phrase "any other equitable relief as the court deems appropriate" was held to limit recovery to back pay, injunctions and other equitable remedies and not to allow"awards for compensatory or punitive damages." Id. (citing Burke, 504 U.S. 229, 238, 112 S.Ct. 1867, 1872-73, 119 L.Ed.2d 34 (1992)). The Mertens Court further concluded that an expansive interpretation of section 502(a)(3) to include money damages would distort the statute by giving the term "equitable relief" "a different meaning [in section 502(a)(3) ] than it bears elsewhere in ERISA." Mertens, 508 U.S. at 258, 113 S.Ct. at 2069.

By foreclosing the award of compensatory damages under ERISA section 502(a)(3), the holding in Mertens also foreclosed any assertion that the McLendon settlement falls within the 104(a)(2) exclusion. The class action award fails the basic test enunciated in Schleier for determining whether an award may...