Horton v. Comm'r of Internal Revenue

Decision Date09 February 1993
Docket NumberNo. 3386–91.,3386–91.
Citation100 T.C. No. 8,100 T.C. 93
PartiesErnest and Mary C. HORTON, Petitioners, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.
CourtU.S. Tax Court

OPINION TEXT STARTS HERE

Thomas J. Utaski, Cincinnati, OH, and Ljubomir Nacev, Highland Heights, KY for petitioners.

Roderick H. Fillinger, Cincinnati, OH, for respondent.

OPINION

RUWE, Judge:

Respondent determined a deficiency of $130,850 in petitioners' 1985 Federal income tax. After concessions, the only issue for decision is whether section 104(a)(2) 1 allows petitioners to exclude an award of punitive damages from taxable income.

This case was submitted fully stipulated pursuant to Rule 122(a). The stipulation of facts and attached exhibits are incorporated herein by this reference.

Petitioners resided in Florence, Kentucky, when they filed their petition in this case.

On December 1, 1981, a Boone County circuit court jury found Union Light, Heat and Power Co. (Union) liable for failing to detect a gas leak in petitioners' residence. This leak resulted in an explosion and resulting fire that destroyed petitioners' residence causing them personal injury.

The jury found that petitioner Ernest Horton was entitled to compensatory damages in the amount of $62,265 and also awarded punitive damages in the amount of $100,000. The jury found that petitioner Mary C. Horton was entitled to compensatory damages in the amount of $41,287 and also awarded punitive damages in the amount of $400,000. The punitive damage awards were based on a finding of gross negligence on the part of Union.

Upon entry of the judgment, Union paid the compensatory damages and appealed the issue of punitive damages to the Kentucky Court of Appeals, which reversed the circuit court on that issue. Petitioners appealed the reversal to the Kentucky Supreme Court. On April 11, 1985, that court reversed the court of appeals and reinstated the punitive damage awards. See Horton v. Union Light, Heat & Power Co., 690 S.W.2d 382 (Ky.1985). During 1985, Union paid $100,000 in punitive damages to petitioner Ernest Horton, and $400,000 in punitive damages to petitioner Mary C. Horton.

Petitioners excluded the punitive damage amounts from income on their 1985 Federal income tax return. Respondent determined that petitioners should have included those amounts in income, and therefore determined a deficiency. Petitioners timely filed a petition with this Court seeking a redetermination of that deficiency.

Section 104(a)(2) provides that gross income does not include:

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; [Emphasis added.2]

The phrase “damages received” is defined in the regulations 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.” Sec. 1.104–1(c), Income Tax Regs.

Respondent does not dispute that petitioners had an underlying claim against Union for personal injuries. The sole issue presented by the parties is whether the punitive damages, which petitioners received in addition to compensatory damages, are excludable from income pursuant to section 104(a)(2).3

We recently considered whether punitive damages received in a personal injury suit were excludable under section 104(a)(2) and held that they were. Miller v. Commissioner, 93 T.C. 330 (1989). We reasoned that:

Section 104(a)(2) excludes from gross income “any damages received * * * on account of personal injuries.” Congress enacted the predecessor of section 104(a)(2) as section 213(b)(6) of the Revenue Act of 1918. Pub.L. 65–254, 40 Stat. 1057, 1066. By that time, the availability of punitive or exemplary damages had long been established. Note, “Exemplary Damages in the Law of Torts,” 70 Harv.L.Rev. 517, 518–520 (1957). Congress, aware of that fact, could have excluded only “compensatory damages” or provided that only damages received “as compensation for” personal injuries be excluded. * * * It did neither, and the plain meaning of the broad statutory language simply does not permit a distinction between punitive and compensatory damages. See Crane v. Commissioner, 331 U.S. 1, 6 (1947) (“the words of statutes—including revenue acts—should be interpreted where possible in their ordinary, everyday senses.”). Thus, we read “any damages” to mean “all” damages, including punitive damages. Webster's Third New International Dictionary (1981). [ Id. at 338.]

The Court of Appeals for the Fourth Circuit reversed our holding in Miller, 914 F.2d 586 (4th Cir.1990). The Court of Appeals agreed that the underlying cause of action in Miller (defamation) was an action for personal injury but, nevertheless, held that the portion of the award attributable to punitive damages was not excludable under section 104(a)(2). The court first found the language of section 104(a)(2) excluding “any damages received * * * on account of personal injuries” to be ambiguous. The court then interpreted this statutory language narrowly so as to apply only to damages intended to make the taxpayer whole, as opposed to awards that generate a gain or profit. Looking to the applicable State law (Maryland) pursuant to which the damages were awarded, the court concluded that the punitive damages in Miller were awarded for “purely punitive” purposes and not to compensate for loss caused by the personal injury.

We have previously rejected the concept that section 104(a)(2) excludes only amounts that restore lost capital as opposed to amounts that would otherwise constitute gains or accessions to wealth. Downey v. Commissioner, 97 T.C. 150, 161 (1991); 4 Miller v. Commissioner, 93 T.C. at 338. After careful consideration of the views of the Fourth Circuit, we reaffirm our holding in Miller that punitive damages received as a result of a personal injury claim are excludable under section 104(a)(2).5 The beginning and end of the inquiry should be whether the damages were paid on account of “personal injuries”. This inquiry is answered by determining the nature of the underlying claim. Once the nature of the underlying claim is established as one for personal injury, any damages received on account of that claim, including punitive damages, are excludable.

The Supreme Court's recent opinion in United States v. Burke, 504 U.S. 229, 112 S.Ct. 1867 (1992), supports the analysis that we have adopted. In that case, the taxpayers contended that backpay 6 awarded in a sex discrimination suit under title VII of the Civil Rights Act of 1964 was excludable from income under section 104(a)(2). In Burke v. United States, 929 F.2d 1119, 1121 (6th Cir.1991), the Sixth Circuit applied a section 104(a)(2) analysis that is identical to this Court's stating:

determining whether the § 104(a)(2) exclusion applies requires an examination of the nature of the injury to determine whether the injury and claim are personal and tort-like in nature, and not whether the consequences of the injury resulted in an award of compensatory damages or damages for back pay. * * *Relying on our analysis in Threlkeld v. Commissioner, 87 T.C. 1294 (1986), affd. 848 F.2d 81 (6th Cir.1988), the Sixth Circuit held:

In sum, Threlkeld and its progeny require that for the purposes of § 104(a)(2), this court determine whether the injury is personal and the claim resulting in the damages is tort-like in nature. If the answer is in the affirmative, then that is “the beginning and end of the inquiry.” Threlkeld, 87 T.C. at 1299. The damages resulting from such a claim are fully excludable under § 104(a)(2). * * * [ Burke v. United States, 929 F.2d at 1123.]

Although the Supreme Court reversed the Court of Appeals holding that the underlying title VII claim was tort-like in nature, the Supreme Court expressly adopted the Sixth Circuit's section 104(a)(2) analysis, which focused on the nature of the underlying claim, rather than on the type of damages received.

We thus agree with the Court of Appeals' analysis insofar as it focused, for purposes of § 104(a)(2), on the nature of the claim underlying * * * [the taxpayers'] damages award. See 929 F.2d, at 1121; Threlkeld v. Commissioner, 87 T.C., at 1305. * * * [ United States v. Burke, 504 U.S. at ––––, 112 S.Ct. at 1872.]

Relying on section 1.104–1(c), Income Tax Regs., the Supreme Court interpreted the words “damages received” as “an amount received * * * through prosecution of a legal suit or action based upon tort or tort type rights”. Id. at ––––, 112 S.Ct. at 1870. Therefore, if the taxpayer's underlying claim was based upon a tort-type personal injury and the damages in question were received through prosecution of that claim, they are excludable. Downey v. Commissioner, supra at 161; Miller v. Commissioner, 93 T.C. at 337; Threlkeld v. Commissioner, supra at 1308. As the Supreme Court stated:

(“The essential element of an exclusion under section 104(a)(2) is that the income involved must derive from some sort of tort claim against the payor * * * [ United States v. Burke, 504 U.S. at ––––, 112 S.Ct. at 1870 (quoting Threlkeld v. Commissioner, supra at 1305).]

While Justice O'Connor, joined by Justice Thomas, dissented from the majority's holding that the title VII claim was not a tort-type action, the dissenting opinion was in full agreement with the majority that the essential determination for excludability under section 104(a)(2) was the nature of the underlying claim.

Section 104(a)(2) allows taxpayers to exclude from gross income “damages received ... on account of personal injuries or sickness.” The Court properly defers to an Internal Revenue Service (IRS) regulation that reasonably interprets the words “damages received” to mean “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...

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    ...in section 104(a)(2) is that the damages be received “ on account of personal injuries or sickness”. See Horton v. Commissioner, 100 T.C. ––––, –––– (1993) (Whalen, J., dissenting). Absent the 1982 amendment, I would not be persuaded that that condition has been met. Indeed, the purposes of......
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    ...the Supreme Court's footnote as an "indicat[ion] that FICA taxation may be a different matter").5 But see Horton v. Commissioner, 100 T.C. 93, 1993 WL 28557 (1993), affirmed by, 33 F.3d 625 (6th Cir.1994).6 In support of this assertion, the concurrence states that ADEA liquidated damages ar......
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    ...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 ......
  • Srivastava v. Commissioner, Docket No. 26605-95.
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    ...were received pursuant to a settlement of a tortlike personal injury that resulted in: * * * punitive damages, Horton v. Commissioner [Dec. 48,856], 100 T.C. 93, 96 (1993); see also Miller v. Commissioner [Dec. 46,021], 93 T.C. 330, 337-342 (1989), revd. [90-2 USTC ¶ 50,511] 914 F.2d 586 (4......
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2 books & journal articles
  • Planning for the Tax Exclusion of Employment-related Damages
    • United States
    • Colorado Bar Association Colorado Lawyer No. 22-11, November 1993
    • Invalid date
    ...93-2 USTC ¶ 50,447 (Ct. Cl. 1993) (punitive damages in sex discrimination case are taxable under unamended § 104); Horton v. Commissioner, 100 T.C. 93 (1993) (punitive damages excludible from gross income prior to 1989 amendment of § 104); Miller v. Commissioner, 914 F.2d 586 (4th Cir. 1990......
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