Miller v. Comm'r of Internal Revenue
| Citation | 93 T.C. No. 29,93 T.C. 330 |
| Decision Date | 13 September 1989 |
| Docket Number | Docket No. 21113-87. |
| Parties | BONNIE A. MILLER, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent |
| Court | United States Tax Court |
OPINION TEXT STARTS HERE
In 1979 and 1982, P commenced civil actions for defamation. In 1983, the first action was tried, and a jury awarded P $500,000 in compensatory damages and $450,000 in punitive damages. After the verdict, P and the defendants in both actions settled P's claims. In 1983, P received $525,000 (after payment of costs and attorneys' fees) pursuant to the settlement agreement. HELD: Section 104(a)(2) excludes the settlement proceeds from gross income. HELD FURTHER: Any portion of the settlement proceeds characterized as punitive damages are nevertheless excluded from gross income by section 104(a)(2). Commissioner v. Glenshaw Glass Co., 348 U.S. 426 (1955), is distinguished. HELD FURTHER: Section 1.61-14(a), Income Tax Regs., is interpreted as consistent with this opinion. S. Ronald Ellison, for the petitioner.
Robert E. Williams, Jr., for the respondent.
Respondent determined a deficiency of $249,106.00 and an addition to tax pursuant to section 6661 1 of $62,254.00 against petitioner for 1983.
The instant case stems from petitioner's receipt of $525,000 in settlement of two defamation actions. We must decide (1) whether the settlement proceeds should be excluded from gross income pursuant to section 104(a)(2), (2) whether any portion of the proceeds characterized as punitive damages should also be excluded pursuant to section 104(a)(2), and (3) whether petitioner is liable for the section 6661 addition to tax.
The facts are fully stipulated. We hereby incorporate by reference the stipulation of facts and attached exhibits.
Petitioner resided in Westminister, Maryland, when she filed her petition.
On or about March 28, 1979, petitioner commenced an action (the ‘first action ‘) by filing a declaration (the ‘declaration‘) in the Superior Court of Baltimore City. The declaration named Cary Wellington, Sidney Rapkin, Publication Press, Inc. (‘Publication Press‘), and Graphic Arts Finishing Co., Inc. (‘Graphic Arts‘), as defendants. According to the declaration, Publication Press and Graphic Arts had employed petitioner as personnel manager. Mr. Wellington was chairman of the boards of both corporations, while Mr. Rapkin was the financial vice president of the corporations.
The declaration alleged a conspiracy by the defendants to accuse petitioner of embezzlement so that a bribery scheme could be concealed. Publication Press and Graphic Arts (collectively, ‘the companies‘) provided printing services to various government agencies. The companies had difficulty making timely delivery of printed material to the agencies. Sometime in 1977, the companies began paying government employees bribes for undated or backdated receipts for printed material. Through early 1979, the companies paid approximately $38,000 in bribes. Around March 1979, the defendants decided to shield themselves from responsibility for the bribery scheme by firing petitioner and accusing her of embezzling the $38,000. The companies fired petitioner on March 23, 1979.
Count I of the declaration alleged that Mr. Wellington accused petitioner of embezzlement in the presence of Mr. Rapkin and two other employees of the companies. Mr. Wellington made the accusation the day petitioner was fired. Counts II through VIII of the declaration alleged that Mr. Wellington told various employees of the companies that petitioner had been terminated for embezzlement.
Counts IX and X of the declaration alleged that Mr. Rapkin made similar allegations respecting petitioner to various employees of the companies.
Count XI of the declaration alleged that Mr. Wellington and Mr. Rapkin told the Internal Revenue Service that petitioner had received embezzlement income from the companies.
Count XII of the declaration alleged that the companies had made a claim on petitioner's fidelity bond, claiming a loss because of petitioner's embezzlement. Count XIII of the declaration alleged that the defendants had engaged in ‘extreme and outrageous conduct‘ that resulted in petitioner's emotional distress.
On or about November 30, 1982, petitioner commenced a second action (the ‘second action‘). She filed a declaration (the ‘second declaration‘) in the Circuit Court for Baltimore County. The second declaration named the Continental Insurance Company (‘Continental‘), The Glen Falls Insurance Company (‘Glen Falls‘), Underwriters Adjusting Company (‘Underwriters‘), Barry Bach, William Butler, David Gischel, Publication Press and Graphic Arts as defendants.
According to the second declaration, Glen Falls was the liability insurer for the companies. Continental was the corporate parent of Glen Falls, while Underwriters was another Continental subsidiary and adjusted claims against Glen Falls (collectively, Glen Falls, Continental, and Underwriters are referred to as ‘the insurance company defendants‘). Mr. Bach served as an attorney for Underwriters. Mr. Butler was the deliveryman for the companies who paid the bribes for undated and backdated receipts.
Petitioner's second declaration alleged that the insurance company defendants knew that the companies lacked a meritorious defense to the first action and that the insurance company defendants therefore conspired to defame petitioner so that her testimony at trial would be less credible. The second declaration also alleged that the insurance company defendants hired Mr. Butler to discredit petitioner.
Count I of the second declaration alleged that Mr. Butler told a group at ‘Shinberg's Bar‘ that petitioner had ‘unchaste‘ relations with the ‘Cash brothers.‘ The Cash brothers were independent contractors who built skids and pallets for the companies. Mr. Butler also told the group that petitioner had assisted the Cash brothers in overcharging the companies. Count II of the second declaration alleged that Mr. Butler made similar allegations in the companies' warehouse.
Count III of the second declaration alleged that Mr. Butler told another employee of the companies, Mr. Gischel, that petitioner had forged receipts for the delivery of skids and pallets from the Cash brothers. Count IV of the second declaration alleged that Mr. Gischel repeated the statement alleged in Count III to Mr. Newcomer, whose name had allegedly been forged by petitioner.
Count V of the second declaration alleged that various defendants had been negligent in employing Mr. Butler to investigate petitioner's first action.
Count VI of the second declaration alleged that defendants' extreme and outrageous conduct resulted in emotional distress to petitioner.
Petitioner's first action went to trial, and on October 6, 1983, a jury awarded petitioner $950,000, consisting of $500,000 in compensatory damages and $450,000 in punitive damages. No portion of the jury award was attributable to Count XIII of the first declaration, i.e., petitioner's claim for the intentional infliction of emotional distress.
After the jury award, petitioner and the defendants in both actions entered into settlement negotiations. The parties reached agreement. On or about November 22, 1983, petitioner signed a general release discharging all defendants in both actions from liability, in exchange for $900,000 (the ‘settlement proceeds‘). Petitioner filed an Order of Satisfaction in the first action and dismissed the second action. In December 1983, petitioner received $525,000 of the settlement proceeds (the ‘net settlement proceeds ‘), after petitioner's attorneys had deducted legal fees and costs of $375,000 from the settlement proceeds.
We must decide whether the net settlement proceeds 2 received by petitioner in 1983 constitute gross income. Generally, a taxpayer must include in gross income ‘all income from whatever source derived.‘ Sec. 61(a). One exception to this rule is provided by section 104(a)(2), which excludes from gross income ‘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 * * *.‘ Regulations broadly interpret this language as encompassing damages received through the litigation of ‘tort or tort type rights.‘ Sec. 1.104-1(c), Income Tax Regs. Thus, section 104(a)(2) does not exclude only recoveries for physical injury. Church v. Commissioner, 80 T.C. 1104, 1106 (1983). Rather, the proper inquiry is whether damages have been recovered for personal injury.
The very purpose of section 104(a)(2) is to exclude from income amounts which would otherwise have been taxed. The fact that punitive damages represent an accession to wealth and therefore would normally be included in gross income is no reason to preclude the application of section 104(a)(2). Indeed, even certain compensatory damages would seem to be includable in taxable income as an accession to wealth were it not for the existence of section 104(a)(2). For example, compensatory damages for personal injury are frequently measured by the injured party's lost future earnings. Such future earnings would have been accessions to wealth and would clearly have been taxable. Even respondent agrees that compensatory damages, that are determined by reference to lost future income, are excludable under section 104(a)(2). Rev. Rul. 85-97, 1985-2 C.B. 50.
By adopting the position expressed in the majority opinion, we avoid producing totally different results under section 104(a)(2), depending upon the characterization of tort damages under various state laws. For example, in Burford v. United States, 642 F. Supp. 635 (N.D. Ala. 1986), the cause of action which produced punitive damages at the state court level was an action for wrongful death. (A wrongful death action would seem to involve the ultimate personal injury.) Nevertheless, as the court in Burford noted, under Alabama law a wrongful...
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