Rickel v. C.I.R., No. 89-1529

• Court: United States Courts of Appeals. United States Court of Appeals (3rd Circuit)
• Writing for the Court: Before SLOVITER, HUTCHINSON and COWEN; COWEN
• Citation: 900 F.2d 655
• Decision Date: 03 April 1990
• Docket Number: No. 89-1529
• Parties: 52 Fair Empl.Prac.Cas. 1389, 106 A.L.R.Fed. 301, 53 Empl. Prac. Dec. P 39,835, 65 A.F.T.R.2d 90-800, 58 USLW 2595, 90-1 USTC P 50,200 Frank E. & Mildred E. RICKEL, Appellants, v. COMMISSIONER OF INTERNAL REVENUE.

Page 655

900 F.2d 655 52 Fair Empl.Prac.Cas. 1389, 106 A.L.R.Fed. 301,
53 Empl. Prac. Dec. P 39,835, 65 A.F.T.R.2d 90-800,
58 USLW 2595, 90-1 USTC P 50,200 Frank E. & Mildred E. RICKEL, Appellants,
v.
COMMISSIONER OF INTERNAL REVENUE. No. 89-1529. United States Court of Appeals,
Third Circuit. Argued Jan. 22, 1990.
Decided April 3, 1990.

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Dixon R. Rich (argued) and Dixon R. Rich, Jr., Rich, Fluke, Tishman & Rich, Pittsburgh, Pa., for appellants.

Shirley D. Peterson, Asst. Atty. Gen., Gary R. Allen, Ann Belanger Durney and Bruce R. Ellisen (argued), Attys., Tax Div., U.S. Dept. of Justice, Washington, D.C., for appellee.

Before SLOVITER, HUTCHINSON and COWEN, Circuit Judges.

OPINION OF THE COURT

COWEN, Circuit Judge.

The appellant Frank E. Rickel ("the taxpayer") ¹ received $80,000 from his former employer in 1983 and $25,000 in 1984 pursuant to a settlement of his Age Discrimination in Employment Act ("ADEA") lawsuit. This appeal requires us to decide whether the United States Tax Court properly determined that one-half of this settlement represented taxable income. Because we conclude that the entire settlement amount is excludable under 26 U.S.C. Sec. 104(a)(2) ², we will reverse the order of the Tax Court.

I.

The relevant facts of this case are not contested. The taxpayer was employed by Malsbary Manufacturing Company ("Malsbary"), Uniontown, Pennsylvania, as a general sales manager. In March 1979, when the taxpayer was 56 years old, the position of president opened up at the company. Despite the taxpayer's qualifications and past suggestions from company officials that the taxpayer would be considered for the post, the company hired a much younger individual as president.

Subsequently, the new president told the taxpayer that he wanted someone younger for the position of general sales manager. The taxpayer was thereafter relieved of his position in favor of a 37 year old individual, placed on partial pay, and eventually discharged on December 31, 1979.

After receiving a right to sue letter from the EEOC, the taxpayer brought suit in federal court against Malsbary and its parent, Carlisle Corporation ("Carlisle"), alleging a violation of the ADEA, 29 U.S.C. Secs. 621-634 (1982). The taxpayer's amended

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complaint contained the following prayers for relief:

A. Order defendants jointly and/or severally to employ the plaintiff as President of Malsbary; or in the alternative to reinstate plaintiff to his former or a comparable position;

B. Order the defendants jointly and/or severally to pay back wages, benefits and other compensations found by the Court to be due plaintiff, together with interest thereon from the date when such amount became due;

C. Grant a judgment requiring defendants jointly and/or severally to pay appropriate back wages and an equal sum as liquidated damages, to plaintiff who has been adversely affected by the unlawful employment practices described herein;

D. Award counsel for plaintiff reasonable attorney's fees and expenses;

E. Award any further relief which is appropriate and proper under the circumstances.

App. at 58-59.

The taxpayer's action was tried before a jury in a bifurcated trial. The jury first heard evidence on the issue of liability. After the testimony, four interrogatories were submitted to the jury for their consideration:

(1) Was plaintiff ... qualified in April 1979 for the position of President of Malsbary ...?

(2) Was age a determinative factor in the decision not to promote the plaintiff?

(3) Was plaintiff ... qualified in August 1979 for the position of General Sales Manager of Malsbary ...?

(4) Was age a determinative factor in the decision to discharge the plaintiff from his job as General Sales Manager?

App. at 86.

While the jury was deliberating, the parties reached a settlement. The specific terms of the settlement depended upon the jury's answers to the interrogatories. When the jury answered all the questions affirmatively, the defendants were obligated to pay the taxpayer $80,000 immediately and $25,000 during each of the next four years. The settlement agreement did not allocate the settlement amount among the taxpayer's various prayers for relief.

Carlisle made the first payment of $80,000 in 1983, and paid $25,000 during each of the succeeding four years. ³ Only the receipt of $80,000 in 1983 and $25,000 in 1984 are at issue in this appeal. Carlisle did not withhold Federal income or Social Security tax from any of the payments. The taxpayer neither reported the $80,000 or the $25,000 as gross income nor disclosed these amounts on his 1983 and 1984 tax returns.

In a statutory notice of deficiency, the Commissioner of the Internal Revenue ("Commissioner") determined that the entire amount of $105,000 was taxable income. The Commissioner argued that the settlement proceeds represented either back pay or punitive damages, both of which the Commissioner asserted were taxable items of income. The taxpayer petitioned the Tax Court seeking a redetermination of the deficiency.

After a trial, the Tax Court found that one-half, i.e. $40,000 in 1983 and $12,500 in 1984, of the settlement was taxable income. The Court found that the other half of the settlement was excludable under Sec. 104(a)(2). In addition, the Tax Court also denied the taxpayer's motion for reasonable litigation costs. This appeal followed. We have jurisdiction over taxpayer's appeal pursuant to 26 U.S.C. Sec. 7482(a).

II.

The Internal Revenue Code ("IRC") states that "[e]xcept as otherwise provided ..., gross income means all income from whatever source derived...." 26 U.S.C. Sec. 61(a). Accordingly, any accession to wealth is presumed to be gross income, unless the taxpayer can demonstrate that the accession fits into one of the specific exclusions created by other sections of the IRC. Commissioner v. Glenshaw Glass

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Co., 348 U.S. 426, 429-30, 75 S.Ct. 473, 475-76, 99 L.Ed. 483 (1955).

The exclusion at issue here is Sec. 104(a)(2) which reads in relevant part: "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...." ⁴ Since the appropriate question to ask for purposes of Sec. 104(a)(2) is whether the damages were received on account of personal injuries, Threlkeld v. Commissioner, 87 T.C. 1294, 1305 (1986), aff'd, 848 F.2d 81 (6th Cir.1988) (full Tax Court), it is important to determine exactly what the term "personal injuries" means for the purposes of the IRC.

Unfortunately, neither the statute, Treasury regulations nor legislative history provides much guidance. Id. However, it is judicially well-established that the meaning of "personal injuries" in this context encompasses both nonphysical as well as physical injuries. Bent v. Commissioner, 835 F.2d 67, 70 (3d Cir.1987); Roemer v. Commissioner, 716 F.2d 693, 697 (9th Cir.1983); Threlkeld, 87 T.C. at 1297; Seay v. Commissioner, 58 T.C. 32, 40 (1972). See generally, L. Frolik, Federal Tax Aspects of Injury, Damage, and Loss 59 (1987). In addition, the Treasury regulations narrow the scope of excludable "damages" to "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 C.F.R. Sec. 1.104-1(c) (1989). See generally Threlkeld, 87 T.C. at 1297. Thus, "[t]he 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." Glynn v. Commissioner, 76 T.C. 116, 119 (1981), aff'd without published opinion, 676 F.2d 682 (1st Cir.1982). See also Byrne v. Commissioner, 883 F.2d 211, 214 (3d Cir.1989) ("As defined by the relevant regulation, personal injury claims assert violations of 'tort or tort type rights' "). Accord Threlkeld, 87 T.C. at 1305.

Consequently, the Tax Court has long held that "[i]f a taxpayer receives a damage award for a physical injury, which almost by definition is personal, the entire award is excluded from income [under Sec. 104(a)(2) ] even if all or part of the recovery is determined with reference to the income lost because of the injury." Threlkeld, 87 T.C. at 1300. The compensation is exempt whether paid for earnings lost prior to the award or settlement, or for expected future earnings. Frolik, supra p. 658, at 9. As one commentator has explained:

Compensation [in the physical injury context] for loss of earnings is excludable even though the lost earnings would have been taxable if earned. Suppose, for example, that a taxpayer is tortiously injured, sues, and settles for $5,000, which is allocated $1,000 for pain and suffering, $2,000 for medical expenses, and $2,000 for wages lost prior to the settlement. Under Sec. 104(a)(2), the entire $5,000 is tax exempt. Of course, if the taxpayer had not been injured and had actually earned the $2,000 in wages, that money would have represented an addition to gross income. Injured taxpayers who recover lost earnings are better off, in terms of taxes, than they would have been if they had not been injured.

Id.

However, the Tax Court has long treated claims for nonphysical personal injuries quite differently. In the nonphysical injury context, before deciding the tax consequences of an award or settlement, the Tax Court has mounted an initial inquiry to determine whether each of the components of the injury are personal or nonpersonal. Threlkeld, 87 T.C. at 1300. For example, if some of the damages received for the nonphysical injury are for mental or physical strain or personal embarrassment, then that portion of the recovery is excludable;

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yet if some of the damages are recovered for economic or professional losses, e.g., back pay or lost income, then that portion of the recovery is taxable income. See, e.g., Coats v. Commissioner, 36 T.C.M. (CCH) 1650 (1977);...