Whitley v. Commissioner

Decision Date15 April 1999
Docket NumberDocket No. 12947-97.
Citation77 T.C.M. 1810
PartiesNorris O. and Betty J. Whitley v. Commissioner.
CourtU.S. Tax Court

James Richard Cox, for the petitioners. Jeanne Gramling, for the respondent.

MEMORANDUM OPINION

LARO, Judge:

This case is before the Court fully stipulated. See Rule 122. Norris O. and Betty J. Whitley petitioned the Court to redetermine deficiencies of $75,694 and $263 in their 1992 and 1993 Federal income tax, respectively. Following petitioners' concessions, we must decide whether their 1992 gross income includes $250,000 in punitive damages that they received during 1992. We hold it does. Unless otherwise indicated, section references are to the Internal Revenue Code in effect for 1992. Rule references are to the Tax Court Rules of Practice and Procedure. Although Betty J. Whitley is a copetitioner, we hereinafter refer to Norris O. Whitley as the sole petitioner.

Background

All facts have been stipulated and are so found. The stipulation of facts and exhibits submitted therewith are incorporated herein by this reference. Petitioner and Betty J. Whitley are husband and wife. They filed joint 1992 and 1993 Federal income tax returns. They resided in Sumter, South Carolina, when they petitioned the Court.

Petitioner began working as an agent for Academy Life Insurance Company (Academy) in the late 1970's. He worked for it as an independent contractor under a contract between the two. Academy fired him in July 1986. When it did, it was contractually obligated to pay him renewal commissions on policies that he or an agent under his supervision had sold. After his firing, Academy remitted to him reduced monthly commissions. It also stopped sending to him the paperwork documenting his commissions.

In September 1987, petitioner sued Academy for breach of contract and conversion, praying in his complaint for an award of actual and punitive damages. Petitioner alleged that Academy was liable to him for: (1) An unlawful termination of contracts with resulting failure to pay money due thereunder (breach of contract and conversion), (2) unfair trade practices (also seeking treble damages and attorney's fees), (3) a termination of resident counselor status, (4) a failure to pay commissions, and (5) the fraudulent filing of Federal tax forms reporting income not paid to him. Following a jury trial, the United States District Court hearing the case directed a verdict against Academy for breach of contract and sent the issues of conversion and resulting damages to the jury. The judge instructed the jury as follows with respect to punitive damages:

The plaintiffs [petitioner and another person not relevant herein] are also seeking punitive damages in their conversion cause of action.

The law permits the jury, under certain circumstances, to award punitive damages in order to punish a wrong-doer for some extraordinary misconduct, and to serve as a warning not to engage in such conduct in the future.

Thus, if you find that the plaintiffs have shown by a preponderance of the evidence, that the defendant converted the plaintiffs' money with malice, ill will, a conscious indifference to the rights of others, or a reckless disregard for the rights of others, you may award the plaintiffs punitive damages.

If you so find, it becomes your right to award punitive damages in such an amount as you unanimously agree to be proper in light of the character of the wrong committed, the punishment which should be applied, and the ability of the defendant to pay.

The jury found against Academy on the conversion claim and awarded $25,390 in actual damages for unpaid commissions and $250,000 in punitive damages, together with interest and costs. That verdict was affirmed upon appeal.

Academy paid $250,000 in punitive damages to petitioner in 1992. Petitioner did not report any of this amount on his 1992 Federal income tax return.

Discussion

We must decide whether petitioner received the punitive damages on account of a personal injury. To the extent that he did, the funds are excludable from his gross income. See sec. 104(a)(2). To the extent that he did not, the funds are includable in his gross income. See sec. 61(a). Because respondent determined that the punitive damages are includable in petitioner's gross income, petitioner must prove otherwise. See Rule 142(a); Welch v. Helvering [3 USTC ¶ 1164], 290 U.S. 111, 115 (1933).

Petitioner concedes that his gross income includes the actual damages of $25,390 which were awarded to him for unpaid commissions. As to the punitive damages, petitioner argues that these damages are excludable from his gross income under section 104(a)(2). Petitioner asserts that he received the punitive damages on account of his claim of conversion, which, he states, is a tort under applicable State (South Carolina) law, and that he received the punitive damages on account of a personal injury. Petitioner asserts that South Carolina law provides that punitive damages are compensatory in nature in that they reimburse a plaintiff for personal injury. Respondent agrees with petitioner's characterization of conversion as a tort under South Carolina law but asserts that the punitive damages were not paid to petitioner on account of a personal injury. Respondent asserts that Academy paid the punitive damages to petitioner on account of its reprehensible behavior.

We agree with respondent that the punitive damages are not excludable from petitioner's gross income under section 104(a)(2). Section 104(a)(2) sets forth a narrowly construed provision under which proceeds from a lawsuit are excluded from gross income to the extent: (1) The cause of action underlying the recovery of the proceeds is based upon tort or tort type rights, and (2) the proceeds are received on account of a personal injury or sickness.1 That section is inapplicable when either requirement is not met. See sec. 104(a)(2); Commissioner v. Schleier [95-1 USTC ¶ 50,309], 515 U.S. 323, 336-337 (1995); United States v. Burke [92-1 USTC ¶ 50,254], 504 U.S. 229, 233 (1992); sec. 1.104-1(c), Income Tax Regs.

In O'Gilvie v. United States, 519 U.S. 79 (1996), the Supreme Court held that Section 104(a)(2) did not reach punitive damages which were awarded under Kansas law to the taxpayers, the husband and two children of a woman who died of toxic shock syndrome. The taxpayers had recovered those damages in a tort action filed against the maker of a product that caused the decedent's death. The Court held that the taxpayers did not receive the punitive damages on account of personal injury because the damages were not awarded as compensation for the injury suffered by them or by the decedent but to punish and deter the tortfeasor's reprehensible conduct. See id.

Petitioner recognizes the holding in O'Gilvie v. United States, supra, but argues that it is inapplicable. First, petitioner states, South Carolina law provides that punitive damages are compensatory in nature, whereas Kansas law provides that punitive damages are entirely punitive. Second, petitioner states, the fact that many decisions prior to O'Gilvie were inconsistent with the decision there requires that we apply O'Gilvie prospectively. Petitioner makes a similar argument for a prospective application of Commissioner v. Schleier, supra, and United States v. Burke, supra.

We disagree with petitioner's assertion that Academy paid him the punitive damages on account of a personal injury. The award of punitive damages to him was not paid on account of a personal injury to the extent that the damages are noncompensatory in nature. See O'Gilvie v. United States, supra. Whether the damages are noncompensatory in nature rests on applicable State law, see Bagley v. Commissioner [Dec. 51,047], 105 T.C. 396, 417 (1995), affd. [97-2 USTC ¶ 50,586] 121 F.3d 393 (8th Cir. 1997), which, in this case, is the law of South Carolina. Under South Carolina law, an award of punitive damages is based upon the defendant's wrongdoing, rather than the extent of the plaintiff's injury; an award of compensatory damages, on the other hand, is based upon the extent of the plaintiff's injury, rather than the defendant's wrongdoing. See South Carolina Farm Bureau Mut. Ins. Co. v. Love Chevrolet, Inc., 478 S.E.2d 57, 59 (S.C. 1996) (a claim for punitive damages may go to the jury only if "the defendant's conduct rises to the level of culpability warranting a punitive damage award"); Laird v. Nationwide Ins. Co., 134 S.E.2d 206, 210 (S.C. 1964) (quoting Bowers v. Charleston & W. C. Ry. Co., 42 S.E.2d 705 (S.C. 1947) ("compensatory damages are damages in satisfaction of * * * loss or injury sustained. Punitive damages are allowed in the interest of society in the nature of punishment and as a warning and example to deter the wrongdoer and others from committing like offenses in the future.")); see also Clark v. Cantrell, 504 S.E.2d 605, 609 (S.C. Ct. App. 1998) (punitive damages are not compensatory in nature under the law of South Carolina) (citing Hubbard & Felix, Comparative Negligence in South Carolina: Implementing Nelson v. Concrete Supply Co., 43 S.C. L. Rev. 273, 314 (1992)).2 Punitive damages serve under South Carolina law to punish the defendant and to deter unacceptable behavior. See Gamble v. Stevenson, 406 S.E.2d 350, 354 (S.C. 1991); Macmurphy v. South Carolina, 367 S.E.2d 150, 151 (S.C. 1988); Laird v. Nationwide Ins. Co., supra at 210; Bowers v. Charleston & W. C. Ry., supra; see also Gilbert v. Duke Power Co., 179 S.E.2d 720, 723 (S.C. 1971) (citing Davenport v. Woodside Cotton Mills Co., 80 S.E.2d 740 (1954) (punitive damages serve to punish a wrongdoer when the plaintiff proves that the wrongdoer violated the plaintiff's rights in a "wanton, willful or malicious" way). Punitive damages do not serve under South Carolina law to reimburse a victim for actual damages. See Laird v. Nationwide Ins. Co., supra at 210; Bowers v. Charleston & W. C. Ry., supra...

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