1 United States Court of Appeals,

Fifth Circuit.

No. 94-41023.

Edward E. ROBINSON & Sandra Robinson, Petitioners-Appellees,

Cross-Appellants,

v.

COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellant, CrossAppellee.

Dec. 5, 1995.

Appeal from a decision of the United States Tax Court.

Before REYNALDO G. GARZA, GARWOOD and DUHÉ, Circuit Judges.

REYNALDO G. GARZA, Circuit Judge:

I.

BACKGROUND

Edward and Sandra Robinson obtained a $60,000,000 jury verdict

a gainst a bank for wrongful failure to release a lien . This

$60,000,000 included $6,000,000 for lost profits, $1,500,000 for

mental anguish, and $50,000,000 in punitive damages. The Robinsons

then settled their claims against the bank for $10,000,000 plus the

release of a judgment that the bank held against the petitioners in

the amount of $691,972.43 while the trial court was considering the

bank's mo tion for a new trial. In the final judgment reflecting

the settlement, which was drafted by the parties and signed by the

trial judge, 95% of the set tlement proceeds were allocated to

mental anguish and 5% were allocated to lost profits.

The Robinsons received $4,935,152.43 of the settlement

proceeds after paying attorneys' fees and costs. Of that amount,1 26 U.S.C. § 104(a)(2).

2

they only rep orted five percent of the proceeds ($246,758)—the

amount allocated to lost profits—as income on their 1987 joint

income tax return. They contended that the other 95% was

excludable under Section 104(a)(2) of the Internal Revenue Code as

"damages received

... on account of personal injuries or

sickness." 1

The Internal Revenue Service ("IRS") considered 95%, rather

than 5%, of the proceeds to be taxable, and recomputed the

Robinsons' taxable income by adding 90% of the proceeds received by

the Robinsons ($4,400,000). This added income eliminated a carried

forward net-operating-loss deduction claimed in the 1988 tax year,

and the IRS noticed deficiencies for the 1987 and 1988 tax years.

The Robinsons then petitioned the Tax Cou rt for redetermination,

arguing that 95% of the settlement proceeds were excludable under

Section 104.

At trial, the IRS discovered and asserted a n additional

deficiency based on the Robinson's discharge-of-indebtedness income

from the bank's release of the $691,972.43 judgment in conjunction

w ith the settlement. The Tax Court allowed the IRS to amend its

pleadings to assert this discharge-of-indebtedness income.

After hearing the evidence and the parties' arguments, the Tax

Court rendered judgment. It first found that the allocation of the

settlement proceeds did not reflect the damages that the Robinsons

suffered. Instead, the Robinsons were allowed to allocate the

settlement proceeds in a manner that minimized their tax liability.3

The Tax Court therefore refused to recogniz e the allocation

contained in the final judgment, and rea llocated the settlement

proceeds among the various elements of damages that t he jury

awarded the Robinsons in their suit against the bank.

The Tax Court allocated the settlement proceeds based on the

relationship of certain amounts awarded to the Robinsons by the

jury. Because the Tax Court agreed that the punitive damages may

have been reduced on appeal, it first allocated the proceeds based

on the amounts awarded by the jury for compensatory damages. It

t hen allocated the remaining balance to punitive damages. Using

this method, the Tax Court allocated the proceeds as follows:

Actual Damages: Damages Percentage of Damages

Lost Profits $6,000,000 60.893

Other Business Damages 175,000 1.776

Injury to Credit Reputation 85,000 .863

Mental Anguish 1,500,000 15.223

Punitive Damages: 2,093,360 21.245

_________ ______

Settlement Less Prejudgment Interest $9,853,360 100.000

______

Prejudgment Interest 146,640

_________

Total Settlement Payment $10,000,0002 The Tax Court held that 100% of the amount allocated to

prejudgment interest was includable in income.

4 _________

The Tax Court then allocated the settlement proceeds based on

the percentage of damages attributed to each item o f damage. It

therefore allocated 37.331% of the proceeds—the amounts

attributable to punitive damages (21.245%), mental anguish

(14.223%) and injury to credit reputation (.863%)—to damages for

tort-li ke personal injuries. The Tax Court then held that

$1,787,599.30—the 3 7.331% of the net payment (less prejudgment

interest) 2 attributable to tort-like injuries—was excludable under

Section 104, and that the balance of the net payment (including

prejudgment interest) was includable in the Robinsons' 1987 gross

income.

The Commissioner of Interna l Revenue then appealed the Tax

Court's exclusion of the portion of settlement proceeds allocable

to punitive damages. The Robinsons cross-appealed, arguing that

the Tax Court erred in its allocation of the proceeds, its refusal

to subpoena the trial judge who presided over their suit against

the bank, and its refusal to reopen the record to allow them to

demonstrate deductions that would offset the

discharge-of-indebtedness income.

II.

THE COMMISSIONER'S APPEAL

The Tax Court held that the portion of the Robinsons'

settlement attributabl e to punitive damages was excludable from3 26 U.S.C. § 104(a)(2).

4 Estate of Moore v. Commissioner, 53 F.2d 712, 716 (5th

Cir.1995).

5 The Tax Court held that 100% of the prejudgment interest

was included in income. The Robinsons did not appeal this

holding.

5 their gross income as "damages received

... on account of personal

injuries or sickness" under Section 104(a)(2) of the Internal

Revenue Code. 3 The Commissioner appeals from this holding, arguing

that, because they are not intended t o compensate plaintiffs for

personal injuries, punitive damages are not excludable from gross

income under Section 104(a)(2). This Court recently held that

punitive damages awarded under Te xas law are not intended to

compensate, and are therefore not excludable under Section

104(a)(2). 4 Accordingly, we reverse the Tax Court on this issue

and hold that the por tion of the Robinsons' settlement proceeds

allocable to punitive damages are not excludable under Section

104(a)(2).

Because the proceeds allocable to p unitive damages are not

excludable, the Robinsons must include the 24.241% of

$4,788,511.72, the net settlement payment (less prejudgment

interest), 5 as well as 24 .241% of the $691,972.43 discharge of

indebtedness. However, because the parties agreed that the

Ro binsons were allowed to deduct the non-excludable portions of

part of the discharged indebtedness, namely the $55,337.44 in

interest and $57,875.91 in attorney fees, the Robinsons should be

allowed to deduct an additional 24.241% of these amounts.6 Cf. Commissioner of Internal Revenue v. Estate of Bosch,

387 U.S. 456, 463-64, 87 S.Ct. 1776, 1781-82, 18 L.Ed.2d 886

(1967) (quoting S. R EPT

. N O . 1013, 80th Cong., 2d Sess., pt. 2, at

4 (1948)).

6 III.

THE ROBINSONS' CROSS-APPEAL

A.

THE ALLOCATION OF THE SETTLEMENT PROCEEDS

The Robinsons contend that the Tax Court erred in reallocating

the settlement proceeds among the various types of damages that

they suffered. They argue that the Tax Court failed to give

"proper regard" to the state court trial judge's allocation of

ninety-five percent of th e settlement proceeds to mental anguish

and five percent to lost profits.

Although the Tax Court is not bound by a state court's

allocation of settlement proceeds, it must give "proper regard" to

allocations made by state courts when such allocations are entered

by the court in a bona fide adversary proceeding. 6 In the case at

bar, however, the Tax Court found that the allocation was not

entered in a bona fide adversary proceeding. Further, it found

that the state trial court simply "ru bber stamped" a judgment

drafted by the Robinsons' attorneys. Therefore, the Tax Court did

not consider itself bound by the state court's allocation, and

reallocated the settlement proceeds.

The Tax Court's findings that the allocation was not entered

into in an adversary proceeding and that the judgment was simply

"rubber stamped" by the state court are findings of fact, which7 Switzer v. Wal-Mart Stores, Inc., 52 F.3d 1294, 1298 (5th

Cir.1995).

8 The Robinsons' lead counsel testified as follows:

I asked [the Bank's counsel], would there be any

objection on their part on how [a settlement] would be

structured if we went in and set the [judgment based on

the jury verdict] aside. He said, "None."

He said, "We don't care how you do it, just so it

is paid and we can get it over with, and we will

cooperate with you in any way you see fit. If you can

get any tax benefit, fine." If you-you know, he didn't

have any ax to grind. He didn't care. He made it

plain.

7 this Court will only disturb upon a finding of clear erro r. 7 We

hold that the trial court did not err in its factual findings. The

testimony of the attorneys who represented the Robinsons in their

suit against the bank supports the Tax Court's finding that the

bank allowed the Robinsons to allocate the settlement proceeds in

any manner they wished. 8 This testimony alone supports a finding

that the Robinsons and the bank were not adversarial in the

allocation of the sett lement proceeds. The circumstances

surrounding the state court judge's entry of judgment also support

the trial court's findings. The parties presented the final

judgment to t he trial judge at his home in the evening. The

meeting at the judge's home last ed no longer than one hour, and

neither the final judgment nor th e settlement agreement were

discussed in detail during that meeting. Therefore, the Tax Court

did not err in failing to give proper regard to the state court

judgment's allocation of settlement proceeds.

The Tax Court also did not err in its allocation of the9 Tiberi v. CIGNA Ins. Co., 40 F.3d 110, 112 (5th Cir.1994).

10 Washington v. Strickland, 693 F.2d 1243, 1263 (5th

Cir.1982), rev'd on other grounds, 466 U.S. 668, 104 S.Ct. 2052,

80 L.Ed.2d 674 (1984). See United States v. Morgan, 313 U.S.

409, 421-22, 61 S.Ct. 999, 1004-05, 85 L.Ed. 1429 (1941).

8 proceeds. Its allocation was based upon the jury verdict, the best

indication of the worth of the Robinsons' claims. We therefore

affirm the Tax Court's reallocation.

B.

REFUSAL TO SUBPOENA THE STATE COURT JUDGE

The Robinsons contend that the Tax Court erred in refusing to

allow them to subpoena the state court judge to testify as to his

understand ing and knowledge of the final judgment and what went

into its determination. The Robinsons served a subpoena on the

state court judge, who in turn moved to quash the subpoena on the

ground that the taxpayers sought to question him regarding the

menta l processes employed by him in entering the Final Judgment.

The Tax Court quashed the subpoena. We review the Tax Court's

quashing of a subpoena for abuse of discretion. 9

A judge may not be asked to testify about his mental

processes in reaching a judicial opinion. 10 The sole reason that

the Robinsons attempted to subpoena the state court judge was to

show that he considered the merits of the allocation contained in

t he Final Judgment rather than simply rubber stamping a judgment

drafted by the Robinsons. There is no way that the trial judge

could be asked about such matters without inquiring into his mental

processes. In fact, the whole purpose of the subpoena was to delve11 Devore v. Commissioner, 963 F.2d 280, 282 (9th Cir.1992).

12 See, e.g., Tweeddale v. Commissioner, 841 F.2d 643, 646

(5th Cir.1988).

9 into the judge's mental processes. Therefore, we hold that the Tax

Court did not err in quashing the subpoena.

C.

REFUSAL TO REOPEN THE RECORD

The Robinsons contend that the Tax Court erred in refusing to

reopen the record to allow them to present evidence of deductions

that offset the discharge-of-indebtedness income. When the

evidence reve aled that the Robinsons received a release of a

$691,971 judgment that the bank held against Ta xpayers, the Tax

Court allowed the Commissioner to amend its pleading to assert the

additional discharge-of-indebtedness income. The Robinsons then

moved that the record be left open for additional submissions on

the issue. The Tax Court denied the motion, and later denied a

motion made by the Robinsons to reopen the record for submission of

evidence of offsetting deductions.

The Tax Court's denial of a motion to reopen the record for

admission of additional evidence is "not subject to review except

upon a demonstration of extraordinary circumstances which reveal a

clear abuse of discretion." 1 1 Further, such motions should be

denied where the evidence to be presented was available at trial,

or could have been obtained with reasonable diligence. 12

We hold that the Tax Court did not err in denying the motion

to reopen because , through the exercise of reasonable diligence,10

the Robinsons could have obtained the evidence of offsetting

deductions. The Robinsons were made aware—through both the

Commissioner's interrogatories propounded to them during discovery

and through the evidence obtained during the deposi tions of the

attorneys that represented the Robinsons in the state court

litigation—that discharge-of-indebtedness income was an issue in

the case. Therefore, they should have obtained evidence of

offsetting deductions before the close of trial.

IV.

CONCLUSION

We REVERSE the Tax Court's judgment to the extent that it held

that the punitive damages portion of the settlement proceeds were

exclud able under Section 104(a)(2), REMAND this case to the Tax

Court for entry of a judgment in accordance with this opinion, and

AFFIRM the remainder of the Tax Court's opinion.