Opinion ID: 2978838
Heading Depth: 3
Heading Rank: 1

Heading: Prong One: Tort or Tort Type Right

Text: Under the first prong, the question is whether Mrs. Stadnyk’s claims against Bank One giving rise to her recovery are based upon tort or tort type rights. The mediation agreement between Mrs. Stadnyk and Bank One did not state what claims provided the basis for the settlement award, nor does the remainder of the record surrounding the settlement provide any insight. Thus, we must look to the complaint to shed light on what claims gave rise to the award. In Mrs. Stadnyk’s First Amended Complaint, she alleged a number of tort claims against J.R. Maze and Nicholasville Auto, 8 No. 09-1485 including malicious prosecution, abuse of process, false imprisonment, defamation, and outrageous conduct, and she repeated, realleged, and incorporated these claims by reference against Bank One. By incorporating these claims by reference, Mrs. Stadnyk raised these tort claims against Bank One. In addition, Mrs. Stadnyk alleged in her First Amended Complaint that Bank One breached its fiduciary duty of care by improperly and negligently marking her check “NSF” for insufficient funds. Kentucky’s banking statutes recognize elements of both contract and tort law in the bankdepositor relationship. Under Kentucky law, banks are required to exercise good faith and ordinary care in the handling of customer accounts, thereby incorporating common law rules of negligence. See Bullitt County Bank v. Publisher’s Printing Co., 684 S.W.2d 289, 291-92 (Ky. Ct. App. 1984); Pulliam v. Pulliam, 738 S.W.2d 846, 849 (Ky. Ct. App. 1987); American Nat’l Bank v. Morey, 69 S.W. 759, 760 (Ky. 1902) (recognizing that a bank customer may have a tort claim against a bank for the wrongful dishonor of a check). Furthermore, under Kentucky law, arrest is a reasonably foreseeable consequence of a bank’s wrongful dishonor, and a bank customer may sue for damages resulting from an arrest over such an error. See Ky. Rev. Stat. § 355.4-402 (“A payor bank is liable to its customers for damages proximately caused by the wrongful dishonor of an item. Liability is limited to actual damages proved and may include damages for an arrest or prosecution of the customer or other consequential damages.”). Based on these Kentucky banking laws and the circumstances of this case, the Tax Court found that Mrs. Stadnyk’s independent claims against Bank One sounded in tort: It is incorrect to characterize [Mrs. Stadnyk’s] complaint against Bank One as a contract claim or merely a dispute over the wrongful dishonor of a check. Rather, [Mrs. Stadnyk] decided to sue Bank One because of the ordeal she suffered as a result of her arrest and detention. [Mrs. Stadnyk] did not suffer an economic loss from 9 No. 09-1485 Bank One’s alleged mishandling of her check. She did not sue Bank One to recover on economic rights arising from a contract with Bank One. [Mrs. Stadnyk] sought damages against Bank One that resulted from her arrest, detention, and indictment. (App. at 85-86.) We agree with the Tax Court’s analysis. Based on the finding that Mrs. Stadnyk alleged tort claims against Bank One in her complaint, we conclude that Mrs. Stadnyk’s settlement with Bank One was based on tort or tort type rights. B. Prong Two: “On Account of Personal Physical Injuries” Having satisfied the first prong, to obtain an exclusion under § 104(a)(2), Mrs. Stadnyk must show that she sustained the damages on account of personal physical injuries or sickness. Under the 1996 Amendment, I.R.C. § 104(a)(2) expressly limits the type of damages excludable from income to personal physical injuries or physical sickness and expressly states that emotional distress does not constitute a physical injury or sickness. Pub. L. No. 104-188, § 1605(a), 110 Stat. 1755, 1838. Kentucky courts have defined false imprisonment as “any deprivation of the liberty of one person by another or detention for however short a time without such person’s consent and against his will, whether done by actual violence, threats or otherwise.” Grayson Variety Store, Inc. v. Shaffer, 402 S.W.2d 424, 425 (Ky. 1966). The tort of false imprisonment protects personal interest in freedom from physical restraint; the interest is “in a sense a mental one” and the injury is “in large part a mental one.” Banks v. Fritsch, 39 S.W.3d 474, 479 (Ky. Ct. App. 2001). During her deposition, Mrs. Stadnyk testified that she did not suffer any physical injury as a result of her arrest and detention. According to Mrs. Stadnyk, nobody carrying out her arrest or detention put their hands on her, grabbed her, jerked her around, bruised her, or hurt her. Petitioners’ brief concedes that the actions of the police were proper and that Mrs. Stadnyk presumes that she 10 No. 09-1485 was treated in the same manner as anyone else arrested for passing a bad check. Nothing in the record suggests that Mrs. Stadnyk suffered physical, as opposed to emotional, injuries as a result of Bank One’s actions. The Tax Court correctly noted that “[t]he damages sought by [Mrs. Stadnyk] against Bank One are stated in terms of recovery for nonphysical personal injuries: [e]motional distress, mortification, humiliation, mental anguish, and damage to reputation.” (App. at 88). These are all emotional injuries, and are thus not excludable under § 104(a)(2). See Sanford v. Comm’r, 95 T.C.M. (CCH) 1618 (2008) (settlement award for emotional distress relating to sexual harassment and discrimination claims is not excludable); Polone v. Comm’r, 86 T.C.M. (CCH) 698 (2003) (settlement award for defamation claim is not excludable), aff’d 505 F.3d 966 (9th Cir. 2007); Venable v. Comm’r, 86 T.C.M. (CCH) 254 (2003) (settlement payment for mental anguish and loss of reputation relating to malicious prosecution claim is not excludable), aff’d 110 Fed. App’x 421 (5th Cir. 2004). However, despite Mrs. Stadnyk’s testimony, Petitioners argue that Mrs. Stadnyk suffered a physical injury because “[p]hysical restraint and detention and the resulting deprivation of [Mrs. Stadnyk’s] personal liberty is [itself] a physical injury . . . that Mrs. Stadnyk endured for an eight hour period.” (Pets.’ Br. at 15.) Petitioners further argue that Mrs. Stadnyk suffered physical damages in addition to emotional damages because “to be falsely imprisoned, the person must first be physically restrained or held against their will” and “[t]hus the damages received from false imprisonment arise from the person’s physical loss of their freedom and the mental suffering and humiliation that accompany this deprivation.” (Pets.’ Br. at 15.) 11 No. 09-1485 In other words, Petitioners are asking the Court to create a per se rule that every false imprisonment claim necessarily involves a physical injury, even though physical injury is not a required element of false imprisonment under Kentucky law. To be sure, a false imprisonment claim may cause a physical injury, such as an injured wrist as a result of being handcuffed. But the mere fact that false imprisonment involves a physical act–restraining the victim’s freedom–does not mean that the victim is necessarily physically injured as a result of that physical act. In the instant case, Mrs. Stadnyk unequivocally testified that she suffered no physical injuries as a result of her physical restraint. Thus, Petitioners have failed to establish that Mrs. Stadnyk suffered from personal physical injuries or physical sickness. In addition, the Supreme Court has construed the “on account of” phrase to require a direct causal link between the physical injury and the damages recovery in order to qualify for the income exclusion. See Schleier, 515 U.S. at 329-31. This direct causal connection must be more than a “but for” link, because a “but for” analysis would “bring virtually all personal injury lawsuit damages within the scope of the provision, since: but for the personal injury, there would be no lawsuit, and but for the lawsuit, there would be no damages.” O’Gilvie v. United States, 519 U.S. 79, 82, 117 S.Ct. 452, 136 L. Ed. 2d 454 (1996) (internal quotation marks omitted). Rather, the “on account of” phrase requires that the damages be awarded by reason of, or because of, a personal physical injury. Id. at 83. See also Greer, 207 F.3d at 327 (requiring that “the agreement was executed ‘in lieu’ of the prosecution of the tort claim and ‘on account of’ the personal injury”). Petitioners bear the burden of “present[ing] concrete evidence demonstrating the precise causal connection” between the personal physical injuries and the settlement payment. Id. at 334. 12 No. 09-1485 The settlement agreement does not include any express language of purpose. It only provides that “Bank One shall pay the total sum of $49,000” and that the “suit shall be dismissed with prejudice.” (App. at 206). Petitioners’ only evidence arguably supporting the purpose necessary for exclusion under § 104(a)(2) is Mrs. Stadnyk’s testimony that her attorney, the attorney for Bank One, and the mediator all advised her that the settlement proceeds would not be subject to income tax. However, even assuming the attorneys did give her this advice, there is no evidence concerning the basis for the advice. The attorneys may have advised Mrs. Stadnyk based on any number of incorrect beliefs, such as the belief that all personal injury awards are excludable from income, as Petitioner argues here, or the belief that a physical injury was unnecessary. Given that the settlement agreement included no indication that Bank One paid the settlement on account of any physical injury and that all of Mrs. Stadnyk’s damages were stated in terms of emotional distress, Petitioners have failed to offer any concrete evidence demonstrating a causal connection between any physical injury and the settlement award. Thus, Petitioner’s settlement award may not be excluded from taxation under § 104(a)(2).