Opinion ID: 197050
Heading Depth: 2
Heading Rank: 2

Heading: Excludability of Prejudgment Interest

Text: 21 The Delaneys next contend that statutory prejudgment interest itself is excludable as damages received ... on account of personal injury or sickness, see 26 U.S.C. § 104(a)(2) (1986) (emphasis added), because the gross income exclusion under section 104(a)(2) embraces all amounts recovered, by settlement or otherwise, as compensation for personal injuries, without regard to the stage in the litigation process at which settlement occurs. We address their predicate arguments in turn.
22 The Delaneys challenge the leading precedent upon which the Tax Court relied, see Kovacs v. Commissioner, 100 T.C. 124, 1993 WL 46512 (1993), aff'd, 25 F.3d 1048 (Table) (6th Cir.), cert. denied, 513 U.S. 963, 115 S.Ct. 424, 130 L.Ed.2d 338 (1994), for its holding that the prejudgment interest component in a compensatory damages recovery for personal injuries is taxable. The Delaneys maintain that Kovacs is unsound because it relied upon judicial precedents for taxing postjudgment interest as authority for taxing prejudgment interest. Consequently, they contend, Kovacs progeny such as Delaney are similarly flawed. As their argument is raised for the first time on appeal, we decline to address it. See, e.g., Villafane-Neriz v. F.D.I.C., 75 F.3d 727, 734 (1st Cir.1996) (arguments first raised on appeal not ordinarily addressed). 6
23 The Delaneys next contend that Rhode Island law controls whether any statutory prejudgment interest included in a personal injury settlement constitutes damages for federal income tax purposes. Since prejudgment interest is an element of damages under Rhode Island law, appellants argue, the entire $250,000 settlement must be excluded from gross income under section 104(a)(2) as damages for personal injury. 24 The Tenth Circuit, recently confronted with a similar problem, noted that though state law governs the nature of legal interests and rights created under state law, the federal tax consequences pertaining to such interests and rights are solely a matter of federal law. Brabson, 73 F.3d 1040, 1044 (Coffin, J.). Accordingly, the Brabson panel first ascertained the pertinent characteristics of statutory prejudgment interest under Colorado law, but then looked to federal law to determine its excludability. Id. at 1044. As we agree with the thoughtful approach in Brabson, we turn first to Rhode Island law to determine the nature of the statutory prejudgment interest ministerially added by the superior court clerk to the personal injury damages award returned by the jury in this case. 25 Unlike the Colorado statute at issue in Brabson, statutory prejudgment interest is not an element of damages in a personal injury action under Rhode Island law. DiMeo v. Philbin, 502 A.2d 825, 826 (R.I.1986) (prejudgment interest in personal injury action purely statutory and therefore not an element of damages); Castrignano v. E.R. Squibb & Sons, Inc., 900 F.2d 455, 463 (1st Cir.1990) (prejudgment interest under Rhode Island law is not an element of damages in personal injury action) (citing Andrade v. State, 448 A.2d 1293, 1295 (R.I.1982)). 7 Accordingly, in order to prevail, the Delaneys must establish that prejudgment interest is excludable under section 104(a)(2) notwithstanding its state-law characterization. 8 26
27 The two requirements for determining exclusions under section 104(a)(2) were recently explained in Schleier: 28 First, the taxpayer must demonstrate that the underlying cause of action giving rise to the recovery is based upon tort or tort type rights; and second, the taxpayer must show that the damages were received on account of personal injuries or sickness. 29 Schleier, --- U.S. at ----, 115 S.Ct. at 2167 (emphasis added). Although their underlying causes of action clearly satisfy the first prong, unless the Delaneys are able to make the second crucial showing--that the portion of their settlement recovery attributable to statutory prejudgment interest was received on account of personal injuries or sickness--their claim fails. Id. 30 The second predicate showing necessitates what the Brabson court termed proof that each element of damages was linked to the injury itself. Brabson, 73 F.3d at 1043. 9 The Delaneys utterly failed to preserve any claim that the prejudgment interest component in their settlement recovery was linked to their personal injuries. 10 Id. See also Manzoli v. Commissioner, 904 F.2d 101, 105 (1st Cir.1990). As it is neither necessary nor practicable to do so in this case, see note 10 supra, we do not consider whether statutory prejudgment interest may ever be excludable from gross income under § 104(a)(2), an important question left for another day. III