Opinion ID: 2600653
Heading Depth: 2
Heading Rank: 1

Heading: under the in lieu of test, the settlement proceeds relate to the original sale of hau, which was subject to utah tax

Text: ¶ 17 Determining the true character and nature of the settlement proceeds presents a mixed question of law and fact, not a mere question of fact as the Division suggests. Because the determination of the character and nature of such proceeds is typically outcome determinative, it deserves a more thorough review than clear error. Cf. Bose Corp. v. Consumers Union of U.S., Inc., 466 U.S. 485, 500-01, 104 S.Ct. 1949, 80 L.Ed.2d 502 (1984) (according less deferential review to findings of ultimate facts which may determine the outcome of litigation). ¶ 18 In State v. Levin , we set out a policy-based balancing test for determining the amount of deference that appellate courts should pay to trial courts when reviewing mixed questions of law and fact. 2006 UT 50, ¶ 25, 144 P.3d 1096. The tripartite test considers (1) the complexity of the facts; (2) the degree to which the trial court relied on observable facts that cannot be reflected adequately in the record, such as witness demeanor and appearance; and (3) policy reasons that favor the exercise of discretion by the lower courts. Id. ¶ 25. ¶ 19 In this case, all three factors favor application of a less deferential standard of review. First, the facts are straightforward and uncomplicated. Second, they are reviewable from the cold record, requiring little reliance on witness demeanor. For example, the nature of the allegations in the underlying lawsuit, Whitworth's assertion of the claim of right, and the Mandells' characterization of the settlement proceeds on their 2001 federal income tax return are all facts memorialized in a written record. Third, although we are not aware of a particular demand for consistency in this area of the law, other policy reasons support a less deferential standard of review. Most importantly, application of the in lieu of test implicates due process because it is the state's jurisdictional hook for taxing the Mandells' settlement proceeds. ¶ 20 We conclude that the character and nature of a settlement or judgment under the in lieu of test presents a mixed question of law and fact and that the three Levin factors weigh in favor of according less deference to the Commission's application of the law to the facts. A finding of fact may occasionally be inseparable from the principles through which it was deduced. At some point, the reasoning by which a fact is found crosses the line between application of those ordinary principles of logic and common experience . . . into the realm of a legal rule upon which the reviewing court must exercise its own independent judgment. Bose Corp., 466 U.S. at 501 n. 17, 104 S.Ct. 1949. ¶ 21 With the appropriate standard of review in mind, we proceed to the two-step analysis pursuant to which we determine whether there is a sufficient connection for Utah to tax the settlement proceeds. We first determine the character and nature of the settlement proceeds by asking, In lieu of what was the settlement paid? See, e.g., Dye v. United States, 121 F.3d 1399, 1409 (10th Cir.1997); Pennzoil Co. v. Dep't of Revenue, 332 Or. 542, 33 P.3d 314, 317 (2001). Once we have determined the character and nature of the settlement, we then analyze whether it constitutes income taxable by the state of Utah.
¶ 22 Because the taxability of a settlement or judgment is dependent upon the underlying transaction or claim, we apply the in lieu of test to determine what the settlement proceeds or damages replaced. Although Utah courts have yet to apply the test, a host of cases from other jurisdictions provide guidance as to the relevant factors. Specifically, we consider the intent of the parties as indicated by express language in the settlement agreement or by circumstances surrounding the settlement, the parties' own characterization of the settlement proceeds, the language of the complaint, and the amount of the settlement. We apply these factors to this case by looking at Whitworth's apparent intent in settling the claim, Mandell's own characterization of the suit, the Mandells' treatment of the settlement proceeds, and the amount of the settlement.
¶ 23 The intent of the payor in settling a claim is one of the most important considerations in determining the underlying nature of a settlement. See Knuckles v. Comm'r, 349 F.2d 610, 613 (10th Cir.1965) (holding that settlement proceeds were not for personal injury claim where the payor did not acknowledge possible liability for personal injury and in fact consistently denied such liability); Hawkins v. Comm'r, 94 T.C.M. (CCH) 310, 312 (2007) (We determine the reason for the settlement payment by ascertaining the intent of the payor in making the payment.). ¶ 24 Typically, the intent of the payor is determined from the language of the settlement agreement. In this case, however, the settlement agreement was confidential. The parties have not provided us with complete copies of the settlement, and the portion contained in the record is silent as to Whitworth's intent. In such cases, other courts have looked to the factual circumstances surrounding the settlement to determine the payor's intent. See, e.g., Gibson v. Comm'r, 94 T.C.M. (CCH) 164, 167 (2007); Connolly v. Comm'r, 93 T.C.M. (CCH) 1138, 1140 (2007). ¶ 25 In this case, Whitworth's tax filings indicate that Whitworth intended the settlement to compensate the Mandells for amounts wrongfully withheld in connection with the original sale of HAU. Whitworth asserted a claim of right [2] on his 2001 federal income tax return. [3] The claim of right sought reimbursement for the tax that Whitworth paid in 1998 on the inflated amount he received in connection with the original sale. Whitworth sought a similar adjustment from the state of Utah. Whitworth's assertion of these claims reflects his intention that the settlement reimburse the Mandells for proceeds that Mandell should have received in connection with the original sale.
¶ 26 Another factor often considered in determining the character of settlement proceeds obtained through litigation is the language of the underlying complaint. See Elliott v. Comm'r, 53 T.C.M. (CCH) 1302, 1304 (1987) (considering a plaintiff's characterization in the complaint in concluding that settlement was for lost profits); see also Villaume v. United States, 616 F.Supp. 185, 189 (D.Minn.1985) (rejecting argument that settlement received was for personal injuries because the complaint in state court contained no indication that the suit was intended to recover damages for personal injuries); Estate of Taracido v. Comm'r, 72 T.C. 1014, 1022 (1979) ([T]he proper test to be applied . . . is that the tax character of the settlement proceeds is determined by the nature of the claims involved and the basis of the recovery.). In cases where the underlying lawsuit has advanced to trial, courts have also looked at evidence introduced and arguments made at trial. See Church v. Comm'r, 80 T.C. 1104, 1107 (1983); see also State Fish Corp. v. Comm'r, 48 T.C. 465, 474-76 (1967), clarified by 49 T.C. 13 (1967). ¶ 27 Mandell's complaint and the documents filed in connection with his motion for summary judgment demonstrate that Mandell filed suit for the purpose of recovering the proceeds that he should have received from the 1998 sale of HAU. The complaint states: [Mandell has] discovered that the allocations of the purchase price fixed by [Whitworth] for each corporation were not based upon the actual values of each corporation compared to the total purchase price offered by [Champion]. Instead, [Whitworth's] allocations inflated the values of those companies that he exclusively owned or where he had a larger percentage of ownership. These allocations decreased the true value of [Mandell's] ownership in [HAU]. The complaint further alleges: [Whitworth] also allocated a substantially larger percentage of the cash portion of the purchase price to himself as compared to the cash paid to [Mandell]. [Mandell was] left relying upon achieving the uncertain performance criteria for the bulk of [his] allocated purchase price. ¶ 28 Similarly, in connection with his motion for summary judgment, Mandell alleged that Whitworth's actions caused him to sell his interests at a value substantially below their fair and equitable share of the purchase price paid by Champion. In addition Whitworth paid himself a disproportionate share of the cash portion of the sales price. ¶ 29 In short, it is clear from the language of the complaint and documents filed in connection with Mandell's motion for summary judgment that Mandell sought reimbursement for the misallocated HAU sale proceeds. Although the complaint states causes of action for breach of fiduciary duties, fraud, undue influence, and unjust enrichment, the primary relief it requests is a constructive trust on the funds that Whitworth received by disproportionately allocating the sale proceeds.
¶ 30 Other evidence also indicates that the Mandells viewed the settlement proceeds as income from the sale of HAU. The first such evidence is the Mandells' treatment of the proceeds on their 2001 federal income tax return, on which they reported the settlement as a long-term capital gain on the sale of Mandell's 20% interest in HAU. Similarly, the testimony of the accountant who prepared the return established that the settlement proceeds were treated as capital gains, rather than ordinary income, because they were earnings from the deemed asset sale in 1998. ¶ 31 The second such evidence is the amount of the settlement payment. The settlement amount is similar to the amount Mandell would have received in 1998 had Whitworth paid the amount Mandell contends was owing. While Mandell should have received $1,671,000 from the original sale of HAU, he received only $621,000. The settlement proceeds of $1,127,977 increased the total proceeds received to $1,748,977, just slightly more than the amount to which Mandell was originally entitled. This similarity between the two amounts further suggests that the proceeds were received in lieu of amounts payable in connection with the original sale of HAU. See Sager Glove Corp. v. Comm'r, 311 F.2d 210, 212 (7th Cir.1962) (considering fact that recovery sought for lost profits closely approximated the settlement amount in determining the character and nature of the settlement). ¶ 32 In summary, having applied the in lieu of test, we conclude that the settlement proceeds were paid in lieu of the funds that Mandell should have received from the 1998 sale of HAU. The Mandells' attempt to distinguish the settlement proceeds from the original sale is unavailing. Whitworth's apparent intent, Mandell's characterization of his claim in the underlying litigation, the Mandells' treatment of the settlement on their federal income tax return, and the amount of the settlement are all consistent with the Commission's determination that the settlement was paid to reimburse the Mandells for the proceeds Mandell should have received in connection with the original sale of HAU.