Opinion ID: 1826617
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Heading: Tax Benefits

Text: Company urges that any award to Cody should be reduced by the tax benefits that Cody received as a result of his investments. The trial court excluded any evidence of tax benefits after considering the motion in limine. The leading case addressing deduction of tax benefits from an award is a securities fraud case. Randall v. Loftsgaarden, 478 U.S. 647, 106 S.Ct. 3143, 92 L.Ed.2d 525 (1986). In Randall, respondents were charged with violations of § 10(b) of the Securities Exchange Act of 1934 and § 12(2) of the Securities Act of 1933. The Court held that neither act authorized the reduction of the trial court's award by the tax benefits the investor received through his tax shelter investment. Id. at 667, 106 S.Ct. at 3155, 92 L.Ed.2d at 544. In reaching its decision, the Court relied on the clear intent of the language of the statutes. However, in deciding not to reduce the damage award by the tax benefits the plaintiff received, the Randall court also considered the application of the tax benefit rule which makes the recovery taxable as ordinary income. Id. at 664, 106 S.Ct. at 3153, 92 L.Ed.2d at 542. The tax benefit rule is a judicially developed principle that is codified in part in the Internal Revenue Code, 26 U.S.C.A. § 111 (West 1988), and prevents plaintiffs from reaping multiple recoveries. DePalma v. Westland Software House, 225 Cal.App.3d 1534, 276 Cal.Rptr. 214, 218 (1990) (citing Mertens, Law of Federal Income Taxation (1990) § 7.74, p. 175). The tax benefit rule allows the government to recapture past tax benefits awarded to a taxpayer if in a later year an event occurs which changes the basis, or is `fundamentally inconsistent with the premise upon which the deduction was initially based.' DePalma, 276 Cal. Rptr. at 218 (citing Hillsboro National Bank v. Commissioner, 460 U.S. 370, 383, 103 S.Ct. 1134, 1143, 75 L.Ed.2d 130, 146 (1983)). An event is considered fundamentally inconsistent when if that event had occurred within the same taxable year, it would have foreclosed the deduction. Hillsboro, at 383-84, 103 S.Ct. at 1143-44, 75 L.Ed.2d at 146. Allowing Cody to recover his initial investments in the limited partnerships equates to Cody never having made the investments in the first place. If Cody had never invested in the partnerships, he would not have qualified for partnership's losses as a tax deduction. Under the tax benefit rule, plaintiffs will be required to report any damages recovered in this action as taxable income, resulting in a recapture of their tax benefits, and any prior tax benefits will thereby be disallowed. Fullmer v. Wohlfeiler & Beck, 905 F.2d 1394, 1402 (10th Cir.1990). Therefore, any of the losses which Cody initially recorded as tax deductions must now be recorded as taxable income as a result of his recovery in this case and will, therefore, offset the tax benefits originally received. Since the Randall decision, numerous courts have applied its reasoning and refused to reduce damage awards by tax benefits the plaintiff has received prior to the successful prosecution for this damage claim. Astor Chauffeured Limousine v. Runnfeldt Inv. Corp., 910 F.2d 1540 (7th Cir.1990); Fullmer, 905 F.2d 1394 (10th Cir.1990); DePalma, 225 Cal.App.3d 1534, 276 Cal.Rptr. 214 (1990); Billings Clinic v. Peat Marwick Main & Co., 244 Mont. 324, 797 P.2d 899 (1990). These cases did not limit Randall 's application to cases involving a claim of security fraud, but refused to reduce awards by tax benefits in cases where recovery was sought on state law fraud, negligence, negligent misrepresentation, breach of contract, and breach of professional duty. Id. Company, on the other hand, cites to opposing authority wherein the courts reduced awards by tax benefits. See Bridgen v. Scott, 456 F.Supp. 1048 (S.D.1978); Froid v. Fox, 132 Cal.App.3d 832, 183 Cal. Rptr. 461 (1982); Delacorte v. Transcontinental Land & Cattle Corp., 127 Misc.2d 707, 486 N.Y.S.2d 811 (N.Y.Sup.Ct.1985). However, these decisions predate the Randall decision and we find them to be unconvincing in their reasoning and will not adopt their holdings. Furthermore, we find that public policy supports disregarding tax benefits in awarding damages. There is a deterrent value against committing fraud if the fraudulent party realizes he will have to compensate the other party for the full extent of his damages with no offset for any tax benefits the other party may have received. DePalma, 276 Cal.Rptr. at 221. `[I]t is more appropriate to give the defrauded party the benefit even of windfalls than to let the fraudulent party keep them.' Randall 478 U.S. at 663, 106 S.Ct. at 3153, 92 L.Ed.2d at 541 (quoting Janigan v. Taylor, 344 F.2d 781, 786 (5th Cir.1965)). See also Astor, 910 F.2d at 1552. Reducing damage awards by tax benefits in effect awards the fraudulent party government funding to subsidize his fraudulent behavior and greed. DePalma, 276 Cal.Rptr. at 221; Burgess v. Premier Coop., 727 F.2d 826, 838 (9th Cir.1984); Danzig v. Jack Grynberg & Assoc., 161 Cal.App.3d 1128, 208 Cal.Rptr. 336, 343 (1984). We likewise refuse to allow Company to not be fully liable for the results of its fraudulent behavior. We agree with the reasoning of Randall, and the lower court [4] , in determining that application of the tax benefit rule serves to offset any tax benefit Cody received from his investments by requiring him to pay income tax on his recovery. Thus, we find no abuse of discretion on the part of circuit court in excluding this evidence.