Court Opinion

ID: 3050298
Source: CourtListenerOpinion
Date Created: 2015-10-13 23:30:40.095494+00
Date Added: 2024-06-11T11:49:23.375607
License: Public Domain

FOR PUBLICATION
  UNITED STATES COURT OF APPEALS
       FOR THE NINTH CIRCUIT

GAVIN POLONE,                                     No. 04-72672
                             Petitioner,
                                                    Tax Ct. No.
               v.
                                                    12665-00
COMMISSIONER OF INTERNAL
                                                   ORDER AND
REVENUE,
                                                     OPINION
                      Respondent.
                                           
                 Appeal from a Decision of the
                   United States Tax Court

                     Argued and Submitted
              April 6, 2006—Pasadena, California

                      Filed October 11, 2007

Before: Jerome Farris and Sidney R. Thomas, Circuit Judges,
           and George Schiavelli,* District Judge.

                    Opinion by Judge Thomas

  *The Honorable George Schiavelli, United States District Judge for the
Central District of California, sitting by designation.

                                13781
13784    POLONE v. COMMISSIONER OF INTERNAL REVENUE

                         COUNSEL

James M. Harris, Edwin L. Norris, Jonathan M. Brenner, Sid-
ley Austin Brown & Wood LLP, for appellant Gavin Polone.

Bridget M. Rowan, Kenneth L. Greene, Eileen J. O’Connor,
United States Department of Justice, for appellee Commis-
sioner of the Internal Revenue Service.

                          ORDER

   The opinion filed March 12, 2007, is withdrawn and a sub-
stituted opinion is filed concurrently with this order.

   With the filing of the opinion, the panel has voted to deny
the petition for rehearing. Judge Thomas voted to reject the
suggestion for rehearing en banc and Judges Farris and Schia-
velli so recommend.

  The full court has been advised of the suggestion for
rehearing en banc, and no judge of the court has requested a
vote on the suggestion for rehearing en banc. Fed. R. App. P.
35(b).

  The petition for rehearing is denied and the suggestion for
rehearing en banc is rejected.

  No further petitions for rehearing or petitions for rehearing
en banc shall be filed or entertained in this case.
         POLONE v. COMMISSIONER OF INTERNAL REVENUE     13785
  The motion to modify opinion is denied as moot.

                         OPINION

THOMAS, Circuit Judge:

   This appeal presents the question of whether payments
received after the effective date of amendments to 26 U.S.C.
§ 104(a)(2) based on a defamation settlement agreement exe-
cuted prior to the effective date can be excluded from gross
income. We conclude that the amendments apply to payments
received after the effective date of the amendment, and we
affirm the judgment of the Tax Court.

                              I

   Gavin Polone worked as a talent agent at United Talent
Agency (“UTA”) from 1989 until April 21, 1996, when he
was fired. After terminating Polone, UTA spoke with various
entertainment industry trade publications, and made state-
ments about Polone’s termination. Specifically, UTA alleged
that Polone was terminated for “inappropriate behavior.”

   Polone hired counsel, and sent UTA a demand letter on
April 22, 1996. The letter alleged that UTA had made defam-
atory statements about Polone, and requested that UTA “cease
and desist from making further defamatory statements.” On
April 24, 1996, Polone filed a complaint in the Los Angeles
County Superior Court alleging, among other things, wrong-
ful termination and defamation. Polone and UTA settled both
claims on May 3, 1996.

   Polone received $2 million as settlement of the wrongful
termination claim, which is not at issue in this case. As part
of the settlement of the defamation claim, UTA issued a press
release retracting its previous statements about Polone’s ter-
13786    POLONE v. COMMISSIONER OF INTERNAL REVENUE
mination, and paid Polone $4 million. The $4 million was
paid in four installments of $1 million, which Polone received
on May 3, 1996; November 11, 1996; May 5, 1997; and
November 11, 1998.

   Polone, a cash basis taxpayer, did not include the May 1996
payment on his 1996 federal income tax return. He included
the November 1996 payment, but later filed an amended 1996
return seeking a refund. He did not pay taxes on the May
1997 or November 1998 payments. Polone justified his failure
to pay taxes on this income on our decision in Warren Jones
Co. v. Comm’r, 524 F.2d 788 (9th Cir. 1975), alleging that
Warren Jones Co. required him “to treat his receipt of his for-
mer employer’s promise to pay $4 million as an amount real-
ized in the 1996 taxable year at the time of his receipt of the
promise to pay.”

   In September 2000, the IRS sent Polone a deficiency notice
for his failure to pay taxes on the settlement payments he
received in May 1996, May 1997, and November 1998.
Polone petitioned for review in the Tax Court in December
2000. He also filed an amended petition in August 2002,
claiming that the IRS should have reduced his 1996 taxable
income by $1 million because he had erroneously paid taxes
on the November 1996 settlement payment. The Tax Court
held that Polone owed taxes on the May 1997 and November
1998 settlement payments, and that the taxes he paid on the
November 1996 settlement payment were proper. Polone v.
Comm’r, T.C. Memo 2003-339 (2003). The Tax Court also
held that Polone did not owe any taxes on the May 1996 set-
tlement payment. Id. He appeals.

                              II

   [1] Section 61(a) of the Tax Code defines “gross income”
as “all income from whatever source derived.” 26 U.S.C.
§ 61(a). Thus, subject to certain exemptions, which are to be
construed narrowly, § 61(a) applies to all income, including
         POLONE v. COMMISSIONER OF INTERNAL REVENUE       13787
settlement payments. Comm’r v. Schleier, 515 U.S. 323, 328
(1995) (“the default rule of statutory interpretation [is] that
exclusions from income must be narrowly construed.” (quota-
tions omitted)); Comm’r v. Glenshaw Glass, 348 U.S. 426,
431 (1955) (“The mere fact that payments were extracted
from the wrongdoers as punishment for unlawful conduct can
not detract from their character as taxable income to the recip-
ients.”).

   In May 1996, when Polone and UTA settled, 26 U.S.C.
§ 104 exempted “the amount of any damages received
(whether by suit or agreement and whether as lump sums or
as periodic payments) on account of personal injuries or sick-
ness” from a taxpayer’s gross income. 26 U.S.C. § 104(a)(2)
(1995). The term “personal injuries” in § 104 had been inter-
preted to include damages from settlements of defamation
claims. Roemer v. Comm’r, 716 F.2d 693, 700 (9th Cir.
1983).

   [2] Congress amended § 104 in August 1996 so that it
exempted “the amount of any damages (other than punitive
damages) received (whether by suit or agreement and whether
as lump sums or periodic payments) on account of personal
physical injuries or physical sickness.” 26 U.S.C. § 104(a)(1)
(1996) (emphasis added). The amendment legislatively over-
ruled court decisions, like Roemer, that had exempted awards
for nonphysical injuries from a taxpayer’s gross income. See
H.R. Conf. Rep. 104-737 at 301 (“Thus, the exclusion from
gross income does not apply to any damages received . . .
based on a claim of . . . injury to reputation.”). The effective
date of the amendments was August 20, 1996, but there was
an exception to the amendment for “amount[s] received under
a written binding agreement, court decree, or mediation award
in effect on (or issued before) September 13, 1995.” 26
U.S.C. § 104, Application of August 20, 1996 Amendments.

  Here, the Tax Court held that pre-amendment § 104 applied
to Polone’s May 1996 payment from UTA, but that post-
13788     POLONE v. COMMISSIONER OF INTERNAL REVENUE
amendment § 104 applied to the November 1996, May 1997,
and November 1998 payments because Polone received those
payments after the amendment’s effective date. Polone, T.C.
Memo 2003-339 at 66. As a result, it held that the May 1996
payment was tax exempt, but that the other payments were
not. Id. at 68. Polone argues that the pre-amendment § 104
applies to all four settlement payments he received, and thus
that the $4 million in its entirety is tax exempt. Whether the
May 1996 version of § 104 or the amended version of § 104
governs the settlement payments that Polone received after
the amendment’s effective date is a question of statutory
interpretation that we review de novo. Leslie v. Comm’r, 146
F.3d 643, 648 (9th Cir. 1998).

   [3] Applying the plain language of § 104, the Tax Court
properly held that the November 1996, May 1997, and
November 1998 payments were taxable. The amended statute
applies to any damages received after its effective date of
August 20, 1996, unless the parties had contracted prior to
September 13, 1995. P.L. 104-188, Title I, Subtitle F, Part 1,
§ 1605(d).1 Although Polone settled his claims with UTA in
May 1996, he did not actually receive the three payments in
question until well after the effective date of the amendments
to § 104. Because the settlement was not in effect before Sep-
tember 13, 1995, it was not subject to the exception to
amended § 104 for preexisting settlement agreements. Thus,
the amended version of § 104 applies to the payments Polone
received in November 1996, May 1997, and November 1998,
and the Tax Court properly sustained the IRS’s deficiency
notice.

                                 III

   Polone, citing our decision in Warren Jones Co., argues
that under 26 U.S.C. § 1001, which explains how to calculate
  1
   September 13, 1995 was the date upon which Congress first proposed
to amend § 104. H.R. 2491 (104th Cong., 1995).
         POLONE v. COMMISSIONER OF INTERNAL REVENUE        13789
taxable gain from the “sale or other disposition of property,”
his entire settlement of $4 million was realized on May 3,
1996, the date of settlement, even though UTA paid him in
installments. Therefore, he argues, pre-amendment § 104
applies to the entire $4 million he received from UTA. The
application of § 1001 to Polone’s settlement with UTA is a
question of statutory interpretation that we review de novo.
Leslie, 146 F.3d at 648.

   [4] A straightforward reading of § 104 — and a broader
inquiry into the system of taxation under this section — coun-
sels against Polone’s novel proposal to import § 1001 to the
structured settlement context. Section 1001 provides that the
“gain from the sale or other disposition of property shall be
the excess of the amount realized therefrom over the adjusted
basis.” 26 U.S.C. § 1001(a). It is true that, as a general matter,
a legal claim can be considered property for purposes of
§ 1001. See, e.g., United States v. Stonehill, 83 F.3d 1156,
1159 (9th Cir. 1996). But § 104 specifically refers to
“amounts received,” and not “amounts realized” — a critical
distinction in deciding whether to treat structured settlements
as dispositions of property. 26 U.S.C. § 104. Indeed, we have
yet to find a case has treated structured settlements taxed
under § 104 as dispositions of property and not as ordinary
income received. The cases cited by Polone for this proposi-
tion are plainly inapposite. See Herbert’s Estate v. Comm’r,
138 F.2d 756 (3d Cir. 1943) (satisfaction of debt by debtor
considered a “disposition”; however, taxed year received, not
year obligation created); United States v. Davis, 370 U.S. 65
(1962) (transfer of property in compliance with divorce settle-
ment agreement treated as a disposition of property, rendering
the transaction a taxable event); Cook v. United States, 904
F.2d 107 (1st Cir. 1990) (same); Reynolds v. Comm’r, 77
T.C.M. 1479 (1999) (same). These divorce settlements deter-
mined that divorce transactions were taxable events in the
first instance; the cases were later legislatively overruled by
enactment of section 1041 of the Internal Revenue Code, 26
U.S.C. § 1041. Cook, 904 F.2d at 109 n.1. Such holdings are
13790    POLONE v. COMMISSIONER OF INTERNAL REVENUE
irrelevant to structured settlements taxed under § 104, which
clearly contemplates that payments be taxed the year in which
they are received.

   [5] Warren Jones Co. does require a taxpayer to report the
amount realized the year property is disposed of under
§ 1001; however, for the reasons just explained, there is no
reason to apply § 1001 to personal injury settlements in the
first place. We should also note that decisions of the Tax
Court support this conclusion. See, e.g., Alexander v.
Comm’r, 69 T.C.M. 1792 (1995); Nahey v. Comm’r,
111 T.C. 256 (1998).

   [6] Were we to adopt Polone’s interpretation of the tax
code, payees of structured settlements would be forced to pay
taxes on the full prospective amount of the settlement on the
date of the settlement, sometimes years before receiving that
amount. This would subvert congressional policy to encour-
age structured settlement as opposed to lump-sum schemes.
See Staff of Joint Comm. on Taxation, 106th Cong., Tax
Treatment of Structured Settlement Arrangements (Comm.
Print 1999) (available at http://www.house.gov/jct/x-15-
99.htm). Moreover, in order to alleviate this burdensome
result, we would have no choice but to also import the opt-out
provision available for income received from installment
sales, 26 U.S.C. § 453(d). Cf. Warren Jones Co., 524 F.3d at
792-93 (determining that Congress enacted the opt-out provi-
sion to alleviate the “hardships” associated with reporting an
installment sale as the full fair market value of the property,
received on the date contracted). We have found no congres-
sional support for such overreaching. Congressional intent is
clear: structured settlements are to be taxed as payments are
received.

                              IV

   Polone also argues that pre-amendment § 104 should apply
to the settlement payments he received in November 1996,
          POLONE v. COMMISSIONER OF INTERNAL REVENUE             13791
May 1997, and November 1998 because applying amended
§ 104 to those payments would amount to retroactive legisla-
tion in violation of his Fifth Amendment due process rights.2
We review this constitutional claim de novo. Quarty v. United
States, 170 F.3d 961, 965 (9th Cir. 1999).

   [7] Retroactive legislation runs the risk of offending the
Due Process Clause of the Fifth Amendment, Landgraf v. USI
Film Prods., 511 U.S. 244 (1994), and the Supreme Court has
provided various formulas for determining whether a particu-
lar statute applies retroactively. For example, the Court has
considered whether a statute “takes away or impairs vested
rights acquired under existing laws,” id. at 269 (quoting Soci-
ety for Propagation of the Gospel v. Wheeler, 22 F. Cas. 756
(CC NH 1814)), or whether a law “changes the legal conse-
quences of acts completed before its effective date,” id. at 269
n.23 (quoting Miller v. Florida, 482 U.S. 423, 430 (1987)).

   [8] The thrust of the various tests is that to operate retroac-
tively, a statute must actually “attach[ ] new legal conse-
quences” to completed, past conduct. Id. at 270. It is not
enough that a statute “is applied in a case arising from con-
duct antedating the statute’s enactment,” or that a statute “up-
sets expectations based in prior law.” Id. at 269-270. Thus, for
example, even though “a new property tax or zoning regula-
tion may upset the reasonable expectations that prompted
those affected to acquire property,” a change in the property
tax regime would not be considered retroactive with respect
to all who had purchased property prior to the effective date
of the amendment. See id. at 270 n.24.
  2
   We do not address whether amended § 104(a)(2) violates the Sixteenth
Amendment of the Constitution, as Polone failed to raise the issue on
appeal. The power of Congress to tax income is provided in the Sixteenth
Amendment: “The Congress shall have power to law and collect taxes on
incomes, from whatever source derived, without apportionment among the
several States, and without regard to any census or enumeration.”
13792    POLONE v. COMMISSIONER OF INTERNAL REVENUE
   [9] Applying this test to § 104, we hold that amended § 104
was constitutionally applied to the payments Polone received
in November 1996, May 1997, and November 1998. As
explained above, the amendment to § 104 explicitly applied
only to amounts received after its effective date, which was
August 20, 1996. 26 U.S.C. § 104, Application of August 20,
1996 Amendments. Although it is possible for a statute with
a seemingly prospective application to apply retroactively in
some circumstances, Landgraf, 511 U.S. at 258-59, the
amendments to § 104 did not because they did not attach new
legal consequences to completed payments. On the contrary,
the amendments applied only prospectively, to payments
made after their date of enactment. Compare with Untermeyer
v. Anderson, 276 U.S. 440, 445 (1928) (a tax was retroactive
where it applied to “bona fide gifts not made in anticipation
of death and fully consummated prior to” the statute’s effec-
tive date) (emphasis added); Blodgett v. Holden, 275 U.S.
142, 147 (1927) (same).

   [10] Polone argues that the amendments to § 104 apply
retroactively because his settlement with UTA was “finalized
on May 3, 1996, more than three months before the enactment
of the statute.” This argument is unconvincing for two rea-
sons. First, although the settlement contract may have been
“finalized” in the sense that both parties signed it, settlement
of Polone’s defamation claim was nowhere near complete as
of August 20, 1996. On the contrary, UTA still had to make
three payments to Polone, and he had to honor his promise to
guard UTA’s confidential information. Thus, the Tax Court
did not apply amended § 104 to a contract that was “fully con-
summated” prior to the amendment’s effective date, as was
the case in Untermeyer and Blodgett. Rather, amended § 104
was applied to a contract whose fulfillment was still a work
in progress. Second, Polone’s argument falls squarely into the
Supreme Court’s warning that “[a] statute does not operate
‘retrospectively’ merely because it is applied in a case arising
from conduct antedating the statute’s enactment.” Landgraf,
511 U.S. at 269. The fact that Polone’s tax dispute stemmed
         POLONE v. COMMISSIONER OF INTERNAL REVENUE    13793
from his settlement with UTA — conduct that antedated the
revisions to § 104 — does not mean that § 104 operates retro-
spectively when it is applied to settlement payments that
Polone received after its effective date.

                             V

  For the reasons explained above, we agree with the Tax
Court that the settlement payments received by Polone after
August, 1996 are taxable as ordinary income.

  AFFIRMED.