Court Opinion

ID: 4472245
Source: CourtListenerOpinion
Date Created: 2020-01-13 23:20:51.129273+00
Date Added: 2024-06-11T15:03:22.636806
License: Public Domain

Laro, J., concurring in part and dissenting in part: This case is before us pursuant to respondent’s motion for reconsideration of our prior opinion in Downey v. Commissioner, 97 T.C. 150 (1991) (Downey I). In light of the Supreme Court’s recent decision in United States v. Burke, 504 U.S. __, 112 S. Ct. 1867 (1992), respondent requested us to reconsider our earlier opinion in Downey I. Respondent’s motion has been granted. In Burke, the Supreme Court held that payments received by taxpayers in settlement of backpay claims under title VII of the Civil Rights Act of 1964 (title VII), Pub. L. 88-352, 78 Stat. 253 (current version at 42 U.S.C. secs. 2000e-2000e-17 (1988)), are not excludable from gross income under section 104(a)(2). United States v. Burke, 504 U.S. at _, 112 S. Ct. at 1874. In Downey I, we held, by a split (11-6) vote, that both the nonliquidated damages and liquidated damages received by Burns P. Downey (petitioner)1 in settlement of his claims under the Age Discrimination in Employment Act of 1967, Pub. L. 90-202, 81 Stat. 602 (current version at 29 U.S.C. secs. 621-634 (1988)), were excludable from his gross income under section 104(a)(2). The nonliquidated damages were received by petitioner as unpaid minimum wages (back-pay). 29 U.S.C. secs. 216(b), 626(b). The liquidated damages were received by petitioner as an “additional equal amount” on account of a willful violation of the ADEA by petitioner’s employer (United). 29 U.S.C. secs. 216(b), 626(b). Following our reconsideration of Downey I, the majority reaffirms the case’s expansive view of section 104(a)(2), notwithstanding the decision in Burke. I agree with my colleagues in the majority to the extent they reaffirm that the settlement proceeds received by petitioner as liquidated damages are excludable from his taxable income under section 104(a)(2). I respectfully part company with them, however, with respect to the taxability of the nonliquidated damages because I believe the dissent in Downey I reached the correct conclusion with respect to the nonliquidated damages, and the dissent’s conclusion is strengthened by the decision in Burke. The dissent in Downey I concluded that section 104(a)(2) does not exclude from taxation the amounts that petitioner received as nonliquidated damages. Downey I, supra at 174. Section 61(a) generally provides that “Except as otherwise provided in [subtitle A of the Internal Revenue Code, see secs. 1 to 1563], gross income means all income from whatever source derived”. In enacting section 61(a), and its státu-tory predecessors, Congress intended to “use the full measure of its taxing power”. Helvering v. Clifford, 309 U.S. 331, 334 (1940). It is well settled that the definition of gross income under section 61(a) is construed broadly to bring within its definition any accessions to wealth realized by taxpayers, and over which the taxpayers have complete dominion. United States v. Burke, 504 U.S. at _, 112 S. Ct. at 1870; Commissioner v. Glenshaw Glass Co., 348 U.S. 426, 431 (1955). It is equally well settled that the exclusions from gross income, such as the ones contained in subtitle A of the Internal Revenue Code, are matters of legislative grace and are construed narrowly to maximize the taxation of any accession to wealth. United States v. Burke, 504 U.S. at _, 112 S. Ct. at 1878 (Souter, J., concurring in the judgment); United States v. Centennial Sav. Bank FSB, 499 U.S. 573, _, 111 S. Ct. 1512, 1519 (1991); Commissioner v. Jacobson, 336 U.S. 28, 49 (1949). It rightfully follows that an accession to wealth, such as the receipt of the settlement proceeds by petitioner, must be included in the broad definition of gross income under section 61(a) unless a narrowly construed exclusion of subtitle A of the Internal Revenue Code clearly directs otherwise. United States v. Burke, 504 U.S. at _, 112 S. Ct. at 1878 (Souter, J., concurring in the judgment). It is undisputed that, but for an exclusion, all the settlement proceeds received by petitioner would be includable in the broad definition of gross income under section 61(a). The controversy is whether any, or all, of the settlement proceeds fall within the narrowly construed exclusion under section 104(a)(2). To the extent that petitioner’s receipt of the settlement proceeds is not clearly within this narrowly construed exclusion, general rules of statutory construction mandate that the proceeds are taxable under section 61(a). United States v. Centennial Sav. Bank FSB, 499 U.S. at _, 111 S. Ct. at 1519; Commissioner v. Jacobson, supra at 49. Section 104(a)(2) generally provides that gross income does not include “the amount of any damages received (whether by suit or agreement * * *) on account of personal injuries or sickness” (emphasis added). The text of section 104, the legislative history thereunder, and the regulations prescribed thereunder do not define the term “personal injuries”. See, e.g., H. Rept. 1337, 83d Cong., 2d Sess. 15 (1954); S. Rept. 1622, 83d Cong., 2d Sess. 15-16 (1954). The term “damages received” was defined by the Treasury Department, in regulations published in 1956 under section 104(a)(2), as an “amount received * * * through prosecution of a legal suit or action based upon tort or tort type rights, or through a settlement agreement entered into in lieu of such prosecution.” T.D. 6169, 1956-1 C.B. 63, 65. To date, this regulatory definition remains the same as when it was originally published. From section 104(a)(2), and the regulations thereunder, we understand that damages received through prosecution of a legal suit or action, or through a settlement agreement entered into in lieu of such prosecution, are excludable from gross income if the: (1) Damages were received on account of personal injuries, and (2) suit or action was based upon tort or tort type rights. Sec. 104(a)(2); sec. 1.104-l(c), Income Tax Regs. From Burke, we learn, once again, that we look to the nature of the claim underlying a taxpayer’s damage award to determine whether the damages were received on account of personal injuries. United States v. Burke, 504 U.S. at _, 112 S. Ct. at 1872; see also Rickel v. Commissioner, 92 T.C. 510, 516 (1989), affd. in part and revd. in part 900 F.2d 655 (3d Cir. 1990), overruled by Downey v. Commissioner, 97 T.C. 150, 168-169 (1991); Metzger v. Commissioner, 88 T.C. 834, 847 (1987), affd. without published opinion 845 F.2d 1013 (3d Cir. 1988); Threlkeld v. Commissioner, 87 T.C. 1294, 1297 (1986), affd. 848 F.2d 81 (6th Cir. 1988); Fono v. Commissioner, 79 T.C. 680, 694 (1982), affd. without published opinion 749 F.2d 37 (9th Cir. 1984). This determination is factual, and petitioner bears the burden of proving that respondent’s determination is incorrect. Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933). In the case of a settlement, the nature of the claim generally is determined by looking to the settlement agreement. When the settlement agreement explicitly allocates the settlement proceeds between contract and tort claims,2 the allocation generally is binding to the extent that it is entered into by the parties at arm’s length and in good faith. Fono v. Commissioner, supra at 694. In this regard, an important factor in determining the reality of the agreement is the “intent of the payor” as to the reason for making the payment. Knuckles v. Commissioner, 349 F.2d 610, 613 (10th Cir. 1965), affg. T.C. Memo. 1964-33; Metzger v. Commissioner, supra at 847-848; Fono v. Commissioner, supra at 694. The main question to ask is “In lieu of what were the damages awarded?” Raytheon Prod. Corp. v. Commissioner, 144 F.2d 110, 113 (1st Cir. 1944), affg. 1 T.C. 952 (1943) (emphasis added); Fono v. Commissioner, supra at 692. Applying this analysis to the instant case, petitioner brought a lawsuit against United alleging age discrimination under the ADEA. In relevant part, petitioner’s complaint contained two “causes of action”.3 With respect to the first cause of action, petitioner’s complaint alleged that United’s refusal to allow petitioner to serve as a second officer after petitioner turned 60 years old constituted unlawful age discrimination. Plaintiffs complaint also alleged, as a second cause of action, that United’s action was a willful violation of the ADEA. Downey I, supra at 154. Petitioner and United ultimately resolved this lawsuit in a settlement agreement entered into by the respective parties. Pursuant to the relevant provisions of this agreement, United paid to petitioner $120,000 in consideration of petitioner’s release of all claims arising out of his employment relationship with United, whether or not asserted in the ADEA. Id. at 155. The settlement agreement explicitly allocated $60,000 of this payment to nonliquidated damages and $60,000 to liquidated damages. The settlement agreement explicitly provided that the nonliquidated damages would be subject to all tax withholdings and tax deductions as required by law. Id. at 155. Thus, it is clear that the settlement agreement allocated the settlement proceeds between two separate components, one of which constituted backpay, and that this was the intent of the parties. A claim of willful discrimination under the ADEA, such as the one made by petitioner, contains elements of both contract and tort. Rogers v. Exxon Research & Eng. Co., 550 F.2d 834, 838-842 (3d Cir. 1977); Rickel v. Commissioner, supra at 520-521. Thus, in order to determine the taxability of petitioner’s recovery under the ADEA, we must bifurcate the settlement proceeds into the part attributable to the contract claim and the part attributable to the tort claim. To the extent that the bifurcated part falls on the tort side of the line, the amount is excludable from gross income under section 104(a)(2). To the extent that the bifurcated part falls on the contract side of the line, the amount is includable in gross income under section 61(a). A suit that requests damages for backpay, and that arises out of the breach of an employment agreement, is a contract action. Rogers v. Exxon Research & Eng. Co., supra at 838; see also United States v. Burke, 504 U.S. at _, 112 S. Ct. at 1878 (Souter, J. concurring in the judgment) (the awarding of backpay is “quintessentially a contractual measure of damages”). In this regard, ADEA’s ban on age discrimination, like title VII’s ban on sex discrimination, is easily seen as a contractual provision implied in every contract as a matter of law. See, e.g., United States v. Burke, 504 U.S. at _, 112 S. Ct. at 1878 (Souter, J. concurring in the judgment). The primary goal in making compensatory damages available in an ADEA action is to restore age discrimination victims to the economic state they would have been in but for the intervening unlawful discriminatory conduct of their employer. Kossman v. Calumet County, 800 F.2d 697, 703 (7th Cir. 1986); Rodriguez v. Taylor, 569 F.2d 1231, 1238 (3d Cir. 1977). In other words, the compensatory damages under the ADEA allow victims of age discrimination to enjoy the benefit of the bargain they were expecting to receive when they entered into the employment contract with their respective employers. The fact that the right to recover the backpay arises from a statute, such as the ADEA, instead of common law, does not change the essential nature of the case. Rogers v. Exxon Research & Eng. Co., supra at 838. Accordingly, any amount that petitioner received for nonliquidated damages falls on the contract side of the line, and, to that extent, the recovery is not excludable from gross income under section 104(a)(2). Cf. Rev. Rul. 72-341, 1972-2 C.B. 32 (payments from employer to employee in settlement of title VII action are includable in the employee’s gross income because the payments would have been received as taxable wages but for the discrimination); see also United States v. Burke, 504 U.S. at _, 112 S. Ct. at 1874 n.13 (Rev. Rul. 72-341, 1972-2 C.B. 32, cited with approval). It is undisputed that, but for the discrimination, an amount awarded as backpay would be taxable upon receipt. Sec. 61(a)(1). The awarding of liquidated damages, on the other hand, is a recovery for a tort or tortlike injury. Trans World Airlines, Inc. v. Thurston, 469 U.S. 111, 125 (1985) (liquidated damages awarded under the ADEA are punitive in nature). As such, any amount that petitioner received for liquidated damages falls on the tort side of the line, and, to that extent, the recovery is excludable from gross income under section 104(a)(2). It appears that the majority is troubled by the thought of bifurcating a recovery between its tort and contract components. To the majority, it appears, a recovery must be all contract or all tort. To support this proposition, the majority cites and relies on our recent decision in Horton v. Commissioner, 100 T.C. 93 (1993). In Horton, the defendant paid the plaintiffs/taxpayers both compensatory and punitive damages in connection with a personal injury that the taxpayers sustained when their home was destroyed by a gas explosion and fire caused by the defendant. With respect to the punitive damages, we held that those damages were excludable from the taxpayers’ gross income under section 104(a)(2). In so doing, we stated that “Once the nature of the underlying claim is established as one for personal injury, any damages received on account of that claim, including punitive damages, are excludable.” Id. at 96. With regard to Horton, it is important to note that we explicitly stated that respondent did not argue that part of the punitive damages were allocated to something other than personal injury (e.g., property damage). Id. at 95 n.3. As Judge Beghe noted in his concurrence, the result might well have been different, in part, if respondent had made such an argument. Id. at 101. More specifically, to the extent that the punitive damages in Horton were attributable to property damage, a strong argument could have been made that those punitive damages were taxable because they were not received “on account of personal injuries.” This bifurcation approach is supported by many of our decisions prior to Downey I. These prior cases were thoroughly discussed in Judge Cohen’s opinion in Downey I, see Downey v. Commissioner, 97 T.C. 150, 175-180 (1991) (Cohen, J., concurring in part and dissenting in part), and need not be discussed here. By this reference, however, Judge Cohen’s discussion of these cases is incorporated herein. See also Stocks v. Commissioner, 98 T.C. 1, 17 (1992) (the Court also applied this bifurcation approach to the facts of a case decided after Downey I). The majority herein fails to discuss the taxability of proceeds received in connection with a nonwillful violation under the adea, understandably so seeing that this case involves a willful violation. Notwithstanding that a nonwillful violation is not at issue here, I believe that a resolution of this case requires a brief discussion of the taxability of proceeds received in connection with a nonwillful violation. In the case of a nonwillful violation, it appears that a plaintiffs recovery, which is limited solely to backpay, see 29 U.S.C. sec. 626(b) (prevailing plaintiff entitled to additional equal amount only in cases of willful violations); Hazen Paper Co. v. Biggins, 507 U.S. _, _, 113 S. Ct. 1701, 1708-1709 (1993) (same), is not excludable under section 104(a)(2) because the recovery flows from a breach of contract. See, e.g., United States v. Burke, 504 U.S. at _, 112 S. Ct. at 1874 (“we cannot say that a statute such as title VII, whose sole remedial focus is the award of backwages, redresses a tortlike personal injury within the meaning of section 104(a)(2) and the applicable regulations.” (Emphasis added; fn. ref. omitted.)). If this is the case, as it appears, it seems illogical that a taxable recovery becomes nontaxable merely because the taxpayer/plaintiff establishes that the employer’s violation is willful, and is awarded an additional equal amount on account of such a violation. In conclusion, the majority in Downey I stated that “we no longer can distinguish age discrimination from sex discrimination”. Downey I, supra at 168. If this is so, we should reverse our decision in Downey I because we have recently learned that an amount received on account of sex discrimination under title VII is not excludable from income under section 104(a)(2). United States v. Burke, 504 U.S. at _, 112 S. Ct. at 1874. Because I believe that the taxability of backpay recovered under title VII is commensurate with the taxability of backpay recovered under the ADEA,4 I respectfully dissent. JACOBS, J., agrees with this concurring in part and dissenting in part opinion.   The wife of Burns P. Downey, Marjorie Downey, is also a petitioner in this case. For purposes of simplicity and clarity, petitioner will be used solely to refer to Burns P. Downey.   In United States v. Burke, 504 U.S. _, _. 112 S. Ct. 1867, 1870-1871 (1992), the Supreme Court indicated that damages for a civil wrong are received on account of either a tort claim or a breach of contract claim, citing Keeton et al., Prosser and Keeton on the Law of Torts 2 (1984) (“A ‘tort’ has been defined broadly as a ‘civil wrong, other than breach of contract, for which the court will provide a remedy in the form of an action for damages.’” (Emphasis added.)).    The term “cause of action” means “The fact or facts which give a person a right to judicial redress or relief against another. The legal effect of an occurrence in terms of redress to a party to the occurrence. A situation or state of facts which entitle party to sustain action and give him right to seek a judicial remedy in his behalf. * f * Matter for which action may be maintained.” Black’s Law Dictionary 221 (6th ed. 1990).    See, e.g., Hodgson v. First Fed. Sav. & Loan Association, 455 F.2d 818, 820 (5th Cir. 1972) (substantive provisions of the ADEA generally are, in terms, identical to those of title VII except that “age” has been substituted for “race, color, religion, sex, or national origin”); Rickel v. Commissioner. 92 T.C. 510, 517 (1989), affd. in part and revd. in part 900 F.2d 655 (3d Cir. 1990), overruled by Downey v. Commissioner, 97 T.C. 150, 168-169 (1991).