The opinion
T.C. Memo. 1998-357
UNITED STATES TAX COURT
CLARENCE D. KIGHTLINGER, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 13890-97. Filed October 5, 1998.
R. Wyatt Mick, Jr., for petitioner.*
Timothy S. Sinnott, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
ARMEN, Special Trial Judge: This case was heard pursuant to
the provisions of section 7443A(b)(3) and Rules 180, 181, and
182.1
* Briefs amicus curiae were filed by Robert W. Mysliwiec, on
behalf of Wayne E. and Judith A. Ellis, and by Mary A. Bridwell.
(continued...)
- 2 -
Respondent determined a deficiency in petitioner's Federal
income tax for the taxable year 1993 in the amount of $1,882, as
well as an accuracy-related penalty under section 6662(a) for
negligence or intentional disregard of rules or regulations in
the amount of $376.
After a concession by respondent,2 the only issue for
decision is whether petitioner may exclude from gross income
under section 104(a)(2) the settlement proceeds that he received
during the year in issue. We hold that petitioner may not
exclude such proceeds under section 104(a)(2).
FINDINGS OF FACT
Some of the facts have been stipulated, and they are so
found. Petitioner resided in Mishawaka, Indiana, at the time
that his petition was filed with the Court.
Petitioner was employed by Whitehall Laboratories, Inc.
(Whitehall) in Elkhart, Indiana, from August 1986 through some
time in 1990 or 1991. Whitehall was a subsidiary of American
Home Products Corp. (AHP). Wyeth-Ayerst Laboratories was a
division of AHP.
(...continued)
1
Unless otherwise indicated, all section references are to
the Internal Revenue Code in effect for the taxable year in
issue, and all Rule references are to the Tax Court Rules of
Practice and Procedure.
2
Respondent concedes that petitioner is not liable for the
accuracy-related penalty under sec. 6662(a).
- 3 -
While employed at Whitehall, petitioner was a member of a
labor union named the Oil, Chemical and Atomic Workers
International Union (the Union).
During the 1980's, AHP initiated a plan to relocate part of
its operations to Guayama, Puerto Rico. As a result of this
plan, AHP closed various plants operated by Whitehall and Wyeth-
Ayerst, including the plant operated by Whitehall in Elkhart, by
the end of 1991 or early 1992. The plant closings caused
approximately 1,100 Whitehall and Wyeth-Ayerst employees to be
laid off and eventually lose their jobs. Petitioner was one such
individual.
In January 1991, the Union filed suit against AHP and
various other entities and individuals in the United States
District Court for the District of Puerto Rico (the District
Court). During that same year, the Union determined that a class
action should be brought against AHP and other defendants on
behalf of the employees that were laid off. Consequently, in
November 1991, the Union sent a notice entitled "Keep Whitehall
Open" to the affected Whitehall employees. The notice stated
that it had become appropriate to seek individual damages for the
laid off members of the Union "under the RICO [Racketeer
Influenced and Corrupt Organization] complaint". The notice
provided further as follows:
the remedy that we would be asking for [is]
compensation for losses in wages and benefits for some
- 4 -
appropriate period of time but not less than the
duration of the current contract * * *.
In February 1992, the Union, its local chapter, and several
individuals (the Plaintiffs) filed a class action against AHP and
various other individuals and entities (the Defendants) in the
District Court. The class action complaint (the Complaint)
stated in its preliminary statement that the Defendants:
did unlawfully and without justification violate federal
Racketeering laws and intentionally interfere with the
protected right of Plaintiffs, including the prospective
economic advantages, enjoyed by the herein described class
of former Elkhart * * * employees.
The Complaint identified several individual plaintiffs as
typical class representatives. An example of a paragraph
identifying an individual class member is as follows:
Defendants' decision to relocate and transfer jobs to
Puerto Rico has caused [individual class representative] a
great personal loss consisting of his being terminated in
December, 1989. [Individual class representative] has since
found no steady work and is forced to maintain temporary
employment with no medical benefits. Defendants' actions,
which provoked his unemployment, caused him great emotional
distress, feelings of low self esteem and self worth.
[Individual class representative] now earns much less and
lost fringe benefits due to his being terminated by
Defendants.
Other individual class representatives were similarly
identified. The Complaint alleged factually in great detail that
the Defendants, in the course of a scheme reasonably calculated
to defraud the plaintiffs, to evade State and Federal taxes, and
to avoid compliance with various other Federal and Puerto Rican
laws, violated Federal racketeering laws and interfered with the
- 5 -
Plaintiffs' economic advantage. All of the factual allegations
revolved around the Defendants' wrongdoing in violations of the
above-mentioned laws. There were no factual allegations
regarding any personal injury.
The Plaintiffs based their claims on four counts consisting
of two separate counts for RICO Act violations, one count for
unlawful interference with prospective economic advantage, and
one count for punitive damages. As required by the RICO Act, the
two counts for RICO Act violations alleged injury to the
Plaintiffs' business and property. Under the count for unlawful
interference with prospective economic advantage, the Plaintiffs
alleged that the Defendants' actions interfered with the rights
of the Plaintiffs to "enjoy the fruits and advantages of their
industries and efforts as employees". (Emphasis added.)3
Finally, by their count for punitive damages, the Plaintiffs
claimed that the Defendants' negligent conduct caused "severe
economic and financial harm as well as other damages" to the
Plaintiffs. No mention was made of any physical or emotional
injury under any of the four counts.
Pursuant to the class action, all AHP employees affected by
AHP's relocation to Guayama, Puerto Rico, received a legal notice
of class action. Petitioner was a member of this class action
3
Not relevant here, the class action also alleged
interference with the Union's right to receive dues income from
its members.
- 6 -
and received the above-mentioned notice. The notice of class
action summarized the underlying class action as follows:
Plaintiffs allege in their complaint that Private
Defendants, who in the course of a scheme reasonably
calculated to deceive Plaintiffs and to evade state and
federal taxes, to avoid compliance with various other
federal and Commonwealth laws and regulations, and to
relocate jobs from a state of the United States * * * to
Guayama, Puerto Rico, and who acting in concert with its
corporate officers and agents of the Commonwealth of Puerto
Rico, did unlawfully and without justification violate
federal Racketeering laws and intentionally interfere with
the protected rights of Plaintiffs, including the
prospective economic advantages, enjoyed by the herein
described class of former * * * employees. Plaintiffs
further allege that as a direct result of AHP's scheme to
relocate its production facilities to Guayama, Puerto Rico
to take advantage of tremendous tax savings, AHP caused
workers to lose jobs, to be downgraded in their employment
and/or to take early retirement, all of which caused
substantial economic damages to members of the plaintiff
class. Plaintiffs in this class action lawsuit seek to
recover, on behalf of themselves and all other similarly
situated workers, for the economic harm losses resulting
from AHP's relocation to Puerto Rico, and the related events
occurring thereafter. [Emphasis added.]
The notice of class action further stated:
If you want to participate in this class action lawsuit
and thereby made a claim for economic loss resulting from
AHP's alleged wrongful relocation of pharmaceutical
production jobs to Guayama, Puerto Rico, you need do
nothing. [Emphasis added.]
* * * * * * *
If you have any claims for damages arising out of AHP's
relocation of production to Guayama, Puerto Rico that [are]
not employment-related economic harms, these claims are not
included in this class action. Examples of economic harm
included in this class action are lost wages or lost salary,
lost health care and/or retirement benefits.
- 7 -
In July 1992, the parties reached a settlement without
trial. Thereupon, the parties filed a joint stipulation of
settlement with the District Court. Pursuant to this joint
stipulation of settlement, AHP agreed to pay $24 million in full
satisfaction of all of the claims brought against it in the class
action. The joint stipulation of settlement did not allocate the
settlement proceeds for any particular claim. However, the
proceeds were allocated among court-approved expenses, class
counsel, the Union, and class members. The joint stipulation of
settlement provided guidelines pursuant to which an independent
trustee would determine the appropriate amount to compensate
individual class members for their demonstrated employment-
related economic harm. Pursuant to this stipulation, economic
harm was to be measured based upon factors such as age, duration
of employment with the company, salary history, and subsequent
employment history, including the date of new employment and
salary history. Noneconomic injury was not a factor to be
considered in the independent trustee's allocation of the
recovery to the class members.
Subsequently, class members, including petitioner, received a
notice of proposed settlement and settlement hearing. The notice
of proposed settlement reiterated that the lawsuit sought to
recover for harm resulting from the Defendants' violation of the
RICO Act and interference with the class members' prospective
- 8 -
economic advantages as employees. The notice of proposed
settlement then informed the class members regarding the method
selected to compensate individual class members for their
demonstrated economic harm arising from the loss of their
employment. Individual class members were given the option to
exclude themselves from the proposed settlement for any reason,
including the possibility that their claim was more expansive
than one for employment-related economic loss.
Individual class members were required to submit a proof of
claim and release to the independent trustee to claim a portion
of the recovery. The proof of claim and release form was
designed to measure each individual class member's degree of
employment-related economic harm. The form inquired as to the
individual class member's age, years of service with AHP, job
classification at the time of separation, whether the individual
was bumped down before separation, whether the individual
received severance pay at the time of separation, how the
individual's current benefits differed from those received at
AHP, and the individual's current sources of income. No inquiry
was made as to whether an individual class member had suffered
any physical or emotional injury.
Petitioner claimed entitlement to a portion of the class
action recovery and stated in his proof of claim as follows:
- 9 -
The economic damages that I have suffered since my
termination from Whitehall Lab. in Elkhart has had a
devastating hardship on my financial future and security.
Since losing my job, I have had to withdraw all my
savings and cash in securities that I had put aside for my
retirement years.
When I was hired at Whitehall Lab. in Elkhart in August
of 1986, I felt as though I had secured my future with the
good wages I would be able to make during my years until
retirement. Also I felt as though I would have good
retirement benefits secured for my "golden years". I knew
if I were given a chance to work at this facility for the
future 27 to 30 years, I would be in a good position with
full pension and medical benefits.
Currently I am working at a job that pays less than 50%
of the wages I made at Elkhart's Whitehall Lab.
In moving the facility to Puerto Rico the results were
that I was one of over 800 plus workers whose life has
changed. Leaving me with an insecure future, and with the
possibility that I will never have the financial security
that I had while employed at Whitehall.
Petitioner may have suffered some depression as a result of
being laid off. However, petitioner did not consult with a
doctor for any such condition. Petitioner did not claim any
emotional or physical injury and did not opt out of the
settlement agreement to pursue a claim for personal injury or
otherwise.
A final order and judgment in the class action was entered
in September 1992. In that document, the District Court approved
the joint stipulation of settlement filed by the parties. The
District Court retained jurisdiction solely for the purpose of
ensuring proper administration of the settlement proceeds.
- 10 -
Subsequently, a "motion for distribution of notice and
release form" was filed by the Plaintiffs. The motion outlined
the independent trustee's determination of the method for the
allocation of the funds among the individual class members.
Pursuant to the guidelines in the joint stipulation of
settlement, the independent trustee considered factors such as
age, years of seniority, and the amount of severance pay
received. Some of the independent trustee's findings, as
pertaining to petitioner,4 are as follows:
Since some terminated employees received up to two
weeks severance and others received less, the first priority
will be to distribute the settlement funds to bring each
qualified claimant up to two weeks of severance pay for each
full year of seniority. Any remaining funds will be
distributed mainly to terminated employees who did not
transfer or receive ERIP [early retirement incentive
program] on the basis of the following point system:
[The point system allocated points based on: (1) Age,
increasing from age 25 to age 51 and decreasing from age 51
and up; and (2) years of service, increasing per year of
service.]
* * * * * * *
The rationale for basing this point system on seniority
and age is that workers who were near retirement age when
they were terminated were not damaged as much as younger
workers, (50, say) who probably will have more years of
lower-paying work or unemployment than a 58-year-old worker
who was closer to retirement. Similarly, young workers
4
Pursuant to the joint stipulation of settlement,
claimants were divided into different priority groups. The group
with the top priority included ex-employees who were terminated
without transfer of benefits under an early retirement incentive
program (ERIP). Petitioner was a member of this group inasmuch
as ERIP was not available to any of the Union members.
- 11 -
(say, at age 25) are assumed to suffer less damage than
older workers, who have greater difficulty finding
comparable jobs. The distribution formula therefore
reflects pension eligibility, as well as age and seniority.
Thereafter, in December 1993, the District Court ordered the
disposition of the settlement proceeds to individual class
members pursuant to the independent trustee's allocations (except
for some minor changes not relevant here). In the same order,
the District Court noted:
Finally, the Court has received some correspondence
from class members expressing concern regarding the
taxability of their settlement awards. One particular class
member * * * suggests that twenty percent (20%) of the
payment amount be withheld for the purpose of satisfying
federal income taxes. At this time the Court makes clear
that there will be no withholding of funds from the
settlement award to class members for tax purposes. This
was not a lawsuit about lost wages. Therefore, each member
shall be responsible for taxes based on their particular
situation. [Emphasis added.]
Petitioner received his portion of the recovery from the
class action, $12,057.45, in December 1993. On his 1993 return,
petitioner did not include this amount in gross income, claiming
exemption under section 104(a)(2). In April 1994, respondent
informally notified class members, such as petitioner, that the
settlement proceeds were not excludable from gross income under
section 104(a)(2).
In March 1995, pursuant to a request by the Plaintiffs, the
District Court issued another order. In that order, the District
Court found that the class action: (1) Involved tort-like claims
arising from allegations of wrongful conduct and was not about
- 12 -
lost wages; and (2) involved personal injury-like claims for
emotional distress as evidenced from the pleadings. The Court
stated that it "was closely involved with the settlement, and
would allocate the total settlement to such tort-like claims and
remedies."
In April 1997, respondent issued the notice of deficiency
involved herein. In the notice of deficiency, respondent
determined that petitioner was not entitled to an exemption under
section 104(a)(2) and included petitioner's recovery in gross
income for 1993, the year of its receipt.
OPINION5
1. General Discussion of Section 104(a)(2)
Except as otherwise provided, gross income includes income
from all sources. Sec. 61(a); Commissioner v. Glenshaw Glass
Co., 348 U.S. 426 (1955). Although section 61(a) is to be
broadly construed, statutory exclusions from income are narrowly
construed. Commissioner v. Schleier, 515 U.S. 323, 336-337
(1995); United States v. Burke, 504 U.S. 229, 233 (1992); Kovacs
v. Commissioner, 100 T.C. 124, 128 (1993), affd. per curiam
without published opinion 25 F.3d 1048 (6th Cir. 1994).
5
As previously noted, briefs amicus curiae were filed by
or on behalf of taxpayers similarly situated to petitioner. In
addressing petitioner's contentions we have also considered the
contentions made by the amici curiae.
- 13 -
As an exception to the general rule under section 61(a),
section 104(a)(2) 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". Section
1.104-1(c), Income Tax Regs., provides in pertinent part:
(c) Damages received on account of personal
injuries or sickness. * * * The term "damages
received (whether by suit or agreement)" means 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.
An amount may be excluded from gross income only if it is
received both: (1) Through prosecution or settlement of an action
based upon tort or tort-type rights; and (2) on account
ofpersonal injuries or sickness. Commissioner v. Schleier,
supra; Wesson v. United States, 48 F.3d 894, 901-902 (5th Cir.
1995); Bagley v. Commissioner, 105 T.C. 396, 416 (1995), affd.
121 F.3d 393 (8th Cir. 1997).
2. Personal Injury
Personal injury need not be purely physical in nature and
may include nonphysical emotional injury. United States v.
Burke, supra; Threlkeld v. Commissioner, 87 T.C. 1294 (1986),
affd. 848 F.2d 81 (6th Cir. 1988). In United States v. Burke,
supra at 239, the Supreme Court described the traditional harms
associated with personal injury as "pain and suffering, emotional
distress, harm to reputation, or other consequential damages
- 14 -
(e.g., a ruined credit rating)." The Supreme Court distinguished
such personal injuries from "legal injuries of an economic
character" such as those arising out of the unlawful deprivation
of the opportunity to earn wages through wrongful termination.
Id.
Consequently, damages received for lost wages in connection
with the settlement of economic rights, such as those arising out
of a breach of contract, are not excludable from income under
section 104(a)(2). Id.; Robinson v. Commissioner, 102 T.C. 116,
126 (1994), affd. in part, revd. in part on another issue 70 F.3d
34 (5th Cir. 1995) and cases cited therein.
Similarly, recovery for "business or property" is separate
and distinct from recovery for personal injury. Genty v.
Resolution Trust Corp., 937 F.2d 899, 918 (3d Cir. 1991); Berg v.
First State Ins. Co., 915 F.2d 460, 464 (9th Cir. 1990); Rylewicz
v. Beaton Servs., Ltd., 888 F.2d 1175, 1180 (7th Cir. 1989); see
Reuter v. Sonotone Corp., 442 U.S. 330, 339 (1979) (holding that
the phrase "business or property" in the context of the Clayton
Act, ch. 323, sec. 4, 38 Stat. 731, 15 U.S.C. sec. 15, does not
denote physical or emotional harm to a person.) In Zimmerman v.
HBO Affiliate Group, 834 F.2d 1163, 1169 (3d Cir. 1987), the
Court of Appeals held in this regard as follows:
A plaintiff seeking recovery under RICO must allege
injury "in his business or property" caused by violation of
the Act. In Reuter v. Sonotone, 442 U.S. 330, 99 S.Ct.
2326, 60 L.Ed.2d 931 (1979), the Supreme Court construed
- 15 -
identical language from the Clayton Act on which the RICO
statute was patterned. The Court concluded that Congress
intended the phrase "business or property" to exclude
personal injuries. Id. at 339, 99 S.Ct. at 2331.
A. The Settlement Agreement
In the case before us, petitioner received a portion of the
recovery in a class action pursuant to a settlement agreement.
When damages are received pursuant to a settlement agreement, the
nature of the claim that was the actual basis for settlement
controls whether such damages are excludable under section
104(a)(2). United States v. Burke, supra; Thompson v.
Commissioner, 866 F.2d 709, 711 (4th Cir. 1989), affg. 89 T.C.
632 (1987); Robinson v. Commissioner, supra. Determination of
the nature of the claim is factual. Bagley v. Commissioner,
supra; Stocks v. Commissioner, 98 T.C. 1, 11 (1992). "[T]he
critical question is, in lieu of what was the settlement amount
paid." Bagley v. Commissioner, supra at 406. Therefore, the
intent of the payor is the most important factor. Knuckles v.
Commissioner, 349 F.2d 610, 612 (10th Cir. 1965), affg. T.C.
Memo. 1964-33; Robinson v. Commissioner, supra; Stocks v.
Commissioner, supra at 10.
We first consider the settlement agreement in deciding the
intent of the payor in paying the settlement proceeds. See
Robinson v. Commissioner, supra. The joint stipulation of
settlement involved herein did not specifically allocate the
- 16 -
settlement proceeds for any particular claim. However, the joint
stipulation of settlement provided that an independent trustee
would determine appropriate amounts to compensate individual
class members for their "demonstrated economic harm". Guidelines
outlined in the joint stipulation of settlement based economic
harm on the loss or reduction of wages resulting from the loss of
employment. Personal injury was not considered. Therefore, the
settlement agreement indicates that the Defendants paid the
settlement proceeds on account of economic harm arising from the
deprivation of a class member's opportunity to earn wages. Such
recovery is clearly not on account of personal injury.
We shall not, however, limit our inquiry to the joint
stipulation of settlement. We shall consider other factors to
ascertain the intent of the Defendants in paying the settlement
proceeds. See Knuckles v. Commissioner, supra; Robinson v.
Commissioner, supra; Stocks v. Commissioner, supra.
B. The Complaint
When payments are received pursuant to a settlement
agreement from which we cannot clearly discern why the payments
were made, the underlying complaint is normally examined as an
indicator of the payor's intent. See Robinson v. Commissioner,
supra. Logic dictates that defendants will ordinarily determine
their liability by taking into account the allegations made in
the complaint. See Threlkeld v. Commissioner, supra; Church v.
- 17 -
Commissioner, 80 T.C. 1104 (1983). Accordingly, the payor's
intent can be discerned from the allegations made in the
complaint.
We must therefore consider the allegations made by class
members, such as petitioner, in the Complaint. We observe at
this point that the mere mention of "emotional harm" in a
complaint does not, by itself, serve to exclude the recovery from
gross income under section 104(a)(2). Clearly such a rule would
improperly expand the scope of section 104(a)(2) because the
"emotional harm" language could easily be included in every
complaint, even if such claim were only a "throwaway" claim.
What is more, the mere fact that a taxpayer suffers
"personal" injury from a defendant's conduct is insufficient to
satisfy the "on account of personal injury or sickness" test.
Commissioner v. Schleier, 515 U.S. 323 (1995). Only recovery
that is "attributable to" such personal injury is excludable from
gross income. Id.
The Supreme Court clarified the law in this regard in
Commissioner v. Schleier, supra. In that case, the Supreme Court
distinguished the recovery that a taxpayer receives as a result
of an automobile accident from the recovery that a taxpayer
receives as a result of age discrimination under the Age
Discrimination in Employment Act (ADEA). Whereas both
individuals may suffer emotional harm as a result of a
- 18 -
defendant's wrongdoing, only the accident victim's recovery can
be considered as received "on account of personal injury". The
ADEA does not provide recovery for personal injury. Therefore,
although the ADEA claimant may have suffered some emotional harm,
the recovery he or she received is not on account of his or her
personal injury. Rather, the ADEA claimant's recovery is on
account of the wrongful discrimination leading to his or her
discharge.
Similarly, the RICO Act does not provide a remedy for
personal injuries. See Genty v. Resolution Trust Corp., supra at
918; Berg v. First State Ins. Co., supra at 464; Rylewicz v.
Beaton Servs., Ltd., supra at 1180; Grogan v. Platt, 835 F.2d
844, 847 (11th Cir. 1988); Zimmerman v. HBO Affiliate Group,
supra. Rather, entitlement to recovery under the RICO Act is
predicated on harm to the claimant's business or property.
Rylewicz v. Beaton Servs., Ltd., supra. Recovery for "business
or property" is separate and distinct from recovery for personal
injury. See Rylewicz v. Beaton Servs., Ltd., supra.
The Complaint in the class action was based on several
claims. First, and predominantly, the Plaintiffs alleged injury
to their business and property under the RICO Act. The factual
allegations were clearly aimed at establishing such wrongful
conduct. In this regard, and as is the case with an ADEA
claimant, petitioner did not receive his recovery on account of
- 19 -
personal injury. Rather, he received his recovery on account of
the Defendants' alleged violation of the RICO Act leading to his
discharge. Recovery based on such allegations could only be for
injury to petitioner's business and property. The amount of the
recovery is independent of the existence or extent of any
personal injury that petitioner may have suffered. See
Commissioner v. Schleier, supra.
Petitioner argues that the RICO Act was meant to expand the
remedies available to claimants and does not limit an
individual's cause of action. Although this assertion may be
true, the Plaintiffs in the class action did not, in fact, seek
to establish any personal injury, but limited their remedy to
that provided by the RICO Act.6 Cf. United States v. Burke, 504
U.S. 229, 233 (1992) (holding that the taxpayer's recovery under
Title VII of the Civil Rights Act of 1964, Pub. L. 88-352, 78
Stat. 253, was not excludable--the underlying action not
constituting a tort-type claim--even though taxpayer had other
tort-type remedies available for the wrongful discrimination
against him.)
Secondarily, the Complaint alleged interference with the
class members' prospective economic advantage as employees.
6
As we have already noted, we do not think that the
Plaintiffs actually sought to establish personal injury. The
Complaint merely mentions "emotional distress" without any
supporting factual allegations within the context of a lengthy
(90-page) and carefully drafted complaint.
- 20 -
Recovery for the Defendants' interference with the class members'
economic advantage as employees is similarly not on account of
personal injury. See Commissioner v. Schleier, supra, United
States v. Burke, supra, Robinson v. Commissioner, 102 T.C. at
126. Petitioner asserts that individual class members did not
have a direct contractual relationship with the Defendants. Even
if such assertion is true, class members based their claim for
interference with prospective economic advantage on an
employer/employee relationship. Their complaint sought remedy
for the Defendants' alleged wrongful interference with their
rights "to enjoy the fruits and advantages of their industries
and efforts as employees". This is further evidenced by the
November 1991 notice to the class members, which stated:
The remedy that we would be asking for [is]
compensation for losses in wages and benefits for some
appropriate period of time but not less than the
duration of the current contract * * * [Emphasis
added.]
Clearly, recovery for economic injury based on such a
contractual type claim is excluded from the scope of section
104(a)(2). See Robinson v. Commissioner, supra, and cases cited
therein.
The Plaintiffs also sought punitive damages for the harm
suffered as a result of the Defendants' alleged wrongful conduct.
Contrary to petitioner's suggestion, the exclusion provided by
section 104(a)(2), as in effect for the year in issue, does not
- 21 -
apply to a recovery for punitive damages not attributable to
"physical" injury. Specifically, section 104(a) provides that
the exclusion from gross income for damages received on account
of personal injuries "shall not apply to any punitive damages in
connection with a case not involving physical injury or physical
sickness." The Complaint did not even mention any physical
injury, nor does petitioner claim any physical injury.
Therefore, any portion of the settlement proceeds that may be
allocated to recovery for punitive damages is outside the scope
of section 104(a)(2).
As a final note in this regard, we refer to the manner in
which counsel for the Plaintiffs summarized the class action
Complaint in two notices sent to the class members.
Specifically, we refer to the following excerpt contained in both
notices:
Plaintiffs in this class action lawsuit seek to
recover, on behalf of themselves and all other similarly
situated workers, for the economic harm losses resulting
from AHP's relocation to Puerto Rico, and the related events
occurring thereafter.
Having considered the allegations made in the Complaint and
the Plaintiffs' counsels' interpretation of the class action, we
cannot find that the Defendants intended to pay class members,
such as petitioner, on account of personal injury. Although
mention of emotional harm was made, we do not think that an
action that revolved around RICO violations and interference with
- 22 -
the prospective economic advantages of employees sought or
obtained redress for any of the traditional harms associated with
personal injury such as pain and suffering or emotional distress.
See United States v. Burke, supra.
C. Other Factors
Other factors support respondent's contention that
petitioner's recovery was not on account of personal injury. As
mentioned, the two notices received by petitioner clearly
describe the class action as one for the recovery of lost wages
and employment-related economic harm. In fact, class members
were informed that claims for any harm other than employment-
related economic harm should be pursued by the class member
independently of the class action. Petitioner did not otherwise
pursue a claim for any personal harm. Rather, he claimed his
portion of the recovery by describing how the Defendants' actions
had economically affected him.
Further, the independent trustee in charge of allocation of
the funds was expected to, and did, devise an arrangement
designed to compensate the class members for employment-related
economic harm. The independent trustee allocated funds to ensure
that qualified claimants received up to 2 weeks of severance pay
for each full year of seniority. The remaining funds were
distributed to terminated employees, such as petitioner, who did
not transfer or receive the benefit of the early retirement
- 23 -
incentive program. The funds were distributed on the basis of a
point system that reflected pension eligibility, as well as age
and seniority. The entire distribution arrangement revolved
around lost wages and retirement benefits and sought to make
class members "economically whole".
Petitioner contends that economic loss can be used to
measure the extent of personal injury, as is the case in many
automobile accident injury cases. In this regard, petitioner
relies on Byrne v. Commissioner, 883 F.2d 211, 215 (3d Cir.
1989), revg. 90 T.C. 1000 (1988), for the proposition that
nonpersonal consequences of a personal injury, such as loss of
future income, are often the most persuasive means of proving the
extent of the personal injury that was suffered. We agree that
using economic loss factors as a yardstick to measure the extent
of personal injury does not necessarily bar a recovery from the
scope of section 104(a)(2). See Bent v. Commissioner, 87 T.C.
236, 251 (1986), affd. 835 F.2d 67 (3d Cir. 1987); State Fish
Corp. v. Commissioner, 48 T.C. 465, 476-77 (1967), modified on
other grounds 49 T.C. 13 (1967).
However, petitioner's reliance on Byrne v. Commissioner,
supra, and the accident injury cases is misplaced. The operative
factor in these cases is that there is in fact a personal injury
and that recovery is made on account of such injury. By
contrast, petitioner's loss of employment by the Defendants'
- 24 -
alleged wrongful conduct, the basis on which petitioner received
his recovery, is not a personal injury. Cf. Commissioner v.
Schleier, 515 U.S. 323 (1995). Further, the focus of the
settlement in the class action was to make class members, such as
petitioner, "economically whole" from the effects of their loss
of employment. Therefore, economic factors were not merely used
as a yardstick to measure the extent of the injury; rather, they
were the harm for which petitioner received his compensation.
This is evidenced by the joint stipulation of settlement, by the
independent trustee's findings as reflected in the motion for
distribution of notice and release form, by the inquiries made in
the proof of claim form, and finally, by the proof of claim as
completed and submitted by petitioner.
D. The District Court's Orders
Finally, we consider the orders issued by the District Court
in December 1993 and March 1995. As a preliminary matter, we
observe that because res judicata and collateral estoppel are
affirmative defenses and neither was pleaded by petitioner, they
are deemed waived.7 See Rule 39; Monahan v. Commissioner, 109
7
We note, however, that even if petitioner had pleaded
these affirmative defenses, res judicata and collateral estoppel
would not apply if for no other reason than the characterization
of the settlement's tax consequences was not essential to the
prior proceeding. See Peck v. Commissioner, 90 T.C. 162, 166-167
(1988), affd. 904 F.2d 525 (9th Cir. 1990), setting forth the
following five conditions that must be satisfied prior to
application of issue preclusion in the context of a factual
(continued...)
- 25 -
T.C. 235, 250 (1997); Green v. Commissioner, T.C. Memo. 1998-274
(collateral estoppel); see also Gustafson v. Commissioner, 97
T.C. 85, 89-92 (1991) (if an affirmative defense is not pleaded,
it is deemed waived). We do, however, consider the contents of
these orders in our factual inquiry.
First, the December 1993 order states that the District
Court would not decide what amount should be withheld as income
tax from the recovery. Rather, the District Court left it up to
the class members, "based on their particular situation", to
determine the amount of tax due. Contrary to petitioner's
assertion, this order does not, on its face, establish that
petitioner's recovery is excludable under section 104(a)(2).
The District Court's March 1995 order does, however, state
that the facts and circumstances of the class action involved
tort-like and personal injury-like claims for emotional distress.
This order also states that the District Court "was closely
7
(...continued)
dispute:
(1) The issue in the second suit must be identical in all
respects with the one decided in the first suit.
(2) There must be a final judgment rendered by a court of
competent jurisdiction.
(3) Collateral estoppel may be invoked against parties and
their privies to the prior judgment.
(4) The parties must actually have litigated the issues and the
resolution of these issues must have been essential to the prior
decision.
(5) The controlling facts and applicable legal rules must
remain unchanged from those in the prior litigation.
- 26 -
involved with the settlement, and would allocate the total
settlement to such tort-like claims and remedies."
We do not understand why, in light of all the contrary
evidence, the District Court issued such an order. However,
because this order did not result from an adversary proceeding,
we find that it does not accurately reflect the realities of the
parties' settlement. Cf. Robinson v. Commissioner, 102 T.C. 116
(1994) (the allocation in the settlement agreement approved by
the court is not controlling when the allocation itself did not
result from an adversary proceeding); Bagley v. Commissioner, 105
T.C. 396 (1995) (same); Hess v. Commissioner, T.C. Memo. 1998-240
(same).
Although the proceedings prior to the settlement agreement
were certainly adversarial, the parties were no longer
adversaries after they reached a settlement. More than a year
after the settlement, the Plaintiffs desired to have the
settlement payment linked to tort-type injuries received on
account of personal injuries and met with no opposition from the
Defendants. Once the Defendants paid the settlement proceeds
they did not have any interest in how such funds were allocated.
The Plaintiffs requested the District Court to issue such an
order, and with the Defendants not objecting, the District Court
did so.
- 27 -
We find, therefore, that in light of all the other facts and
circumstances, the March 1995 order does not establish that
petitioner received his recovery on account of personal injury.
3. Tort-type Claim
Petitioner contends that under the law for the taxable year
in issue, if recovery is received on account of a tort-type
claim, then there is no requirement that recovery be on account
of personal injury. In this regard, petitioner relies on United
States v. Burke, 504 U.S. 229 (1992). We disagree with
petitioner's contention, which is squarely refuted by
Commissioner v. Schleier, 515 U.S. 323 (1995).
In Commissioner v. Schleier, supra, the Supreme Court held
that even if the underlying lawsuit is tort-type, the recovery
itself must be "on account of personal injury". Id. Further,
the Supreme Court noted that its holding in United States v.
Burke, supra, did not imply a contrary rule. The following
excerpt from Commissioner v. Schleier, supra at 334-336, clearly
establishes the law in this regard:
[Appellee] also suggests that our decision in United
States v. Burke, 504 U.S. 229 (1992), compels the
conclusion that his settlement award is excludable. In
Burke, we rejected the taxpayer's argument that the payment
received in settlement of her backpay claim under the pre-
1991 version of Title VII of the Civil Rights Act of 1964
was excludable from her gross income. Our decision rested
on the conclusion that such a claim was not based upon "tort
or tort type rights" within the meaning of the regulation
quoted above [sec. 1.104-1(c), Income Tax Regs.]. For two
independent reasons, we think Burke provides no foundation
for [appellee's] argument.
- 28 -
* * * * * * *
Second, and more importantly, the holding of Burke is
narrower than [appellee] suggests. In Burke, following the
framework established in the Internal Revenue Service
regulations, we noted that § 104(a)(2) requires a
determination whether the underlying action is "based upon
tort or tort type rights." * * * In so doing, however, we
did not hold that the inquiry into "tort or tort type
rights" constituted the beginning and end of the analysis.
In particular, though Burke relied on Title VII's failure to
qualify as an action based upon tort type rights, we did not
intend to eliminate the basic requirement found in both the
statute and the regulation that only amounts received "on
account of personal injuries or sickness" come within §
104(a)(2)'s exclusion. Thus, though satisfaction of Burke's
"tort or tort type" inquiry is a necessary condition for
excludability under § 104(a)(2), it is not a sufficient
condition. [Fn. ref. omitted.]
Because the record does not establish that the settlement
recovery was attributable to any personal injury, we need not
decide whether the underlying class action was tort-type.
4. Conclusion
Consistent with the requirement that exclusions from income
are to be narrowly construed, we hold that the settlement
proceeds received by petitioner are not excludable from gross
income under section 104(a)(2).
Petitioner has raised other arguments that we have
considered in reaching our decision. To the extent that we have
not discussed these arguments, we find them to be without merit.
- 29 -
To reflect our disposition of the disputed issue, as well as
respondent's concession,
Decision will be entered
for respondent as to the
deficiency in tax and for
petitioner as to the accuracy-
related penalty.