Miller v. Commissioner

WHALEN, J., dissenting: I disagree with the majority’s conclusion that the amount received by petitioner in settlement of her claims under Maryland law for punitive damages is excludable under section 104(a)(2) as “damages received * * * on account of personal injuries.”

As the Supreme Court stated in Gertz v. Robert Welch, Inc., 418 U.S. 323, 350 (1974), punitive damages awarded in defamation actions

are not compensation for injury. Instead, they are private fines levied by civil juries to punish reprehensible conduct and to deter its future occurrence. [Emphasis supplied.]

The same is true under Maryland law. Embrey v. Holly, 293 Md. 128, 141-143 , 442 A.2d 966, 973 (1982). See generally Murnaghan, “Ave Defamation Atque Vale Libel and Slander,” 6 U. Balt. L. Rev. 27 (1976); McCadden, “Punitive Damages in Tort Cases in Maryland,” 6 U. Balt. L. Rev. 221 (1977).

Thus, in summary, the amount paid to satisfy petitioner’s claims for punitive damages was paid “on account of” the tort-feasor’s culpable conduct, not petitioner’s personal injuries. Accordingly, it should be included in petitioner’s income under section 61(a) as an accession to her wealth, rather than excluded as compensation which makes her personal injuries whole. Commissioner v. Glenshaw Glass Co., 348 U.S. 426 (1955); Starrels v. Commissioner, 304 F.2d 574, 576 (9th Cir. 1962); Villaume v. United States, 616 F. Supp. 185 (D. Minn. 1985).

In this case, petitioner filed law suits in the State of Maryland seeking both compensatory and punitive damages. She asserted claims for compensatory damages based upon allegations that the defendants had made false and untrue statements about her, and claims for punitive damages based upon allegations that the statements were made “maliciously” and “with reckless disregard for the truth.” In settlement of all of her claims, she received a lump-sum payment, after attorney’s fees, of $525,000. This settlement payment is fully taxable, unless it qualifies under section 104(a)(2) as an amount paid “on account of personal injuries.”

Whether any portion of this payment is “on account of personal injuries,” and therefore nontaxable, depends on the nature of each claim made and settled. E.g., Rickel v. Commissioner, 92 T.C. 510 (1989). The law of the State under which the claim is made determines the nature of the claim. Rickel v. Commissioner, supra; Threlkeld v. Commissioner, 87 T.C. 1294 (1986), affd. 848 F.2d 81 (6th Cir. 1988). In Threlkeld v. Commissioner, supra at 1306 n. 6, we noted that:

It has often been stated that State law creates legal interests and rights, but Federal statutes determine when and how they shall be taxed. Morgan v. Commissioner, 309 U.S. 78, 80 (1940); Burnet v. Harmel, 287 U.S. 103, 110 (1932). However, Congress may indicate, either expressly or by implication, that the operation of a taxing statute depends upon State law classifications. Jerome v. United States, 318 U.S. 101, 104 (1942); Poe v. Seaborn, 282 U.S. 101, 110 (1930).

We find that the use of the terms “damages” and “personal injury” by Congress necessarily implies that the exclusion under sec. 104(a)(2) depends, to some degree, upon classification under State law. This is confirmed by use of the term “tort or tort type rights” in the regulations under sec. 104(a)(2).

In analyzing petitioner’s claim- for compensatory damages for defamation, the majority looks to Maryland law and concludes that “defamation is an action for personal injury in Maryland.” (Majority opinion at .) As authority for its conclusion, the majority cites New York, Philadelphia and Norfolk Railroad Co. v. Waldon, 116 Md. 441, 453 , 82 A. 709, 714 (1911). I agree with the majority’s analysis and holding that the portion of the settlement proceeds which compensates petitioner for her injury due to the defamation is excluded from income pursuant to section 104(a)(2). In my view, the majority also correctly declined to reexamine our opinion in Threlkeld v. Commissioner, supra.

Turning to petitioner’s claim for punitive damages, however, the majority fails to analyze the nature of her claim under Maryland law. If it had done so, it would have found that under Maryland law petitioner’s claim for punitive damages is not an adjunct to or substitute for compensatory damages, but represents an entirely different claim based upon different proof and a different theory than her claim for compensatory damages. The difference between the two is summarized as follows:

Compensatory damages are such as will compensate the injured party for the injury sustained, and nothing more; such as will simply make good or replace the loss caused by the wrong or injury. Black’s Law Dictionary, 352 (5th ed. 1979). In other words, they are “damages awarded to a person as compensation, indemnity, or restitution for harm sustained by him.” Id. See McAllister v. Carl, 233 Md. 466, 451-457 , 197 A.2d 140 (1964).

Punitive or exemplary damages are damages on an increased scale, awarded not as the measure of actual loss suffered but “as punishment for outrageous conduct and to deter future transgressions.” Black at 352. [Fn. ref. omitted.] See First National Bank v. Fid. & Dep. Co., 283 Md. 228, 232 , 389 A.2d 359 (1978); General Motors Corp. v. Piskor, 281 Md. 627, 638 , 381 A.2d 16 (1977). [Nast v. Lockett, 312 Md. 343, 348-349 , 539 A.2d 1113, 1116 (1988).]

In Maryland, punitive or exemplary damages thus represent a form of civil punishment. In effect, the term “punitive damages” is somewhat of a misnomer because it is wholly unrelated to the plaintiff’s damages. The defendant’s “malice” or intentional conduct in the commission of the tort is the essential element for an award of punitive damages. Nast v. Lockett, supra at 349-350 ; McCadden, “Punitive Damages in Tort Cases in Maryland,” supra at 205-206. As the court stated in Exxon Corp. v. Yarema, 69 Md. App. 124, 137 , 516 A.2d 990, 997 (1986):

Punitive damages Eire inherently different from compensatory damages and the reasons for the award of each differ sharply. The award of compensatory damages is an attempt to make the plaintiff whole again by monetary compensation. In contrast, the award of punitive damages does not attempt to compensate the plaintiff for harm suffered by him but rather is exemplary in nature and is over and above any award of compensatory damages. The fundamental purpose of a punitive damages award is to punish the wrongdoer for misconduct and to deter future egregious conduct by others. Cheek v. J.B.G. Properties, Inc., 28 Md. App. 29, 43-44 , 344 A.2d 180 (1975). In Embrey v. Holly, 293 Md. 128 , 442 A.2d 966 (1982), the Court explained: “punitive damages are awarded, over and above full compensation, to punish the wrongdoer to teach him not to repeat his wrongful conduct and to deter others from engaging in the same conduct.” 293 Md. at 141 , 442 A.2d 966 (quoting Wedeman v. City Chevrolet Co., 278 Md. 524, 531 , 366 A.2d (1976)). [Emphasis supplied.]

Maryland courts are reluctant to impose punitive damages, and as a safeguard, they normally require the plaintiff to show actual injury, for which an award is made of at least nominal compensatory damages, before punitive damages will be awarded. Shell Oil Co. v. Parker, 265 Md. 631, 643 , 291 A.2d 64, 71 (1972). See generally McCadden, “Punitive Damages in Tort Cases in Maryland,” supra at 206. However, actions for defamation are an exception to this requirement because of the difficulty of showing injury and, at least in the case of libel or slander per se, Maryland courts follow the common law practice of presuming damages and allowing punitive damages with no showing of actual injury. See Sindorf v. Jacron Sales Co., 27 Md. App. 53 , 341 A.2d 856 (1975).

The U.S. Supreme Court recognized the inherent difference between compensatory and punitive damages, described above by the Maryland courts, in Gertz v. Robert Welch, Inc., supra. In balancing the competing demands of the First Amendment and the interest of the States in compensating the victims of defamation, the Court found that this inherent difference necessitated a more stringent standard of malice as a prerequisite for an award of presumptive or punitive damages. If applicable, a plaintiff must show “actual malice,” as defined by the Court in New York Times v. Sullivan, 376 U.S. 254 (1964), in terms of knowing falsity or reckless disregard of the truth. See also Dun & Bradstreet, Inc. v. Greenmoss Builders, Inc., 472 U.S. 749 (1985); cf. Sindorf v. Jacron Sales Co., supra. If this constitutional standard is satisfied, however, a plaintiff can obtain both compensatory and punitive damages in a defamation action with no proof of actual damages of any kind. International Brotherhood of Electrical Workers Local 1805 v. Mayo, 281 Md. 475, 482 , 379 A.2d 1223, 1227 (1977).

The Supreme Court again recently recognized the fundamentally different nature of punitive damages in Browning-Ferris Industries of Vermont, Inc. v. Kelco Disposal, Inc., 492 U.S _, 109 S. Ct. 2909 (1989). In that case, the Court noted that the practice of awarding punitive damages, “damages far in excess of actual compensation for quantifiable injuries,” 492 U.S. at _ , 109 S. Ct. at 2919 , was known to the framers of the Eighth Amendment of the U.S. Constitution, and further noted that “punitive damages advanced the interests of punishment and deterrence, which are also among the interests advanced by the criminal law.” 492 U.S. at _ , 109 S. Ct. at 2920 . In this case, the majority cites Browning-Ferris, but fails to explain why the fundamentally different nature of a claim for punitive damages should not be taken into account for purposes of section 104(a)(2).

It is clear that the majority treats petitioner’s claim for punitive damages as in the nature of a claim for “personal injuries” within the meaning of section 104(a)(2). However, the basis for doing so is not clear. The majority neither specifically states that Maryland law is irrelevant nor provides an explanation for its failure to take Maryland law into account. The majority’s opinion, reasonably interpreted, is that once petitioner’s claim for compensatory damages has been determined to be in the nature of a claim for personal injuries, it is not necessary to review State law to determine the characterization of petitioner’s claim for punitive deimages.

Unlike the majority, I do not believe that this approach is justified by the fact that section 104(a)(2) uses the words “any deimages” and does not expressly distinguish between compensatory and punitive damages. Rather, it seems to me that the majority’s analysis on that point begs the question of whether the payment, by whatever name it is described, qualifies under section 104(a)(2) as an amount “paid on account of personal injuries.” We have consistently held that the law of the State or jurisdiction under which the claim is made must be analyzed in order to make that determination. E.g., Rickel v. Commissioner, supra; Byrne v. Commissioner, 90 T.C. 1000, 1007-1011 (1988); Metzger v. Commissioner, 88 T.C. 834, 850-859 (1987), affd. 845 F.2d 1013 (3d Cir. 1988); Threlkeld v. Commissioner, supra; Bent v. Commissioner, 87 T.C. 236, 245 (1986), affd. 835 F.2d 67 (3d Cir. 1987); Church v. Commissioner, 80 T.C. 1104, 1107 (1983); Roemer v. Commissioner, 79 T.C. 398 , 406 and 408 n. 4 (1982), revd. on other grounds 716 F.2d 693 (9th Cir. 1983). To the extent that the majority fails to analyze petitioner’s claim for punitive damages under Maryland law, its approach contradicts prior decisions which have consistently held that State law must be consulted.

The memorandum opinion of the U.S. District Court in Alabama cited by the majority, Burford v. United States, 642 F. Supp. 635 (N.D. Ala. 1986), does not provide authority for the majority’s failure to analyze State law. In fact, to the contrary, the court there made a detailed analysis of Alabama’s wrongful death statute under which the taxpayer’s claim was made. While damages under that statute are labeled “punitive damages” and “are intended to punish and deter wrongdoers,” the court found evidence in the form of Alabama cases and statutes that actions under the statute are treated in Alabama as actions for “bodily injuries” and as the equivalent of a suit for personal injury. Burford v. United States, supra at 637-638 and 638 n. 5. Moreover, the court was unable to accept the Commissioner’s position that section 104(a)(2)’s exclusion for personal injuries was not intended to include damages paid under Alabama’s wrongful death statute. The court appears to have taken the view that, simply stated, death is the ultimate personal injury and damages for wrongful death are covered by section 104(a)(2) even if they are labeled “punitive.”

Unlike Burford v. United States, the majority fails to point to any reason to disregard for tax purposes the characterization of punitive damages by the Maryland courts as penal and not compensatory in nature. I note that the majority opinion makes the statement, “punitive damages have served as a means of compensating plaintiffs for intangible harm and for costs and attorneys’ fees.” (Majority opinion at 341.) However, the authorities cited by the majority for that proposition make clear that any such compensatory effect of punitive damages is extremely limited in application and does not apply in Maryland. 1

The majority argues that the phrase “on account of” as used in section 104(a)(2) suggests “causation” and is triggered in the case of punitive damages by the fact that they may not be awarded without a showing of actual damages. (Majority opinion at 339.) In effect, the majority reasons that petitioner’s punitive damages were paid “on account of personal injuries” because petitioner could not obtain punitive damages without first making a showing of actual damage. The majority’s premise is incorrect in the case of a defamation action. As mentioned above, a plaintiff in an action for defamation is sometimes presumed to have been injured, at least in the case of defamation per se, and is entitled to compensatory and punitive damages without a showing of actual injury. See Sindorf v. Jacron Sales Co., supra. Even after the Supreme Court’s decision in Gertz, the same is true once a plaintiff has shown “actual malice” sufficient to satisfy First Amendment standards, International Brotherhood of Electrical Workers Local 1805 v. Mayo, supra, and the same may also be true in cases of purely private defamation, as in petitioner’s case.

In any event, the majority’s “causation” analysis confuses a prerequisite for eligibility to make a claim for punitive damages with the nature of the claim itself. I do not believe that the nature of petitioner’s claim for punitive damages is established as a matter of law under section 104(a)(2) by the nature of a taxpayer’s claim for compensatory damages.

Moreover, the majority’s “causation” analysis departs from our previous and consistent approach in other cases where one type of damages is a prerequisite for another: Rickel v. Commissioner, 92 T.C. 510 (1989); Byrne v. Commissioner, 90 T.C. 1000 (1988); Thompson v. Commissioner, 89 T.C. 632 (1987), affd. 866 F.2d 709 (4th Cir. 1989); Pistillo v. Commissioner, T.C. Memo. 1989-329 ; Sparrow v. Commissioner, T.C. Memo. 1989-315 ; and Wirtz v. Commissioner, T.C. Memo. 1989-139 . Rather than simply concluding that the prerequisite type of damages caused, and thus determined the taxability of, the second type of damages, we analyzed the nature of each in order to delineate its tax consequences. See also Thomson v. Commissioner, T.C. Memo. 1965-237 .

For example, in Rickel v. Commissioner, supra, we differentiated, for purposes of section 104(a)(2), the tax consequences of the two types of damages available under the Age Discrimination in Employment Act (ADEA), despite a similar “causation” relationship between the two types of damages. Under the ADEA, a victim of discrimination is entitled to lost wages if the employer violated the ADEA, and liquidated damages if the discrimination was willful. Both arise from the same injury, discrimination, and liquidated damages cannot be awarded unless lost wages are first awarded. Each, however, produces different tax consequences: the lost wages damages component is includable in income, but the liquidated damages component is excludable. Had we applied in Rickel v. Commissioner the causation analysis which the majority applies to the facts before us today, we would have been compelled to hold that liquidated damages under the ADEA are includable in income because the taxpayer would never have received them “but for” the underlying includable lost wages. Instead, we examined the character of both types of damages and held each had differing tax consequences, despite the “causation” relationship between the two.

In adopting the approach that punitive damages are automatically covered by section 104(a)(2) without any consideration of State law, the majority has formulated an expansive view of the statute and, in my view, has run afoul of the Supreme Court’s long-standing admonition that exclusions from income are to be narrowly construed. See, e.g., Commissioner v. Jacobson, 336 U.S. 28, 48-49 (1949); Helvering v. Northwest Steel Mills, 311 U.S. 46, 49 (1940); Deputy v. du Pont, 308 U.S. 488, 493 (1940); New Colonial Ice Co. v. Helvering, 292 U.S. 435, 440 (1934).

Because of the distinction between compensatory and punitive damages under both Maryland and Federal law, and our mandate to construe exclusions from income narrowly, I would hold that the punitive damages received by petitioner in this case are not “damages received * * * on account of personal injuries.”

HAMBLEN, J., agrees with this dissent. See Note, "Exemplary Damages in The Law of Torts,” 70 Harv. L. Rev. 517 , 520-521 (1957) ("the unbroken line of judicial authority in all but three states would seem to preclude any argument that exemplary damages ‘in theory’ retain any major compensatory character,” supra at 521). See also W. Prosser and W. Keeton, The Law of Torts, sec. 2, at 9-10 (5th ed. 1984), to the effect that:

Such damages are given to the plaintiff over and above the full compensation for the injuries, for the purpose of punishing the defendant, of teaching the defendant not to do it again, and of deterring others from following the defendant’s example. Occasional decisions [fn. ref. omitted, citing one case each from Georgia, Iowa, Kansas and Texas] have mentioned the additional purpose of reimbursing the plaintiff for elements of damage which are not legally compensable, such as wounded feelings or the expenses of suit.

Something more than the mere commission of a tort is always required for punitive damages. There must be circumstances of aggravation or outrage, such as spite or “malice,” or a fraudulent or evil motive on the part of the defendant, or such a conscious and deliberate disregard of the interests of others that the conduct may be called wilful or wanton. [Fn. refs, omitted.)