Petition for Writ of Certiorari — Kovacs v. Commissioner

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\ Supreme Court, U.S.

FILE pb

No.

—_ 94 428 S5P 71994

In The — OFFICE OF THE CLERK

Supreme Court of the United States

October Term, 1994

ROSEMARY S. KOVACS; LOIS E. KOVACS;

KATHLEEN L. KOVACS,

Petitioners,

COMMISSIONER OF INTERNAL REVENUE,

Respondent.

Petition For Writ Of Certiorari

To The Sixth Circuit Court Of Appeals

PETITION FOR WRIT OF CERTIORARI

Rosert B. PIERCE

Counsel of Record

Pierce & Pierce, P.C.

255 S. Woodward Ave.

Suite 205

Birmingham, MI 48009

(810) 647-0404

C. Rosert BELTz

Be.ttz & Assoc.

444 Church Street

Flint, MI 48502

(313) 767-5421

DAN DARNELL

MacLean, PROPPE,

MacLean & Darne _t, P.C.

38285 W. Twelve Mile Road

Farmington Hills, MI 48331

(810) 553-6170

Attorneys for Petitioners

COCKLE LAW BRIEF PRINTING CO., (800) 225-6964

OR CALL COLLECT (402) 342-2831

QUESTION PRESENTED

Whether any portion of a lump-sum judgment recov-

ered in a wrongful death tort action is taxable as income

even though:

1) The same amount would be excluded from

income under Section 104 of the Internal Reve-

nue Code if received in periodic payments; and,

2) Code Section 104 specifically requires identical

tax treatment, of the amount so received whether

as a lump-sum or as periodic payments.

3) State law treats time value of money added

(interest) as damages.

4) The widow and children of the decedent recov-

ered less than the full amount of the verdict plus

judgment interest due to delay in payments,

because of the expense of recovery.

TABLE OF CONTENTS

CORFE EUR ee F EEE: i 6 6h rs nccevscassesedueeuen i

pr ee me ess 68). re Perr rr error iv

PETITION FOR A WRIT OF CERTIORARI TO THE

UNITED STATES COURT OF APPEALS FOR THE

Os CS... ivr eee 1

OPniNes GOW. 6.655 Se as 1

WHOUTION «bn See 1

PRINCIPAL STATUTORY AND REGULATORY PRO-

VIGOR INVOINER. i. 2

STATION... 5.55 oe ee 3

REASONS FOR GRANTING THE PETITION....... 5

I THE JUDGMENT AMOUNT INCLUDING ITS

COMPONENTS SUCH AS “STATUTORY INTER-

EST” RECEIVED THROUGH PROSECUTION OF

A LEGAL ACTION BASED UPON WRONGFUL

DEATH IS EXCLUDED FROM INCOME UNDER

a, SEES ROUGE 4 hn cb case nmn seeuaeeeneeees 8

II THE AMOUNT UNDER DISPUTE IS NOT

“INTEREST” AS THAT TERM IS DEFINED IN

EWM BAG GAPE 6 ine cdc a eeu eee ereeenaee ees 15

III RAMIFICATIONS OF THE PERIODIC PAY-

MENT SETTLEMENT ACT OF 1982........... 18

A. NO DISTINCTION SHOULD BE DRAWN

BETWEEN A LUMP-SUM PAYMENT

INCLUDING AN INTEREST ELEMENT

AND PERIODIC PAYMENTS INCLUDING

iby |) Serr ys 18

iil

TABLE OF CONTENTS - Continued

Page

B. THE MAJORITY TAX COURT DID NOT

PROPERLY TAKE ACCOUNT OF THE 1982

AMENDMENT TO CODE SECTION

a 5h yc Vn Ve ws 22

CONCLUSION 25

ee a ke oe ee ee a a ee oe a oe i i ie oe ee a er a a a a oe oe oe ae

TABLE OF AUTHORITIES

Page

Cases

Banish v Hamtramck, 9 Mich. App 381, 157 N.W. 2d

2). rare errr mre iy ert er er ae 12

Brabson v United States, Civil action 93-K-2288

decided August 15, 1994..............-0000--9, 7, 19

Gordon Sel-Way, Inc. v Spence Brothers, Inc., 438

ce ek. | rr ee erg eee ree 11, 12, 24

Hettler Lumber Co. v Olds, 242 F. 456 (C.A. 6, 1917) .... 16

Horton v Commissioner, 100 T.C. 93, No. 8 (1993),

er oko ok kao eas ca ok RG ed Ae doe 13

Julia B. Bennett v Commissioner, T.C. memo

Ds 5s Suk c ade cde Pees NES eee Maas we es 10

McCleary v Green, 38 Mich. 172 (1878).............--. 10

McShane v Commissioner, 53 T.C.M. 409 (1987) ........ 6

Mitchell v Reolds Farms Co., 268 Mich. 301, 256

kh OE: | Rr re rr re rere 12

Old Orchard by the Bay v Hamilton Mut. Ins. Co.,

434 Mich. 244, 454 N.W. 2d 73 (1990)............. 11

Riddle v Commissioner, 27 B.T.A. 1359... ......200006- 10

Threlkeld v Commissioner, 87 T.C. 1294 (1986)......... 13

United States v Burke, 504 U.S. __, 112 S. Ct. 1867

(1992), 92 USTC Para. SO256 «2... cccee. 5, 13, 14, 15

MISCELLANEOUS

om, er rT eer T Terr epee? rey rere 20

Michigan Standard Jury Instruction SJI 2d 53.03...... 4

Michigan Standard Jury Instruction SJI 2d 53.04..... 11

TABLE OF AUTHORITIES - Continued

Page

REGULATIONS

I, NN a ae ace wie each Bw ee 2, io

REVENUE RULINGS

Revenue Ruling 65-29, 1965-1 C.B.59................ 19

Revenue Ruling 76-133, 1976-1 C.B. 34.............. 19

VUNG FITI FE oes ned is veda csecaneceens 19, 21

VOIR TRGTI FOr 6 cig hese scrnceriavereecgeun 19

RULES

Supreme Court Rule 10.1(c)............----e eee eeeees 6

STATUTES

DO WBA, SOC. SUIS 6 veo x 6 ec cee is ct es passim

pT a es ne ene ry 17

a ee ee oa ie 4. ae a |

Se Eee Cn cs oo 0 cee oo ea ee ewe wee 1

2b USA. Se FORA) 6 «656 os cesar cede steeews 2

ee es, I FN kg we bho hobs cong ae oh awe aeea ]

ey Oe ee EEGs ook oe bck) oor ene eee eens 2

fag RY FE ee rr yr eye ere re ee re 12

ER Bite WD sb cc ns ve he es eee an ee eee rues 12

ae eer rrr rr eres tere a: ta, Ba

es I ci kn hes utd tee Woes here hase Reeenss 12

Toe FS Peer reer ee TT re ee ee 12

PETITION FOR A WRIT OF CERTIORARI TO THE

UNITED STATES COURT OF APPEALS

FOR THE SIXTH CIRCUIT

Rosemary S. Kovacs, Lois E. Kovacs and Kathleen L.

Kovacs petition for a Writ of Cer! ~ ri to review the

decision of the Sixth Circuit Court oi Appeals, affirming

the United States Tax Court, which held that there was a

deficiency in Petitioners’ income tax for the taxable year

ending December 31, 1987 as determined by the Commis-

sioner of Internal Revenue.

on @

OPINIONS BELOW

The opinions of the Tax Court and the Sixth Circuit

Court of Appeals are appended to this Petition in the

Appendix. The opinion of the Tax Court is reported at 100

T.C. 124 (1993). The opinion of the Court of Appeals is

unreported.

JURISDICTION

Respondent-Appellee, Commissioner of Internal Rev-

enue, issued Notices of Deficiencies to Petitioners-

Appellants on December 29, 1989 asserting deficiencies in

income tax for the calendar year, 1987. Pursuant to 26

U.S.C. § 6213 (a), Petitions were timely filed in the United

States Tax Court giving the Tax Court jurisdiction pur-

suant to 26 U.S.C. § 7442. Decisions of the Tax Court were

entered on March 3, 1993, and a Notice of Appeal to the

Sixth Circuit was timely filed pursuant to 26 U.S.C. § 7483

on April 23, 1993. Mary Ann Kovacs, one of the original

Petitioners, did not join in the appeal. This matter was

appealable to the Sixth Circuit pursuant to 26 U.S.C.

§ 7482(b)(1)(A), as the Appellants are individuals legally

residing in the State of Michigan. The Sixth Circuit

entered its Opinion and Judgment on June 9, 1994. Peti-

tioner invokes the jurisdiction conferred on this Court by

28 U.S.C. § 1254(1).

PRINCIPAL STATUTORY AND REGULATORY

PROVISIONS INVOLVED

Section 104(a)(2) of the Internal Revenue Code, 26 USA.

104, provides, in pertinent part, that gross income does

not include:

(2) the amount of any damages received (whether

by suit or agreement and whether as lump-sums or peri-

odic payments) on account of personal injuries or sick-

ness.

Treasury Regulations, Section 1.104-1(c) state:

“Section 104(a)(2) excludes from gross income

the amount of any aamages received (whether

by suit or agreement) on account of personal

injuries or sickness. The term ‘damages’

received (whether by suit or agreement) means

an amount received (other than workmen’s com-

pensation) 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.”

Michigan Complied Laws 600.6013 states, in pertinent

part, as follows:

(1) Interest shall be allowed on a money judgment

recovered in a civil action, as provided in this section,

except that for complaints filed on or after October 1,

1986, interest shall not be allowed on future damages

from the date of filing the complaint to the date of entry

of the judgment. As used in this subsection, “future dam-

‘

ages” means that term as defined in section 6301.

(2) For complaints filed before June 1, 1980, in an

action involving other than a written instrument having a

rate of interest exceeding 6% per year, the interest on the

judgment shall be calculated from the date of filing the

complaint to June 1, 1980, at the rate of 6% per year and

on and after June 1, 1980, to the date of satisfaction of the

judgment at the rate of 12% per year compounded annu-

ally.

STATEMENT

The relevant facts, as stipulated by the parties, or

otherwise reflected in the record are summarized as fol-

lows:

Charles L. Kovacs, Appellants’ husband and father,

died on September 30, 1976 as the result of injuries sus-

tained when the truck he was operating was struck by a

train owned by the Chesapeake and Ohio Railroad Com-

pany, (“the Railroad”).

A Complaint was filed against the Railroad on Sep-

tember 25, 1978 under the Michigan Wrongful Death Act.

After trial on May 28, 1982, the jury entered a verdict in

the amount of $1,500,000, which pursuant to Michigan

Standard Jury Instruction (SJI 2d 53.03), had been

reduced to present worth for future damages by 5 percent

per annum in order to take into account the time value of

money (interest). The jury also found comparative negli-

gence of 33-1/3 percent which required the Trial Court to

reduce the verdict to $1,000,000.

On June 18, 1982, the Trial Court entered its Judg-

ment in the total amount of $1,355,777.40 computed as

follows:

(A) The jury verdict was reduced by $5,000,

per agreement of the parties, to $995,000.

(B) The Trial Court added $360,777.41 calcu-

lated as pre-judgment interest pursuant to

M.C.L. Section 600.6013 from the date of

filing the Complaint to the date of the

Judgment.

On December 8, 1982, the Railroad filed a Claim of

Appeal to the Michigan Court of Appeals and on May 14,

1984 the Court of Appeals affirmed the trial court’s Judg-

ment. The Railroad continued the appellate process to the

Michigan Supreme Court. On December 16, 1986, the

Michigan Supreme Court affirmed the Court of Appeals.

Finally, on February 3, 1987, the Michigan Supreme Court

denied the Railroad’s motion for a rehearing which termi-

nated the appellate process. On March 17, 1987, after

<hausting all its appellate rights, the Railroad in satisfac-

a of the Judgment issued its lump-sum check for

$2 254,741.70 for a tort that occurred in 1976. The pro-

eds of the Judgment were disbursed as follows:

oor

a. Attorney Fees $749,535.72

b. Costs Advanced 6,134.53

c. Rosemary Kovacs-widow 999,380.96

d. Mary Ann Kovacs-daughter 166,563.50

e. Lois Elizabeth Kovacs-daughter 166,563.50

f. Rosemary Kovacs, Conservator

of the Estate of Kathleen Lynn

Kovacs, a minor-daughter 166,563.50

REASONS FOR GRANTING THE PETITION

The decision of the Tax Court as adopted by the Sixth

Circuit Court of Appeals is in conflict with the reasoning

of this court in United States v Burke, 504 U.S. __, 112 S.

Ct. 1867 (1992), 92 USTC Para. 50,254 and other Circuits

including the Tenth Circuit and is in direct conflict with

the decision of the United States District Court for the

District of Colorado in Brabson v United States, Civil

action 93-K-2288 decided August 15, 1994. See Memoran-

dum Opinion and Order by Senior Judge John L. Kane, Jr.

appended to this Petition in the Appendix. The District

Court in Brabson declined to follow the Kovacs majority

and adopted instead the analysis of Judge Beghe in dis-

sent. The issue is pending in several IRS Districts

throughout the country and therefore is national in scope.

The Kovacs majority is also contrary to the plain language

of Section 104(a)(2) of the Internal Revenue Code. More-

over, it creates an enormous anomaly and inequity in the

administration of the tax law that seriously alters the

balance of power between litigants in all courts in the

nation, state as well as Federal. Hence, the Tax Court and

Court of Appeals have decided an important question of

Federal Law that has not been, but should be settled by

this Court pursuant to Supreme Court Rule 10.1(c).

It is acknowledged by the parties that the damages

were tort-type damages resulting from personal injuries

(The Petitioners/ Appellants are the widow and surviving

daughters of Charles L. Kovacs who was killed in 1976

when the tru“ he was driving was struck by a train).

Had the Appellants (Plaintiffs in the original tort

action that produced the damages at issue here) and the

Railroad settled the earlier litigation, they would have

been entitled to designate the amount they received as

anything the parties chose. See McShane v Commissioner,

53 T.C.M. 409 (1987). A settlement amount, even if

received many years after the original injury, generally

does not designate or allocate any amount as interest

even if the time value of money obviously had been

considered. A settlement providing for periodic pay-

ments, including interest, (i.e. time frame value of

money) is entirely tax free. The decision of the Tax Court

and the Court of Appeals acknowledges that an amount,

including the interest component, is tax free if split into

periodic payments, even if split into only two payments.

The only circumstance in which the “statutory interest”

component of a tort judgment would be taxable would

involve precisely the circumstances in this case, i.e. where

the matter is pushed to trial judgment and paid in full by

the Defendant. The result of the Kovacs majority is cre-

ation of judicial blackmail by shifting the balance of

power between litigants thus enabling a Defendant to put

intense pressure on the Plaintiff to settle because then

and only then can arrangements be made to exclude the

_—— Ee

time value of money portion of the judgment from

income.

It is, of course, a matter of good public policy to

encourage settlements, but the law as formulated by the

Kovacs majority provides one-way pressure, only on

Plaintiffs to settle. Defendants, particularly where large

amounts are involved, are encouraged to fight to the

bitter end if the Plaintiff will not agree to a greatly

discounted award to avoid taxation on delayed time

value added (interest).

Had the Railroad paid immediately after entry of the

Trial Court’s Judgment on June 18, 1982 (or, in fact, upon

first demand by the Plaintiff’s attorney) the amount paid

would have been $1,355,777.40. They paid many years

later $2,254,741.70 determined by applying a percentage

to the amount obtained by judgment pursuant to Michi-

gan statute which the Michigan legislature labeled inter-

est. With respect to the Kovacs majority conclusion that

the percentage amount was taxable interest, Senior Judge

John L. Kane, Jr. in Brabson v United States, App. 86 stated:

“The Kovacs majority invokes the following syl-

logism to conclude prejudgment interest

awarded as damages in personal injury actions

is not ‘damages’ excludable from income under

§ 104(a)(2): prejudgment interest is ‘interest’;

‘interest’ is not ‘damages’; therefore prejudg-

ment interest is not ‘damages’ excludable from

income under § 104(a)(2). The cornerstone of the

majority’s analysis, and the one without which

it fails, is the conclusory maxim ‘interest is inter-

est.’ This tautology withers under scrutiny, and I

decline to follow it.”

The conclusion that the interest portion of the lump-

sum payment amount was taxable results in all tort cases

tried before a Court or Jury, indistinguishable in principle

from settled tort cases, being treated inconsistently. Most

civil litigations are settled. Very few litigants can afford to

pay off sizeable judgments with lump-sum payments.

The end result of the holdings of the Tax Court and the

Sixth Circuit is that a litigant who receives a judgment

from a Defendant who is particularly wealthy and partic-

ularly stubborn has to pay taxes on one portion of the

award, but other litigants in tort-type actions do not. This

is poor public policy and, far from being mandated by

statute, is diametrically opposed to the clear language of

the statute which specifically states that payments of

damages in tort-type actions, whatever their nature, are

to be treated the same. A determination by this Court that

the interest component in periodic payments are taxable

would be consistent with the Kovacs decision; however, in

view of the statute such determination obviously could

not be made.

THE JUDGMENT AMOUNT INCLUDING ITS COM-

PONENTS SUCH AS “STATUTORY INTEREST”

RECEIVED THROUGH PROSECUTION OF A LEGAL

ACTION BASED UPON WRONGFUL DEATH IS

EXCLUDED FROM INCOME UNDER SECTION

104(A)(2)

Section 104(a)(2) of the Internal Revenue Code pro-

vides that gross income does not include:

“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 . i

The Treasury Regulations, Section 1.104-1(c) states:

“Section 104(a)(2) excludes from gross income

the amount of any damages received (whether

by suit or agreement) on account of personal

injuries or sickness. The term ‘damages’ received

(whether by suit or agreement) means an amount

received (other than workmen’s compensation)

through prosecution of a legal suit or action based

upon tort or tort type rights, or through a settle-

ment agreement entered into in lieu of such

prosecution.” (EMPHASIS SUPPLIED)

The Regulation’s unequivocal definition of damages

as an amount received through prosecution of an action

based upon tort alone leads to the conclusion that any

interest element which accrues during the prosecuting of

a claim based upon tort should be treated as part of the

damages award.

The parties agreed and the majority Tax Court opin-

ion held that the Appellants’ underlying claim was for a

tort and that the “damages” were awarded on account of

a personal injury. (Tax Court Op. App. p. 13). Therefore,

there is no issue regarding whether the amount in ques-

tion was received on account of personal injuries. The Tax

Court majority opinion, however, construes the “statu-

tory interest” added to the jury verdict pursuant to

M.C.L. 600.6013 as entirely separate and distinct from the

damages recovered by reason of the tort. Both dissenting

opinions agreed that the “interest” at issue constitutes

“damages” within the meaning of Code Section 104(a)(2)

and the Regulations thereunder.

The Tax Court placed great reliance on the 1933 case

of Riddle v Commissioner, 27 B.T.A. 1339, dealing with

international law and claims resulting from the sinking of

the Lusitania. See Julia B. Bennett v Commissioner, T.C.

memo 1994-190 f.n. 5. In Riddle the then Board of Tax

Appeals determined that interest could not accrue on an

unliquidated personal injury award and that the only

interest payable by law is that amount earned after the

claim was liquidated. The “interest” accruing before the

claim became liquidated would be amounts considered as

damages because of the personal injury.

The Lusitania sank May 7, 1915 and the $15,000

award for personal injury was granted November 1, 1923.

Interest on the liquidated claim ran from November 1,

1923 to 1928 when it was paid, not from the filing of the

Complaint as in the instant case. Application of the Riddle

principle to the instant case would mean that taxable

interest on Appellants’ claim ran from February 3, 1987 to

March 17, 1987, the date of payment. As stated by Judge

Beghe, the $30,000 interest accruing after finality of the

Judgment would be taxable as Appellants conceded in

the Tax Court proceeding. (Beghe Op. App. p. 35). Riddle

does not stand for the proposition that pre-judgment

interest is not excludable from gross income under Sec-

tion 104(a)(2) but only that post judgment interest must

be included in gross income (Beghe Op. App. p. 55).

The Tax Court’s reliance on Michigan law for support

was equally flawed. For 100 years or more, Michigan

Courts have recognized that the failure to pay money

promised when by law it ought to be paid authorizes the

allowance of interest in the nature of damages for the

improper detention of the sum so promised. McCleary v

Green, 38 Mich. 172, 185 (1878). That case held that inter-

est is allowable as damages for non-payment of commis-

sions when they were earned. Moreover, the Michigan

Standard Jury Instructions make it clear that in a wrong-

ful death action, interest as an element of damages may

be awarded by the jury from the date of the deceased’s

death (the tort) to the filing of the Complaint. See Michi-

gan Standard Jury Instruction SJI 2d 53.04. Under the

rationale of the Tax Court “statutory interest” added by

the Court would be taxed; however interest added by the

jury from date of the tort to date of filing the complaint

would be exempt. Thus, the “interest” element has been

treated by the majority in diametrically opposed ways

depending on what period of time the “interest” covers.

As indicated in Judge Beghe’s dissenting opinion, the

majority Tax Court opinion that Michigan law precludes a

finding that “damages” received on account of wrongful

death may include interest or a time value of money

element is clearly erroneous. Old Orchard by the Bay v

Hamilton Mut. Ins. Co., 434 Mich. 244 (1990), 454 N.W. 2d

73, 76, cited in the Tax Court opinion does not support

such conclusion. Moreover, the more recent Michigan

Supreme Court opinion in Gordon Sel-Way, Inc. v Spence

Brothers, Inc., 438 Mich. 488 (1991), at page 499, con-

clusively shows that Judge Beghe’s dissenting view is

correct. The Michigan Supreme Court stated:

“Finally, we acknowledge, as did the Court of

Appeals, the fact that Michigan has long recog-

nized the common-law doctrine of awarding

interest as an element of damages. 177 Mich.

App 128-131. The doctrine recognizes that

money has a ‘use value’ and interest is a legiti-

mate element of damages used to compensate

the prevailing party for the lost use of its funds.

See McCormick, Damages, Section 50, pp.

205-206. Furthermore, the decision whether to

award interest as an element of damages is not

dependent upon a contractual promise to pay

interest. Id. See also Mitchell v Reolds Farms Co.,

268 Mich. 301, 313; 256 NW 445 (1934). As stated

in Banish v Hamtramck, 9 Mich. App 381, 399-400;

157 N.W. 2d 445 (1968) the pivotal factor in

awarding such interest is whether it is necessary

to allow full compensation.”

Indeed, the Michigan Supreme Court’s language in

the Gordon Sel-Way case is consistent in more than one

respect with Judge Beghe’s dissenting opinion. (See

Beghe opinion, App. pages 37, 38, 43 et seq.).

The Tax Court’s conclusion that damages and interest

are separate items because the Michigan Wrongful Death

Act does not repeat the provisions of Section 600.6013 of

the Michigan Compiled Laws within its provisions, does

not square with the legislative process. Michigan has at

least three statutes which apply directly to the Kovacs

case. M.C.L. 600.2922 is the Michigan Wrongful Death Act

that describes the tort and as Judge Beghe noted (Beghe

Op. App. p. 45-46), “There is nothing in subsection 6 of

the Michigan Wrongful Death Act that prohibits a Michi-

gan court or jury from including an interest (time value of

money) element in its verdict so long as it is fair and

equitable.” M.C.L. 600.2922(6). Section 600.6306 deter-

mines the items included in the order of judgment, stat-

ing in salient part that “All taxable and allowable costs,

including interest as permitted by Section 6013 or 6455 on

——————

the judgment amounts” is included in the order of judg-

ment. M.C.L. 600.6013 provides for the calculation of the

interest element included in a judgment. It is not as the

Tax Court majority claims a separately recovered amount.

The Supreme Court’s decision in United States v

Burke, 504 US. __, 112 S. Ct. 1867, 92 US.T.C. Para.

50,254 (1992) supports Judge Beghe’s well reasoned con-

clusions that:

“This regulation covers all amounts received

and does not distinguish among the component

parts of an award received by a plaintiff in a tort

action, such as lost future earnings, medical and

funeral expenses, pain and suffering, loss of

companionship, etc., or interest. Instead, the

regulation focuses on the nature of the underly-

ing claim. Once it is found that the personal

injury claim is tort or tortlike, all amounts

received from the defendant and its insurer

through the prosecution of the claim are

excluded from gross income.” (Beghe Op. App.

p. 42)

Threlkeld v Commissioner, 87 T.C. 1294, 1305 (1986)

aff’d by the Sixth Circuit at 848 F.2d 81 (6th Cir. 1988)

which required an investigation into the nature of the

claim rather than the consequences flowing from the

injury, was cited with approval by the Supreme Court in

Burke. Threlkeld stands for the proposition that the essen-

tial element of exclusion is that the income be derived

from some sort of tort claim. See also Horton v Commis-

sioner, 100 T.C. 93, No. 8 (1993), CCH Dec 48,856 involv-

ing punitive damages.

As observed by Justice Blackmun in Burke at f.n. 6,

112 S. Ct. at 1871 the enactment in 1989 of a limited

amendment of Section 104(a)(2) addressing exclusion of

punitive damages only in the cases involving physical

injury or sickness “shows that Congress assumed that

other damages (i.e. compensatory) would be excluded

...” In the body of the opinion Justice Blackmun further

stated in pertinent part that: “Indeed one of the hallmarks

of traditional tort liability is the availability of a broad

range of damages to compensate . . . fairly for injuries

caused by the violation of his legal rights” 112 S. Ct. 1871.

He further stated that the victim may be permitted under

relevant state law, to recover damages not only for lost

wages, medical expenses, and diminished future earning

capacity on account of the injury, citing Threlkeld. A rea-

sonable conclusion from Burke is that Judge Beghe’s opin-

ion should be adopted and the lower Courts reversed.

Significantly, Judge Beghe’s language (App. p. 43) stating

that the “regulation covers all amounts received and does

not distinguish among the component parts . . . such as

loss of future earnings or interest” is almost identical

with the language of Justice Blackmun.

The incompatibility of the majority Tax Court with

the Supreme Court in Burke is most obvious. Moreover,

the Supreme Court’s specific approval in Threlkeld of the

Sixth Circuit’s analysis, in so far as it focused on the

nature of the claim underlying the damage award, is

added reason for reversal of the Tax Court, as affirmed by

the Sixth Court.

In Burke, Justice O’Connor stated in her dissenting

opinion:

“The Court properly defers to an Internal Reve-

nue Service Regulation that reasonably interprets

the words “damages received” to mean “an

amount received through prosecution of a legal

suit or action based upon tort... ”

She then concluded that, “Therefore, respon-

dents may exclude from gross income any

amount they received as a result of asserting a

‘tort type’ right to recover for personal injury”

112 S. Ct. 1878.

Concurring in Burke, Justice Souter interpreted Regu-

lation 26 CFR § 1.104-1(c) as reflecting “the broad dichot-

omy between contract and tort” 112 S. Ct. 1877. He then

analyzed the claim in Burke to determine whether the

remedies sought in that case were tort-like or contract-

like. There is no question that the present case is a tort

and none of the damages are contractual in nature. As no

contractual damages exist in this case, it appears under

Justice Souter’s reasoning that the interest component of

the amount received would not be taxable. The Kovacs

majority's opinion is contrary to Justice Souter’s opinion

in Burke.

THE AMOUNT UNDER DISPUTE IS NOT “INTER-

EST” AS THAT TERM IS DEFINED IN THE TAX CODE

The cornerstone of the Kovacs majority analysis and

the one without which it fails, is the conclusory maxim

“interest is interest.” As stated by Judge Kane in Brabson

v United States, “This tautology withers under scrutiny”

(App. p. 86).

Interest in the commercial sense generally would be

calculated upon an ascertained or defined base. Under

the facts of this case, the base upon which the statutory

enhancement was calcuiated was inchoate, was not

known, nor was it real until after exhaustion of the judi-

cial process. In short, the base becomes choate and known

only after the enhancement is achieved. To paraphrase

the language of the Sixth Circuit in Hettler Lumber Co. v

Olds, 242 F. 456, 460 (C.A. 6, 1917) prior to a certain time

the right of the Appellants to demand anything of the

Railroad was in the clouds.

In the instant case, there was no sum of money upon

which “interest” could be computed until the finalization

of the litigation by the Michigan Supreme Court. Thus,

there could be no interest in the commercial sense.

Only by violently straining language can one say that

the Appellants exercised forbearance with respect to the

payment of their unadjudicated claim as in the case of

taxable interest. Far more accurately, Appellants, upon

filing the complaint, were entitled to nothing. They were

exercising no forbearance at all. The Commissioner's

arguments have been that merely because the Michigan

Legislature provided that, with respect to any money

judgment including actions for torts, the amount in ques-

tion should be calculated as “interest” means that it can-

not be considered as an element of damages within the

meaning of Section 104(a)(2). That argument is patently

unsound. The amount at issue was received as damages

for personal injuries within the meaning of Section

104(a)(2) and the Regulations thereunder which have

been outstanding for many years.

If the Commissioner’s underlying argument that the

amount at issue was to compensate for the delay in

payment of a debt were valid, then the defendant railroad

would be entitled to deduct the accrued interest under

the decision of the Tax Court majority. However, as Judge

Beghe observed, (Beghe Op. App. p. 38) such a deduction

would not be permitted because “prejudgment interest

included in an award on a non-contractual claim is not

deductible by the payor as interest on indebtedness

under Section 163(a) and its statutory predecessors.” This

is because there is no “debtor-creditor relationship”

between the parties until the judgment is entered. It is

only after a final judgment that Section 163(a) of the Code

allows the defendant a deduction for interest paid or

accrued on the judgment. After Kovacs, then, pre-judg-

ment interest is “damages” not interest for purposes of

the deduction for interest under Section 163(a); but it is

“interest” not damages for purposes of the exclusion

from income under Section 104(a)(2) (Brabson, App. 88).

While “interest” is income just as are wages, capital

gains, and indeed, all accessions to wealth, the purpose of

Section 104(a)(2) is to exclude income on account of per-

sonal injuries in order to make the injured party whole.

The Kovacs majority taxes a portion of a protected recov-

ery even though Appellants were not made whole.

Ill

RAMIFICATIONS OF THE PERIODIC PAYMENT SET-

TLEMENT ACT OF 1982

NO DISTINCTION SHOULD BE DRAWN BETWEEN A

LUMP-SUM PAYMENT INCLUDING AN INTEREST

ELEMENT AND PERIODIC PAYMENTS INCLUDING

INTEREST

Judge Halpern’s dissent in the Tax Court holds that

the Tax Court Majority has not properly taken account of

Congress’ 1982 amendment to Code Section 104(a)(2). The

legislative history of the 1982 amendment makes it abun-

dantly clear that the exclusion for periodic payments of

damages on account of personal injuries is not limited to

present value of such periodic payment but includes

“interest.” (Halpern Op. App. p. 24) That is to say that

periodic payments, in their entirety, are excludable from

gross income under Section 104(a)(2) as damages received

from personal injuries. No allocation is allowed for that

portion of the payments that represent the element or

consideration for the use-of money over time. Judge

Halpern therefore properly concluded that lump-sum

payments from prosecution of a law suit, including any

interest component or element, likewise is fully exclud-

able under Section 104(a)(2) as damages received on

account of personal injuries.

There is no distinction and Congress did not provide

for a distinction in tax treatment between a lump-sum

payment involving interest elements resulting from pros-

ecution of a suit for tort from periodic payments involv-

ing the same elements derived from a settlement of a law

suit for a tort.

All the Tax Court opinions agreed that the Periodic

Settlement Act of 1982 was designed to codify and clarify

existing law. All agree that under then existing case law

and Revenue Rulings the exclusion for damages for per-

sonal injury did not exclude income or interest from a

lump-sum award that was invested by or on behalf of the

taxpayer. See Revenue Ruling 76-133, 1976-1 C.B. 34: Reve-

nue Ruling 65-29, 1965-1 C.B.59. Thus, the application or

non-application of Section 104 under the law as it existed

in 1982 depends on whether the taxpayer has exercised

control over the funds or has received an economic bene-

fit from the funds.

Neither condition exists in the instant case. Appel-

lants had no constructive receipt or economic benefit

whatsoever until February 3, 1987 when the Michigan

Supreme Court denied the Railroad’s motion for rehear-

ing. The Commissioner does not dispute that the Appel-

lants did not have and could not exercise dominion and

control over any liquidated or unconditional amount

until 1987 (See Revenue Ruling 79-220 and Revenue Ruling

77-230.) It was only after February 3, 1987 that the Com-

missioner could argue that Appellants had any economic

benefit of the present value of the damages. Indeed, there

was no principal sum, liquidated amount, or any uncon-

ditional amount that could generate interest until the

appeal process became final.

The law, prior to the 1982 Amendment, was that

portions of periodic payments representing interest on a

fund invested on the recipients’ behalf were not taxed so

long as the invested funds were not actually or construc-

tively received. Consequently, the Treasury Department

argued at hearings before the Committee on Ways and

Means, House of Representatives, 97th Congress, 2d Ses-

sion regarding H.R. 5470, treatment of certain arrange-

ments for periodic payment of personal injury damages

that “the interest components of periodic damage pay-

ments should not escape taxation simply because the

Plaintiff has elected in effect, to have the Defendant or a

third party invest the proceeds of the settlement for him.”

Although the Treasury’s argument did not prevail,

the Legislative history documents the Treasury's opposi-

tion to H.R. 5470 in the following discussion making clear

references to the treatment of interest:

“ this bill points out a serious problem under

current law relating to the taxation of damages

for personal injuries that are paid periodically

rather than in a lump-sum. The problem arises

from the fact that under current law, the por-

tions of periodic damage payments representing

interest on a fund invested on the recipient's

behalf are not actually or constructively

received.”

Those remarks recognize that any interest element of

damages would be excludable from gross income regard-

less of the characterization as long as the taxpayer had

not actually or constructively received that portion of the

periodic payment. In short, the criteria for exclusion then

and now is whether the taxpayer had constructive receipt

of or economic benefit from the amount in question and

not whether the amount reflected periodic payments or a

lump-sum with elements of interest.

The importance of Revenue Ruling 77-230, 1977-2 C.B.

214, cited by the Tax Court majority (Op. App. p. 21)

(involving excludability of medical payments from a Gov-

ernment trust for future medical expenses) is the side

comment referring to Section 104(a)(2). The comments

were “ ... benefits received through distributions made

from income or corpus ... in payment of medical expenses

are amounts received through a settlement agreement in

lieu of prosecution of a legal suit based upon tort... and

therefore are excludable from income under Section

104(a)(2).” (Emphasis supplied). The Ruling then held

that there should be no allocation for interest elements

and the full amount of any periodic payment would be

tax exempt.

Because investment interest received on a lump-sum

is taxable, the logic prior to Revenue Ruling 77-230, was

that a portion of each periodic payment made in place of

a lump-sum settlement for personal injuries might be

treated by IRS as taxable in the same way as an annuity

payment especially because annuities were purchased to

fund the payments. In order to reach the conclusion in

Revenue Ruling 77-230 there necessarily was recognition

that any “interest” element in a lump-sum received prior

to investment, constructive receipt or economic benefit

was excluded under Section 104(a)(2).

Prior to the 1982 Amendment Section 104(a)(2) stated

in salient part only that “ ... gross income does not

include . . . (2) the amount of any damages received

(whether by suit or agreement) on account of personal

injuries...” The language, “and whether as lump-sums or

as periodic payments” was added by the 1982 amendment

to clarify and codify existing law. It therefore follows that

any “interest” element in a lump-sum received by way of

settlement or prosecution of a tort action also was

excluded.

The Tax Court majority apparently agreed with Judge

Halpern’s conclusion that the time value of money is to

be disregarded and the entirety of periodic payments

discharging an obligation for damages on account of per-

sonal injuries is excluded by virtue of the 1982 Amend-

ment codifying existing law. However, the majority

erroneously opined that the time value of money (inter-

est) is not excluded where there is a one time (lump-sum)

payment. This conclusion does not square with the lan-

guage “whether as lump-sums or as periodic payments”

added by Congress in the 1982 amendment. Therefore the

“interest,” or “statutory interest,” is included within the

broad range of damages to compensate Appellants such

as “lost wages, medical expenses and diminished future

earning capacity” as observed by Justice Blackmun in

Burke.

THE MAJORITY TAX COURT DID NOT PROPERLY

TAKE ACCOUNT OF THE 1982 AMENDMENT TO

CODE SECTION 104(A)(2)

The Tax Court and Sixth Circuit’s Opinions with

regard to the Periodic Payment Act ignores the point that

it is a recognized principle of statutory construction that

a statute is to be construed so as to give effect to every

word in it. If the Commissioner’s interpretation as

adapted by the Tax Court and the Sixth Circuit is allowed

to stand, the “lump-sums” portion of the phrase, “and

whether as lump-sums or as periodic payments,” has no

meaning.

The same argument that the interest portion is not

“on account of personal injuries or sickness,” not exclud-

able, applies equally to the interest portion of periodic

payments. Yet, the Commissioner did not attempt to

argue that some portion of periodic payments are not “on

account of personal injuries or sickness.” Periodic pay-

ments, including the interest portion, are excludable. The

same applies to “lump-sum payments.” The wording of

the statute makes it clear that payments of damages in

tort actions, “whether as lump-sums or as periodic pay-

ments,” are to be treated the same. In this connection

Dissenting Tax Court Judge Halpern (App. p. 26-27)

stated as follows:

“Once it is understood that the 1982 amendment

stands for the proposition that, with regard to

periodic payments, the time value of money is

to be disregarded, then the only remaining ques-

tion is whether Congress intended any different

result with regard to lump-sum payments. |

believe that it did not and, consequently,

whether payments are made periodically or ina

lump-sum, time value of money considerations

are to be disregarded in determining the tax-

ability of amounts received under Section

104(a)(2). As stated earlier the language of the

1982 amendment supports that conclusion:

‘whether as lump-sums or as periodic payments’

suggests that Congress intended to disregard

any difference between the two methods of pay-

ment.”

The Commissioner suggested below that it is justifia-

ble to treat identical receipts of funds differently for

administrative convenience. Even if this were a good and

sufficient reason (in fact, it is not) it is not even true. The

Commissioner argued that state law controls the charac-

terization of payments received in lawsuits and quoted

Michigan law to the effect that the purpose of statutory

interest is “to compensate the prevailing party for the

delay in payment of money damages, to cover the costs of

litigation and to encourage prompt settlement” (p. 21 of

the Commissioners’ Brief in the Court of Appeal).

Accordingly, even under that view, not all of such statu-

tory amount is payment for the time value of money

under Michigan law. Some of it is to cover expenses and

of course, as stated in Gordon Sel-Way, common law inter-

est as damages shares the same full compensation goals

of MCL 600.6013.

As with periodic payments, it is impossible to tell

what portion of the “interest” is for what purpose lump-

sum or periodic payment, the character of the payment is

the same. How much is paid for what is impossible to

disentangle. As stated by Tax Court Judge Halpern (App.

p. 27-28):

“For whatever reasons, Congress decided that it

was best to disregard the fact that time value of

money concerns play a role in determining the

size of personal injury damage awards or settle-

ment amounts, and to treat no part of any pay-

ment of damages received in connection with

personal injuries as being on account of the time

value of money. Thus, I would not distinguish

between lump-sum payments and periodic pay-

ments with regard to time value of money con-

siderations.”

Yet, if this decision is allowed to stand, lump-sum

payments and periodic payments, despite the mandates

of the statue, would be treated differently.

As stated by Tax Court Judge Halpern (App. p. 28)

treating periodic payments and lump-sum amounts dif-

ferently with regard to interest “illustrates a patent incon-

sistency in the majority’s interpretation of that

amendment, whereby Congress decided for whatever rea-

son, in connection with Section 104(a)(2) payments, to

turn a blind eye to interest. We are obliged to respect that

decision.”

CONCLUSION

The petition for the Writ of Certiorari should be

granted.

Respectfully submitted,

Rosert B. Pierce

DAN DARNELL

C. Rosert Betz

App. 1

NOT RECOMMENDED FOR PUBLICATION

No. 93-1637

UNITED STATES COURT OF APPEALS

FOR THE SIXTH CIRCUIT

ROSEMARY S. KOVACS, ON APPEAL FROM

et al., THE UNITED STATES

Petitioners-Appellants, 25 ee

(Filed

-COMMISSIONER OF

INTERNAL REVENUE,

June 9, 1994)

Respondent-Appellee.

Neem eee ee ee ee”

BEFORE: NORRIS and DAUGHTREY, Circuit

Judges, and GILMORE, Senior District Court Judge.*

PER CURIAM. In this appeal from the United States

Tax Court, we are asked to decide whether interest paid

on an award of damages for wrongful death is excludable

as income under section 194(a)(2) of the Internal Revenue

Code. That provision of the tax code excludes from gross

income “the amount of any damages received (whether by

suit or agreement and whether as lump sums or as peri-

odic payments) on account of persona! injuries or sick-

ness... . ” 26 U.S.C. § 104(a)(2) (emphasis added).

“Interest,” on the other hand, is included in gross income

under section 61(a)(4) of the Code. 26 U.S.C. § 61(a)(4).

* The Honorable Horace W. Gilmore, Senior United States

District Court Judge for the Eastern District of Michigan sitting

by interchange.

App. 2

The Tax Court upheld the Commissioner’s deter-

mination that the amounts in dispute here were subject to

taxation as gross income to the petitioners. We agree and

affirm.

The facts in this case were stipulated in the Tax

Court. The petitioners are the widow and three surviving

daughters of Charles L. Kovacs, who was killed in 1976

when the truck he was driving was struck by a locomo-

tive operated by the Chesapeake and Ohio Railroad Com-

pany. Suit for wrongful death was filed on behalf of his

estate in Michigan state court, resulting in a 1982 damage

award of $995,000. In 1987, after exhausting the appeals

process, the railroad paid the petitioners a total cf

$2,254,741.70, which included the sum of the damages,

plus $6,134.53 in costs and $1,253,607.17 in statutory

interest.

After receiving their pro rata shares of the railroad’s

payment, the petitioners did not report any of the

amounts as gross income (but also did not deduct any

part of their attorneys’ fees, totalling some $750,000, as

expenses). The Commissioner subsequently notified the

petitioners of substantial deficiencies for the tax year

1987, based on their failure to include as gross income the

amounts calculated as interest on the original damage

award. The taxpayers promptly petitioned the Tax Court

for a redetermination, arguing that the interest in ques-

tion was an element of damages under Michigan state

law and, therefore, non-taxable as gross income.

App. 3

In a split opinion,’ the Tax Court upheld the Com-

missioner’s determination and further held that the peti-

tioners could deduct the attorneys’ fees attributable to

interest, under section 212(1) of the Internal Revenue

Code. See 26 U.S.C. § 212(1). In doing so, the court

analyzed in detail the federal precedents controlling the

tax law questions raised in this case, relying principally

on the Board of Tax Appeals’s seminal opinion in Riddle v.

Commissioner, 27 B.T.A. 1339 (1933), and on the Tax

Court’s recent opinion in Aames v. Commissioner, 94 T.C.

189 (1990). It also analyzed Michigan statutory and case

law precedents controlling the distinction between dam-

ages and interest as a matter of state law. Moreover, the

majority opinion responded to the argument raised by the

dissenters concerning the continued validity of Riddle and

the propriety of Aames in light of the enactment by Con-

gress of the Periodic Payment Settlement Act of 1982.

That amendment to Internal Revenue Code section

104(a)(2) permits the exclusion of damages made by peri-

odic payments, despite the possibility that such payments

may include a time-value-of-money component that is

arguably the functional equivalent of statutory interest.

See 26 U.S.C. § 104(a)(2).

After careful study of the record and the opinions of

the Tax Court in this case, we conclude that the majority

opinion correctly analyzes the legal issues and reaches

the proper decision on the narrow question presented.

' Writing for the majority, Judge Ruwe was joined by 13 of

his collegues, one of whom concurred in the result only. Four

members of the Court dissented, but the two dissenting opin-

ions proposed different results.

App. 4

We, therefore, AFFIRM the judgment of the Tax Court on

the basis of that opinion and for the reasons stated

therein.

App. 5

UNITED STATES TAX COURT

Washington, D.C. 20217

ROSEMARY S. KOVACS, _ )

¥: )

Petitione

“——— \ Pieces fo, S6itO

V. )

COMMISSIONER OF )

INTERNAL REVENUE, )

)

Respondent )

DECISION

Pursuant to the determination of the Court, as set

forth in its Opinion (100 T.C. No. 10), filed February 24,

1993, it is

ORDERED AND DECIDED: That there is a deficiency

in income tax due from the petitioner for the taxable year

1987 in the amount of $220,572. It is further

ORDERED AND DECIDED: That there is no addition

to tax due from the petitioner under section 6661, I.R.C.,

for the taxable year 1987.

/s/ Robert P. Ruwe

Robert P. Ruwe

Judge

Entered: MAR 3 1993

App. 6

UNITED STATES TAX COURT

Washington, D.C. 20217

LOIS E. KOVACS,

Petiti

= Docket No. 5618-90

COMMISSIONER OF

INTERNAL REVENUE,

eee ee OT Oe el

Respondent

DECISION

Pursuant to the determination of the Court, as set

forth in its Opinion (100 T.C. No. 10), filed February 24,

1993, it is

ORDERED AND DECIDED: That there is a deficiency

in income tax due from the petitioner for the taxable year

1987 in the amount of $34,992. It is further

-ORDERED AND DECIDED: That there is no addition

to tax due from the petitioner under section 6661, mA...

for the taxable year 1987.

(Signed) Robert P. Ruwe

Robert P. Ruwe

Judge

Entered: MAR 3 1993

App. 7

UNITED STATES TAX COURT

Washington, D.C. 20217

KATHLEEN L. KOVACS, )

Petitioner

) Docket No. 5620-90

V. )

COMMISSIONER OF )

INTERNAL REVENUE, )

)

Respondent )

DECISION

Pursuant to the determination of the Court, as set

forth in its Opinion (100 T.C. No. 10), filed February 24,

1993, it is

ORDERED AND DECIDED: That there is a deficiency

in income tax due from the petitioner for the taxable year

1987 in the amount of $30,184. It is further

ORDERED AND DECIDED: That there is no addition

to tax due from the petitioner under section 6661, I.R.C.,

for the taxable year 1987.

(Signed) Robert P. Ruwe

Robert P. Ruwe

Judge

Entered: MAR 3 1993

App. 8

100 T.C. No. 10

UNITED STATES TAX COURT

ROSEMARY S. KOVACS, ET AL.,!

Petitioners v. COMMISSIONER OF

INTERNAL REVENUE, Respondent

Filed February 24, 1993.

Docket Nos. 5617-90, 5618-90,

5619-90, 5620-90.

Ps were awarded damages of $995,000 in a Michigan

wrongful death action and D appealed. After exhausting

its appeals, D paid Ps $2,254,741.70, which was the sum

of the damages, $6,134.53 in costs, and $1,253,607.17 in

statutory interest. Held: Sec. 104(a)(2), I.R.C., excludes

from gross income “damages received * * * on account of

personal injuries”. Statutorily imposed “interest” on

damages is not included within the exclusionary terms of

Sec. 104(a)(2). Ps may not exclude the portion of the

payment representing interest. Held further: Ps may

deduct the portion of their attorney’s fees attributable to

the interest.

Dan A. Darnell and Robert B. Pierce, for petitioners.

Lynn M. Brimer, for respondent.

1 Cases of the following petitioners are consolidated here-

with: Lois E. Kovacs, docket No. 5618-90; Mary Ann Kovacs,

docket No. 5619-90; and Kathleen L. Kovacs, docket No.

5620-90.

App. 9

OPINION

RUWE, Judge: Respondent determined deficiencies in

petitioners’ 1987 Federal income taxes and additions to

tax as follows:

Addition to Tax

Petitioner Deficiency Sec. 6661

Rosemary S. Kovacs $220,572 $55,143

Lois E. Kovacs 34,992 8,748

Mary Ann Kovacs 33,103 8,276

Kathleen L. Kovacs 30,184 7,546

Kespondent has conceded the additions to tax under sec-

tion 6661.2

[he primary issue remaining for decision is whether

“Interest”, which petitioners received pursuant to Michi-

gan Compiled Laws (M.C.L.) séction 600.6013 (1987), on

“damages” that were awarded to them in a wrongful

death action is excluded from gross income under section

104(a)(2). The deductibility of attorney’s fees paid by

petitioners will depend upon our resolution of the pri-

mary issue

Petitioners resided in Fowlerville, Michigan, when

they filed the petitions in this case.

[he parties submitted this case fully stipulated pur-

suant to Rule 122. The stipulation of facts and attached

exhibits are iricorporated herein by this reference.

¢ Unless otherwise indicated, all section references are to

the Internal Revenue Code in effect for the year in issue, and all

Rule references are to the Tax Court Rules of Practice and Pro-

cedure

App. 10

Rosemary S. Kovacs is the widow of Charles L.

Kovacs, who was killed in 1976 when the truck that he

was driving was struck by a locomotive operated by the

Chesapeake & Ohio Railroad Co. (C & O). On September

25, 1978, Mrs. Kovacs, as administratrix of her husband's

estate, filed a complaint in the Livingston County Circuit

Court against C & O and others in accordance with

M.C.L. section 600.2922 (the Michigan wrongful death

statute). .

On May 28, 1982, a Livingston County Circuit Court

jury delivered a verdict in favor of Mrs. Kovacs, award-

ing damages in the amount of $1,500,000, later reduced to

$995,000.23 The Michigan Court of Appeals affirmed, as

did the Michigan Supreme Court. Kovacs v. Chesapeake &

Ohio Ry. Co., 351 N.W.2d 581 (Mich. Ct. App. 1984), affd.

397 N.W.2d 169 (Mich. 1986).

On March 17, 1987, C & O issued a check in the

amount of $2,254,741.70, payable to Rosemary Kovacs,

administratrix of the estate of Charles L. Kovacs,

deceased, and C. Robert Beltz, her attorney. The check for

$2,254,741.70 was full payment for damages in the

amount of $995,000, $6,134.53 in costs advanced, and

$1,253,607.17 in interest on the damages, pursuant to

M.C.L. section 600.6013. Pursuant to M.C.L. section

600.6013, interest was calculated from the commencement

3 The original verdict of $1,500,000 was reduced one-third

due to Charles L. Kovacs’ contributory negligence and further

reduced by $5,000 for an amount previously paid by the Board

of Road Commissioners for the County of Livingston to settle

claims against the board.

App. 11

of the action until March 17, 1987, the date the judgment

was Satisfied.

By order of the trial court, Mrs. Kovacs received

66-2/3 percent from the net proceeds and her daughters,

Lois, Mary Ann, and Kathleen, each received 11-1/9 per-

cent. The total award of $2,254,741.70 was disbursed as

follows:

Attorney’s fees $749,535.72

Costs advanced 6,134.53

Rosemary S. Kovacs 999 380.96

Mary Ann Kovacs 166,563.50

Lois Elizabeth Kovacs 166,563.50

Rosemary S. Kovacs, conserva-

tor of the Estate of Kathleen L.

Kovacs, a minor 166,563.50

Petitioners did not report any part of the amounts

received on their 1987 Federal income tax returns, nor did

they deduct any part of the attorney’s fees. Respondent

determined that petitioners should have included the

interest portion of the award in gross income. Respon-

dent allocated the interest among the recipients in pro-

portion to the percentages in the trial court’s order.

Respondent also determined that, under section 212(1),

petitioners were entitled to miscellaneous itemized

deductions, subject to the 2-percent floor provided by

section 67, for attorney’s fees attributable to the interest

portion of the award. Respondent allocated the amounts

of interest income and deductions for attorney’s fees,

after taking into account the 2-percent floor, as follows:

App. 12

Interest

Income Attorney’s Fees

Rosemary S. Kovacs $ 835,730 $260,961.16

Mary Ann Kovacs 139,290 43,448.67

Lois E. Kovacs 139,290 43,251.67

Kathleen L. Kovacs 139,290 43,637.67

Totals $1,253,600 $391,299.17

Petitioners filed a timely petition with this Court.

Section 61(a)(4) provides that gross income includes

“interest”. See Kieselbach v. Commissioner, 317 U.S. 399,

403-404 (1943); Tiefenbrunn v. Commissioner, 74 T.C. 1566,

1572 (1980); Smith v. Commissioner, 59 T.C. 107, 111-113

(1972); Wheeler v. Commissioner, 58 T.C. 459, 461-462

(1972); Trez v. Commissioner, T.C. Memo. 1976-141. Nev-

ertheless, petitioners argue that the “interest” they

received pursuant to M.C.L. section 600.6013 (1987) is

excludable from gross income under section 104(a)(2).

Section 104(a)(2) provides that gross income does not

include:

+ Michigan Compiled Laws (M.C.L.) sec. 600.6013 (1987),

provides:

(1) Interest shall be allowed on a money judgment

recovered in a civil action, as provided in this sec-

ton ** *

(2) For complaints filed before June 1, 1980, in

an action involving other than a written instrument

having a rate of interest exceeding 6% per year, the

interest on the judgment shall be calculated from the

date of filing the complaint to June 1, 1980, at the rate

of 6% per year and on and after June 1, 1980, to the

date of satisfaction of the judgment at the rate of 12%

per year compounded annually.

App. 13

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 sickness; [Emphasis added.]

For damages to be excludable under section 104(a)(2),

the taxpayer’s underlying claim must be for tortlike per-

sonal injury. United States v. Burke, 504 U.S. eee 5

Ct. 1867, 1870 (1992) (quoting sec. 1.104-1(c), Income Tax

Regs.). The underlying claim in the instant case is for

wrongful death, which clearly lies in tort, see Prosser &

Keeton, Law of Torts, sec. 127, at 945-960 (Sth ed. 1984),

and it is undisputed that the amount designated as “dam-

ages” was awarded on account of a personal injury.

Petitioners take the position that the term “damages”

in section 104(a)(2) should be construed expansively so as

to include interest on such damages. However, it is a

longstanding rule of statutory interpretation that statutes

providing exclusions from income must be construed nar-

rowly. Commissioner v. Jacobson, 336 U.S. 28, 49 (1949).

Section 104(a){2) makes no mention of “interest”. In order

for us to accept petitioners’ position — that interest on

damages is excluded from income by section 104(a)(2) -

we would have to interpret the term ‘ ‘damages” broadly

and overrule previous opinions. This we decline to do.

There is no more persuasive evidence of the purpose

of a statute than the words which the legislature used to

give expression to its wishes. United States v. American

Trucking Associations, 310 U.S. 534, 543 (1940). This maxim

is especially true in interpreting tax statutes. Crooks v.

Harrelson, 282 U.S. 55, 61 (1930); United States v. Merriam,

263 U.S. 179, 187-188 (1923); Masonite Corp. v. Fly, 194 F.2d

257, 260-261 (5th Cir. 1952). “{T]he words of statutes —

App. 14

including revenue acts — should be interpreted where

possible in their ordinary, everyday senses.” Crane v.

Commissioner, 331 U.S. 1, 6 (1947); Miller v. Commissioner,

93 T.C. 330, 338 (1989), revd. on other grounds 914 F.2d

586 (4th Cir. 1990). The term “damages” connotes the

“compensation or satisfaction imposed by law for a

wrong or injury”. Webster’s Third New International Dic-

tionary (1986). The word “interest” in this context means

“the price paid for borrowing [i.e., withholding] money”.

Id.5 Petitioners had the right to, and did, demand pay-

ment of the damages when they filed their wrongful

death claim. The Michigan courts upheld the validity of

the claim and awarded damages plus statutory interest

from the date the claim was filed. The statutory interest

from the date on which petitioners filed their claim to the

date of payment, therefore, falls within the established

definition of interest.© In ordinary parlance, interest

5 See also Kieselbach v. Commissioner, 317 U.S. 399, 403-404

(1943) (interest constitutes “compensation for the delay in pay-

ment”); Tiefenbrunn v. Commissioner, 74 T.C. 1566, 1572 (1980)

(interest component of a condemnation award constitutes

amount separate from price of condemned property); Smith v.

Commissioner, 59 T.C. 107, 111-113 (1972) (interest as compensa-

tion for delay in payment).

6 Cf. Albertson's, Inc. v. Commissioner, 95 T.C. 415 (1990),

where we held that amounts which were deducted as accrued

interest in a transaction that did not involve borrowing, with-

holding of amounts due, or forbearance from demanding pay-

ment were not properly characterized as “interest” because

there was not, and never had been, a present right to claim the

so-called principal amount. Alberison’s involved employment

contracts, wherein the employer and employees agreed, in

advance of the performance of any services, that part of the

employees’ compensation would be deferred until retirement or

App. 15

requires a principal sum. In the instant case, the damages

are the principal sum on which the interest is owed, and

ordinary usage suggests the two are separate. See 25

C.J.S., Damages, sec. 1(b) at 614 (1966) (“The term ‘dam-

ages’ is to be distinguished from other terms, such as

‘debt’, ‘interest’, ‘penalty’, ‘salary’, and ‘value’.”).

We last analyzed this issue in Aames v. Commissioner,

94 T.C. 189 (1990), in which we held that “interest” was

not excludable under section 104(a)(2). In that case, the

taxpayer had sued his attorney for malpractice for failing

properly to prosecute the taxpayer’s personal injury

claim and was awarded damages and interest thereon.

We drew a distinction between the damages and the

interest on such damages, noting that the nature of inter-

est is that it is paid because of the delay in the receipt of a

principal amount. In Aames, the principal amount was the

amount awarded as “damages”. Id. at 193.

This issue first arose in Riddle v. Commissioner, 27

B.T.A. 1339 (1933), which concerned the excludability of

damages and interest awarded thereon in connection

with personal injuries sustained during the sinking of the

steamship Lusitania. The Board, applying predecessors of

sections 61(a) and 104(a)(2) (subsections (a) and (b)(5),

termination of employment. The amounts which were ulti-

mately to be paid were characterized by the employer as

deferred compensation plus interest. A deduction for interest on

the amount designated as deferred compensation was taken by

the employer prior to retirement or termination of the

employees, even though the employees had never had a basis

upon which they could have filed a claim demanding payment.

Under those circumstances, we held that no part of the agreed-

upon deferred compensation arrangement constituted interest.

App. 16

respectively, of section 22 of the Revenue Act of 1928),7

held that interest was not a part of damages, observing

that the interest was “separately computed and speci-

fically designated as interest * * * and as such is includ-

able in income.” Id. at 1341.

We have found no cases since Riddle was decided in

1933 which suggest that “interest” paid on an award of

“damages” received on account of personal injury is

excludable under section 104(a)(2). See Church v. Commis-

sioner, 80 T.C. 1104, 1111 n.8 (1983), and Roemer v. Commis-

sioner, 79 T.C. 398, 403-404 (1982), revd. 716 F.2d 693 (9th

Cir. 1983), which both involved the exclusion of damages

under section 104(a)(2), and in which there was agree-

ment by the parties that interest was taxable. Since

Riddle, the exclusion for personal injury damages has

7 The Revenue Act of 1928, ch. 852, sec. 22(b)(5), 45 Stat.

791, 798, excluded from gross income the following:

Amounts received, through accident or health insur-

ance or under workmen’s compensation acts, as com-

pensation for personal injuries or sickness, plus the

amount of any damages received whether by suit or

agreement on account of such injuries or sickness;

® Cf. McShane v. Commissioner, T.C. Memo. 1987-151, which

involved a one-time settlement payment for a personal injury. In

excluding the full amount of that payment, we relied primarily

on the taxpayers’ testimony, which indicated that no interest or

costs were included in the settlement payment. In addition, we

reasoned that no unconditional obligation upon which to com-

pute interest existed until the settlement agreement was

reached. We noted, however, that “any statutory interest on the

final judgment would have been taxable income under section

61.”

App. 17

been reenacted and amended numerous times.? Neverthe-

less, the statute continues to exclude only “damages” and

omits any mention of “interest”. This implies a continu-

ing acceptance by Congress of the existing interpretation

of the exclusion. Merrill Lynch, Pierce, Fenner & Smith. Inc.

v. Curran, 456 U.S. 353, 381, 382 & n.66 (1982) (longstand-

ing judicial interpretation of statute approved by reenact-

ment); see Society of Plastics Indus. v. ICC, 955 F.2d 722,

728-729 (D.C. Cir. 1992) (same).!° Based on the foregoing,

we hold that the statutory “interest” received by peti-

tioners is not excludable as “damages received * * * on

account of personal injuries” within the meaning of sec-

tion 104(a)(2).

The relevant statutory and case law in Michigan is

consistent with our holding. The claim underlying peti-

tioners’ interest award was brought under M.C.L. section

600.2922, entitled “Death by wrongful act; action for dam-

ages; liability.” At common law, no cause of action for

wrongful death existed in Michigan. Hardy v. Maxheimer,

416 N.W.2d 299, 305 (Mich. 1987) (citing In re Olney Estate,

14 N.W.2d 574 (Mich. 1944); Hyatt v. Adams, 16 Mich. 180

(1867)); accord Fisher v. Volkswagenwerk A.G., 321 N.W.2d

814, 815 (Mich. Ct. App. 1982). Thus, petitioners’ right to

? See Periodic Payment Settlement Act of 1982, Pub. L.

97-473, sec. 101(a), 96 Stat. 2605: sec. 104(a)(2), IL.R.C. 1954, 68A

Stat. 30; sec. 22(b)(5), ILR.C. 1939, 53 Stat. (Part 1) 10. The most

recent amendment to sec. 104(a)(2) was enacted by the Omnibus

Budget Reconciliation Act of 1989, Pub. L. 101-239, sec. 7641(a),

103 Stat. 2106, 2379.

'0 See also Cannon v. Univ. of Chicago, 441 U.S. 677, 696-697

(1979) (“It is always appropriate to assume that our elected

representatives, like other citizens, know the law;”).

App. 18

“damages” for wrongful death stems solely from, and is

limited to, what is provided by M.C.L. section 600.2922.

See Endykiewicz v. State Highway Commn., 324 N.W.2d 755,

757, 758 & n.2 (Mich. 1982). That statute enumerates

several types of damages available for wrongful death in

Michigan, including:

reasonable medical, hospital, funeral, and burial

expenses for which the estate is liable; reason-

able compensation for the pain and suffering,

while conscious, undergone by the deceased

person during the period intervening between

the time of the injury and death; and damages

for the loss of financial support and the loss of

the society and companionship of the

deceased. * * * [M.C.L. sec. 600.2922(6).]

Petitioners received their interest pursuant to M.C.L.

section 600.6013, which is a separate statute devoted

solely to the “Interest rate on [the] judgment; [or] settle-

ment.” Under M.C.L. section 600.6013(1) and (2), interest

is calculated on and added to the judgment and is

designed to compensate the plaintiff for the loss of use of

the monetary damages.!! McGraw v. Parsons, 369 N.W.2d

251, 254 (Mich. Ct. App. 1985). Statutory interest under

M.C.L. section 600.6013 accrues from the date the com-

plaint was filed until the judgment is paid and is not a

part of damages. Vannoy v. City of Warren, 182 N.W.2d 65,

11 Under the Michigan statute, interest is awarded as a

matter of right upon entry of the judgment at a specified rate

regardless of the type of claim or the importance of any element

thereof. See M.C.L. sec. 600.6013 (1987) (“Interest shall be

allowed on a money judgment recovered in a civil action, as

provided in this section”) (emphasis added).

ent

App. 19

69 (Mich. Ct. App. 1970), affd. 194 N.W.2d 304 (Mich.

1972); Banish v. City of Hamtramck, 157 N.W.2d 445, 451

(Mich. Ct. App. 1968); Swift v. Dodson, 149 N.W.2d 476,

478 (Mich. Ct. App. 1967). The distinction between “dam-

ages” and “interest” under M.C.L. section 600.6013 is

further illustrated by the opinions of the Michigan

Supreme Court and Court of Appeals in petitioners’ case,

in which the Courts’ references to “damages” clearly do

not include “interest” paid pursuant to the statute. Kovacs

v. Chesapeake & Ohio Ry. Co., 397 N.W.2d 169, 169 (Mich.

1986); Kovacs v. Chesapeake & Ohio Ry. Co., 351 N.W.2d 581,

992 (Mich. Ct. App. 1984); see also Old Orchard by the Bay

v. Hamilton Mut. Ins. Co., 454 N.W.2d 73, 76 (Mich. 1990);

Denham v. Bedford, 287 N.W.2d 168, 174 (Mich. 1980);

accord Ramada Dev. Co. v. U.S. Fid. & Guaranty Co., 626

F.2d 517, 523-526 (6th Cir. 1980). }2

'2 Historically, judges and commentators have debated

over whether interest constitutes an award “in the nature of

damages”. See 25 C.J.S., Damages, sec. 51 (1966), and cases cited

therein. The historically debated status of interest shows, at a

minimum, that it has always been recognized as a concept with

its own identity distinct from “damages”.

To permit an award of interest it is necessary that the

claim for damages shall represent a pecuniary loss

which is susceptible of computation with reasonable

certainty, or by means of established market values or

other generally recognized standards. [25 C.J.S.,

Damages, sec. 51, at 790 (1966)].

The cases in Michigan make clear that statutory interest com-

puted from the date of filing a claim until payment pursuant to

M.C.L. sec. 600.6013 is not a part of damages. See Vannoy v. City

of Warren, 182 N.W.2d 65, 68 (Mich. Ct. App. 1970), affd. 194

N.W.2d 304 (Mich. 1972); Swift v. Dodson, 149 N.W.2d 476, 478

(Mich. Ct. App. 1967).

App. 20

Finally, petitioners argue that the Periodic Payment

Settlement Act of 1982, Pub. L. 97-473, section 101, 96

Stat. 2605, supports their position that interest is exclud-

able under section 104(a)(2).!% The purpose of this Act

was to codify the position of the Internal Revenue Service

as it existed at that time with respect to the excludability

of damages received in periodic payments. The Internal

Revenue Service’s position was that section 104(a)(2)

excluded personal injury damages, regardless of whether

they were received in periodic payments or as a lump

sum. S. Rept. 97-646 (1982), 1983-1 C.B. 514, 515. Peti-

tioners seem to argue that since the amount of future

periodic payments would normally be determined by

taking into consideration the time value of money, it

would be inconsistent to exclude the entire amount of

such periodic payments while taxing petitioners on the

“interest” that they received.

The legislative history indicates that the limited pur-

pose of the Periodic Payment Settlement Act of 1982 was

to “provide statutory certainty” for the exclusion of

“damages” that are paid in “periodic payments.” S. Rept.

97-646 (1982), 1983-1 C.B. 514, 515. Petitioners did not

receive “periodic payments” of damages. Therefore, we

perceive no relief that they can derive from the Periodic

Payment Settlement Act of 1982, and certainly none from

the revenue rulings cited in the legislative history to

13 The Periodic Payment Settlement Act of 1982, Pub. L.

97-473, sec. 101, 96 Stat. 2605, amended sec. 104(a)(2) by striking

out “whether by suit or agreement” and inserting in lieu thereof

“whether by suit or agreement and whether as lump sums or as

periodic payments.”

App. 21

illustrate the legislative objective.’ Any potential

theoretical inconsistency that might arise between taxing

statutorily imposed “interest” while excluding “periodic

payments” of damages, some part of which may be attrib-

utable to the time value of money, is not within our

province to remedy. If Congress perceives an inconsis-

tency, and is dissatisfied with the result, it has the power

to change the statute. In the meantime, it is our duty to

apply the statutory language. Regarding the nonex-

cludability of interest, application of the relevant statu-

tory language has been consistent since Riddle v.

Commissioner, 27 B.T.A. 1339 (1933), was decided in 1933.

'4 The legislative history cites four prior revenue rulings

dealing with settlements of personal injury claims. See S. Rept.

97-646 (1982), 1983-1 C.B. 514, 515. In Rev. Rul. 77-230, 1977-2

C.B. 214, periodic payments from a Federal Government trust

for a taxpayer’s future medical expenses were ruled fully

excludable. In Rev. Rul. 79-220, 1979-2 C.B. 74, all periodic

payments from an annuity contract purchased by a tortfeasor’s

insurer were ruled fully excludable. In Rev. Rul. 79-313, 1979-2

C.B. 75, 50 consecutive annual payments, to be increased by 5

percent each year, were ruled fully excludable. Finally, in Rev.

Rul. 76-133, 1976-1 C.B. 34, involving a lump sum awarded ina

personal injury suit, part of which was then ordered by the

court to be invested on behalf of a minor until he reached

majority, the interest earned on the investment was ruled includ-

able in the minor taxpayer’s gross income. What distinguished

Rev. Rul. 76-133, supra, from the other three rulings was that the

taxpayer in Rev. Rul. 76-133 was found to have had constructive

receipt or the economic benefit of the damages at the time they

were invested on his behalf. See S. Rept. 97-646 (1982), 1983-1

C.B. 515 nn. 2 and 3; Rev. Rul. 76-133, supra. It is clear from the

legislative history that it was Congress’ intent to provide “statu-

tory certainty” that the type of “periodic payments” described

in the first three rulings would continue to be excluded from

gross income.

App. 22

The legislative history of the Periodic Payment Settlement

Act of 1982 states explicitly that “This provision is

intended to codify, rather than change, present law.” S.

Rept. 97-646 (1982), 1983-1 C.B. 514, 515. Thus, the

amendment effected no change to the longstanding prece-

dent established in Riddle, wherein it was held that inter-

est on personal injury damages is not excludable from

income.

where * * * Congress adopts a new law incor-

porating sections of a prior law, Congress nor-

mally can be presumed to have had knowledge

of the interpretation given to the incorporated

law, at least insofar as it affects the new statute.

[Lorrilard v. Pons, 434 U.S. 575, 581 (1978).]

Deductibility of Attorney's Fees

The parties have agreed that if we hold that peti-

tioners’ interest award is includable in income, the attor-

ney’s fees attributable to interest are deductible under

section 212(1).!° Because we have held that the interest is

includable in income, petitioners will be allowed to

deduct the portion of their attorney’s fees attributable to

interest. Stocks v. Commissioner, 98 T.C. 1, 18 (1992);

Metzger v. Commissioner, 88 T.C. 834, 860 (1987), affd.

1S Attorney’s fees attributable to the damages excludable

from income are not deductible. Sec. 265(a); Metzger v. Commis-

sioner, 88 T.C. 834, 860 (1987), affd. without published opinion

845 F.2d 1013 (3d Cir. 1988).

App. 23

without published opinion 845 F.2d 1013 (3d Cir. 1988);

Church v. Commissioner, 80 T.C. 1104, 1110-1111] (1983).16

Decisions will be entered for

respondent as to the deficiencies in

tax and for petitioners as to the addi-

tion to tax

Reviewed by the Court.

HAMBLEN, PARKER, SHIELDS, COHEN, CLAPP,

SWIFT, GERBER, WRIGHT, PARR, WELLS, CHIECHI,

AND LARO, JJ., agree with the majority opinion.

JACOBS, J., concurs in the result only.

CHABOT, /., dissents.

HALPERN, J., dissenting. I dissent because I believe

that the majority has not properly taken account of Con-

gress 1982 amendment to section 104(a)(2). See section

101 of the Periodic Payment Settlement Act of 1982 (the

1982 amendment), Pub. L. 97-473, 96 Stat. 2605, which

struck from section 104(a)(2) the language “whether by

suit or agreement” and inserted in lieu thereof the lan-

guage “whether by suit or agreement and whether as

lump sums or as periodic payments”. The majority would

treat the 1982 amendment as a narrow-purpose amend-

ment, confirming only the application of the section

104(a)(2) exclusion to periodic payments of damages.

Majority op. p. 10. I agree with the majority that the 1982

amendment confirms the application of the section

'6 In Church v. Commissioner, 80 T.C. 1104 (1983), we used

the following formula to determine the correct deduction:

Total Attorney’s Fees x Nonexmpt Income - Deductible Fees

Total Award

App. 24

104(a)(2) exclusion to periodic payments of damages. |

disagree with the majority, however, as to what Congress

had in mind when it confirmed that application of section

104(a)(2).

The legislative history of the 1982 amendment makes

it crystal clear that the exclusion for periodic payments of

damages on account of personal injuries is not limited to

the present value of such periodic payments. Periodic

payments — in their entirety — are excludable from gross

income under section 104(a)(2) as damages received on

account of personal injuries. No allocation is allowed for

that portion of such payments that represents consider-

ation for the use of money over time, i.e., interest. |

would hold that lump-sum payments, including any

interest component, likewise are fully excludable under

section 104(a)(2) as damages received on account of per-

sonal injuries. Certainly, the phrase “whether as lump

sums or as periodic payments”, which, in the statute,

modifies the phrase “damages received”, suggests that

Congress intended to disregard any difference between

the two methods of payment. Based on the 1982 amend-

ment, I would hold for petitioners on the exclusion issue.'

1 Judge Beghe, in his dissent, informs us that petitioners

have conceded the taxability of certain “postjudgment” interest.

I would limit my holding for petitioners to “prejudgement”

interest, saving the question of “postjudgment” interest for

another day.

App. 25

Interest Portion of Periodic Payments Excluded

The legislative history of the 1982 amendment states

that the amendment was intended to codify, rather than

change, present law:

The bill specifically provides that the Code

section 104 exclusion from gross income of dam-

ages for personal injuries or sickness applies

whether the damages are paid as lump sums or

as periodic payments. This provision is intended

to codify, rather than change, present law. Thus,

the periodic payments of personal injury dam-

ages are still excludable from income only if the

recipient taxpayer is not in constructive receipt

of or does not have the current economic benefit

of the sum required to produce the periodic

payments. See Rev. Rule 79-220, and Rev. Rul.

77-230.

S. Rept. 97-646 (1982), 1983-1 C.B. 514, 515; accord H.

Rept. 97-832 (1982). As a preliminary matter, it is clear

that the Finance Committee intended no change in the

law of constructive receipt or in the economic benefit

doctrine. See, e.g., Rev. Rul. 65-29, 1965-1 C.B. 59 (income

realized from the investment of a lump-sum award repre-

senting the discounted present value of a damage award

for personal injuries is not excludable from gross income

under section 104(a)(2)). Therefore, two possibilities pre-

sent themselves as to what the Finance Committee had in

mind in confirming the application of the section

104(a)(2) exclusion to periodic payments. The committee

may have intended that periodic payments of damages

on account of personal injuries are to be received tax-free

only until an amount equal to the present value of such

periodic payments has been recovered, with the section

App. 26

104(a)(2) exclusion thereafter being inapplicable, because

exhausted. Alternatively, the committee may have

intended that such periodic payments, in their entirety,

are to be excluded from gross income. The committee’s

report is persuasive evidence of the latter. See S. Rept.

97-646, supra, citing four revenue rulings (described supra

majority op. note 14) as illustrative of present law. Accord

H. Rept. 97-832 (1982). The first three rulings amply

illustrate that the Finance Committee intended the

entirety of periodic payments received in discharge of an

obligation to pay damages on account of personal injury

to be received tax free. See, e.g., Rev. Rul. 79-220, 1979-2

C.B. 74 (present value at settlement date of monthly

payments to be received less than nominal total of such

payments; nominal total excluded from income under

section 104(a)(2)). Indeed, the majority does not appear to

disagree with that point.

Lump-Sum Payments”

Once it is understood that the 1982 amendment

stands for the proposition that, with regard to periodic

payments, the time value of money is to be disregarded,

then the only remaining question is whether Congress

intended any different result with regard to lump-sum

payments. I believe that it did not and, consequently,

whether payments are made periodically or in a lump

sum, time value of money considerations are to be disre-

garded in determining the taxability of amounts received

under section 104(a)(2). As stated earlier, the language of

the 1982 amendment supports that conclusion: “whether

as lump sums or as periodic payments” suggests that

App. 27

Congress intended to disregard any difference between

the two methods of payment.

The revenue rulings cited in the legislative history of

the 1982 amendment are of little help in resolving the

question, their analysis being mostly conclusory and

illustrating well only how to avoid receipt (for tax pur-

poses) of. the present value of the expected future pay-

ments. Certainly, the rule of exclusion for periodic

payments is not limited to the three situations cited as

illustrative of present law. Indeed, it appears indisputable

that those examples are merely illustrative of some

broader rationale on the part of Congress. The breadth of

that rationale, however, is unclear. I perceive no persua-

sive evidence to explain Congress’ distinguishing

between lump-sum and periodic payments, as the major-

ity suggests.

Congress, one might hypothesize, may have been

concerned that a taxpayer accepting a periodic payment

arrangement had accepted the credit risk that even the

present value of the expected periodic payments would

not be received. Revenue Rulings 79-220, supra, and

79-313, 1979-2 C.B. 75, are consistent with that conclusion.

It is difficult, however, to see that concern as prompting

the wholesale exclusion of periodic payments, which, as

discussed earlier, the 1982 amendment clearly requires.

Certainly, if that were Congress’ concern, it would have

been sufficient to exclude damages received only up until

the principal portion of such damages is received. In

trying to determine Congress’ concern in adopting the

1982 amendment, I find myself ina puzzlement that I can

only resolve by deciding that, for whatever reasons, Con-

gress decided that it was best to disregard the fact that

App. 28

time value of money concerns play a role in determining

the size of personal injury damage awards or settlement

amounts, and to treat no part of any payment of damages

received in connection with personal injuries as being on

account of the time value of money. Thus, I would not

distinguish between lump-sum payments and _ periodic

payments with regard to time value of money consider-

ations.

I have no quarrel with the majority’s distinction

between a principal sum and interest. Majority op. p. 8.

That distinction, however, appears to be irrelevant when

dealing with damages received, whether by suit or agree-

ment and whether as a lump-sum or periodic payment,

on account of personal injuries. For purposes of section

104(a)(2), interest constituting a portion of such an award

or settlement amount and attributable to the payment of

damages for personal injury is to be treated no differently

from what the majority would agree are damages on

account of personal injuries. Treating periodic payments

and lump-sum amounts differently with regard to inter-

est does not, as the majority would have it, illustrate only

a “potential theoretical inconsistency” wrought by Con-

gress in enacting the 1982 amendment; it illustrates a

patent inconsistency in the majority’s interpretation of

that amendment, whereby Congress decided, for what-

ever reasons, in connection with section 104(a)(2) pay-

ments, to turn a blind eye to interest. We are obliged to

respect that decision.

App. 29

Judges Beghe’s Dissent

Judge Beghe also dissents from the opinion of the

majority. Of course, I agree with Judge Beghe to the

extent that he would exclude the entirety of petitioners’

recovery based on the 1982 amendment. Beghe op. p.

45-47. | also agree with his rejection of application of the

so called “reenactment doctrine” to this case. Id. p. 49. I

disagree, however, with his conclusion that the sole con-

dition for exclusion of a receipt under section 104(a)(2) is

that the amount received (here prejudgment interest) con-

stitutes “damages” within the meaning of that section.

Judge Beghe reaches that conclusion based, in part, upon

the following reading of United States v. Burke, 504 USS.

—__ 112 S. Ct. 1867 (1992): “Once it is found that the

personal injury claim is tort or tort like, all amounts

received * * * through the prosecution of the claim are

excludable from gross income.” Beghe op. p. 37.

Unlike Judge Beghe, I do not read Burke as standing

for the proposition that all amounts received through the

prosecution of a claim for a tort (or tort like) personal

injury are excludable under section 104(a)(2). In Burke,

the Supreme Court merely considered whether the type

of injury redressed by 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. sections 2000e to 2000e17 (1988)), is a

“personal injury” within the meaning of section 104(a)(2).

"he Supreme Court did not have before it, nor did it

App. 30

consider, the meaning of the term “damages” as used

therein.? The Court’s holding was as follows:

Notwithstanding a common-law tradition of

broad tort damages and the existence of other

federal antidiscrimination statutes offering sim-

ilarly broad remedies, Congress declined to rec-

ompense Title VII plaintiffs for anything beyond

the wages properly due them - wages that if

paid in the ordinary course, would have been

fully taxable. Thus, we cannot say that a statute

such as Title VII, whose sole remedial focus is the

award of backwages, redresses a tort-like personal

injury within the meaning of section 104(a)(2)

and the applicable regulations.

Accordingly, we hold that the backpay

awards received by respondents in settlement of

their Title VII claims are not excludable from

gross income as “damages received . . . on

account of personal injuries” under section

104(a)(2). * * * [Id. at __, 112 S. Ct. at 1874:

emphasis added; fn. ref. omitted; citations omit-

ted.]

I therefore would hold that Burke sheds no light on

the question of whether the interest at issue constitutes

damages received on account of personal injuries within

the meaning of section 104(a)(2).

* The Court relied in part on sec. 1.104-1(c), Income Tax

Regs., which defines “damages received”. Justice Scalia, ques-

tioning the relevance of ihat regulation, noted: “this regulation

purports expressly to define only the term ‘damages received,’

and not the *** term we are called upon to interpret today

(‘personal injuries’)”. United States v. Burke, 504U.S.__, __‘112

S. Ct. 1867, 1875 (1992) (Scalia, J., concurring) (citations omit-

ted).

App. 31

Nevertheless, I am prepared to agree with Judge

Beghe that the interest at issue constitutes “damages”

within the meaning of section 104(a)(2). Section

1.104-1(c), Income Tax Regs., is expansive in defining the

term “damages” for purposes of section 104(a)(2): “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.” However, unlike Judge Beghe (and

perhaps many of my colleagues), I do not think the sole

condition for exclusion contained in section 104(a)(2) is

that an amount constitute damages received in a suit

involving such tortlike personal injury. Another neces-

sary condition contained in section 104(a)(2) is that the

damages be received “on account of personal injuries or

sickness”. See Horton v. Commissioner, 100 T.C. eS

(1993) (Whalen, J., dissenting). Absent the 1982 amend-

ment, | would not be persuaded that that condition has

been met. Indeed, the purposes of the Michigan statutory

interest provision in question (Mich. Comp. Laws sec.

600.6013 (1987)) have been stated by the Michigan

Supreme Court to be compensating for delay in payment

of money damages, covering the costs of litigation, and

encouraging prompt settlement. Old Orchard by the Bay v.

Hamilton Mut. Ins. Co., 454 N.W.2d 73, 76-77 (Mich. 1990).

From that description alone, I would not conclude that

the interest in question was received “on account of per-

sonal injuries or sickness.” For that reason, without bene-

fit of the 1982 amendment, I would not conclude that the

requirements of section 104(a)(2) have been satisfied.

WHALEN, J., agrees with this dissenting opinion.

App. 32

BEGHE, J., dissenting: I respectfully dissent. Statu-

tory prejudgment interest on damages received on

account of personal injuries is properly excluded from

gross income under section 104(a)(2). I am impelled to

this conclusion by the preexisting character of prejudg-

ment interest on tort and other unliquidated claims as

damages, for Federal income tax purposes and at com-

mon law and under such superseding statutes as Mich.

Comp. Laws (M.C.L.) section 600.6013 (1987). This con-

clusion is supported by recent Federal income tax devel-

opments, including the Supreme Court’s opinion in

United States v. Burke, 504 U.S. ___, 112 S. Ct. 1867 (1992),

our own reviewed decisions excluding from gross income

under section 104(a)(2) punitive damages in personal

injury actions! and settlements of claims to backpay in

age discrimination suit2, our treatment of amounts

denominated “interest” under deferred compensation

arrangements as deferred compensation subject to the

deduction timing restrictions of section 404,° and the

disregard of the interest element in both lump-sum settle-

ments of claims for damages on account of personal

injuries? and in deferred payment settlements governed

by the amendment to section 104(a)(2) by the Periodic

Payment Settlement Act of 1982, Pub. L. 97-473, 96 Stat.

1 Horton v. Commissioner, 100 T.C. __ (1993); Miller v.

Commissioner, 93 T.C. 330 (1989), revd. and remanded 914 F.2d

586 (4th Cir. 1990).

2 Downey v. Commissioner, 97 T.C. 150 (1991); Keller v. Com-

missioner, T.C. Memo. 1991-373.

3 Albertson’s, Inc. v. Commissioner, 95 T.C. 415 (1990), on

appeal (9th Cir., June 6, 1991).

4 McShane v. Commissioner, T.C. Memo. 1987-151.

App. 33

2605 (1982). As a result of these developments, “related

principles of law have so far developed as to have left the

old rule[5] no more than a remnant of abandoned doc-

trine”,° so that neither stare decisis nor shopworn

maxims about reenactment and narrow construction of

exclusions from gross income require us to persist in

following the old rule.” we should confine to their gener-

ative facts the decisions that have treated as ordinary

income, rather than as part of the amount realized,

amounts received for delay in receipt of condemnation

awards.® Finally, the majority do not address some ques-

tions about proper allocation of the attorney’s fees; the

answers not only support the inapplicability of the con-

demnation cases to the primary issue in this case, but also

indicate that a pro rata apportionment of such fees

between the excludable and taxable parts of the award? is

not the only way to go on this subsidiary issue.

° Of Aames v. Commissioner, 94 T.C. 189 (1990); see also

Riddle v. Commissioner, 27 B.T.A. 1339 (1933).

6 Planned Parenthood v. Casey, 504 U.S. __, __,, 112 S. Ct.

2791, 2808-2809 (1992).

’ Opposed to the thrust of each such maxim or canon of

construction is a parry or counterthrust. See Llewellyn, The

Common Law Tradition: Deciding Appeals, 521-535 (1960); infra

pp. 48-52.

5 Kieselbach v. Commissioner, 317 U.S. 399 (1943); Tie-

fenbrunn v. Commissioner, 74 T.C. 1566 (1980); Smith v. Commis-

sioner, 59 T.C. 107 (1972); Wheeler v. Commissioner, 58 T.C. 459

(1972); see also Ferreira v. Commissioner, 57 T.C. 866, 872 n.7

(1972).

” See, e.g., Church v. Commissioner, 80 T.C. 1104, 1110-1111

(1983),

App. 34

I. Exclusion of Prejudgment Interest as Damages

A. Distinction Between Prejudgment and Postjudg-

ment Interest

The way to get into this case is to observe that, on

February 3, 1987, the Michigan Supreme Court, the State

court of last resort, denied the C & O’s motion for a

rehearing. Prior thereto, petitioners had no legal right to

recover on their claims, but on that date the judgment

against the C & O in favor of petitioners became final,

and petitioners’ entire claim for damages, including stat-

utory interest, was liquidated and became an indebted-

ness of the C & O to petitioners.

Petitioners argue that the “prejudgment interest”

accruing to February 3, 1987, is part of the damages

excludable from gross income under section 104(a)(2).

However, petitioners concede that statutory interest

accruing after that date, until March 17, 1987, when the C

& O satisfied the judgment by issuing its check for

$2,254,741.70, is “interest” includable in gross income

under section 6i(a)(4).!° The concededly taxable interest

10 The thrust of Judge Halpern’s dissent is that petitioners’

concession should be disregarded and that, for cash basis tax-

payers such as petitioners, the entire award received by them is

entitled to exclusion under sec. 104(a)(2), and only the subse-

quent earnings on the amounts received and invested by them

are properly taxable. Inasmuch as it was the income from invest-

ment of the proceeds of a personal injury or malpractice award

that was at issue in Trez v. Commissioner, T.C. Memo. 1976-141,

the citation of that case by the majority is inapposite (majority

op. p. 5).

Orie NE PLS Baie Ns

Petar D

App. 25

accruing from February 3, 1987, until the date of payment

I call “postjudgment interest”.!!

| agree with petitioners that the statutory interest

accruing to February 3, 1987, or “prejudgment interest”,

should be treated as part of the damages received on

account of Mr. Kovacs’ wrongful death.!2 Although a time

1! Petitioners have not provided a computation of the tax-

able amount, but, at the 12-percent compounded rate under

Mich. Comp. Laws (M.C.L.) sec. 600.6013 (1987), it would

appear to be approximately $30,000. This amount could be fixed

on a Rule 155 computation.

'? The trial court had awarded statutory interest under

M.C.L. sec. 600.6013, calculated from the commencement of the

suit, Sept. 25, 1978, through the date of its original judgment,

June 18, 1982, in the amount of $360,777.41. The swelling of the

interest amount included in the award finally paid on March 17,

1987, $1,253,607.17, is attributable not only to the passage of

time, but also to the increase in the statutory rate under M.C.L.

sec. 600.6013. Effective as of June 1, 1980, the statutory rate was

increased from 6 percent per year to 12 per cent per year com-

pounded annually. This raises the question whether the division

date between prejudgment and postjudgment should be the

date of the original judgment of the trial court or the later date

on which the decision of the court of last resort became final.

The question can have substantive law significance, e.g., for

insurance law purposes. Compare Matich v. Modern Research

Corp., 420 N.W.2d 67, 75 n.15 (Mich. 1988) with Incollingo v.

Ewing, 379 A.2d 79 (Pa. 1977). In any event, I think this question

should be decided by reference to a Federal standard, see the

discussion in Fisher v. Commissioner, T.C. Memo. 1992-740, and

that the date the judgment becomes final should be the choice

for Federal income tax purposes. I would choose the later date,

when the judgment becomes final, as the division date, by anal-

ogy to the rule that an accrual basis taxpayer is not entitled to

accrue a deductible claim until he ceases to contest it or the

judgment becomes final. Compare United States v. Consolidated

Edison Co., 366 U.S. 380 (1961) with sec. 461(f).

App. 36

value of money element inheres in both prejudgment and

postjudgment interest, there is a long history of legal

precedent that treats prejudgment interest on an unliqui-

dated claim as part of the damages received on account of

the injury that gave rise to the claim and the resulting

right to receive such damages, see McCormick, Hand-

book on the Law of Damages, sec. 50, at 205 (1935),

whereas postjudgment interest is considered interest eo

nomine (“by that name”), Dobbs, Law of Remedies, sec.

3.5, at 164 (1973), because it accrues on an indebtedness

that has been fixed by final court order.

Interest has been generally defined as the compensa-

tion allowed by law or fixed by the parties for the use or

forbearance of money. See Black’s Law Dictionary 812

(6th ed. 1990). While this definition applies to most types

of interest, it fails to capture the nature of interest on

damages arising from noncontractual claims. As Pro-

fessor McCormick stated in his often-cited treatise on the

law of damages: “This definition * * * is defective in

ignoring interest allowed as compensation for delay in

satisfying unliquidated claims.” McCormick, supra at 205

n.1.13 The defect is that interest (as compensation for the

time value of money) is not simply a creature of contract,

13 Although Professor McCormick’s treatise on the law of

damages has remained unchanged since its publication in 1935,

‘t continues to be cited as one of the leading authorities on the

subject, particularly with reference to its exposition of the his-

tory of interest as an element of damages. See, e.g., Monessen

Southwestern Ry. v. Morgan, 486 U.S. 330, 337 (1988); Library of

Congress v. Shaw, 478 U.S. 310, 314 (1986); see also Williams,

“Prejudgment Interest: An Element of Damages Not To Be Over-

looked”, 8 Cumb. L. Rev. 521 (1977).

App. 37

but also may be an amount “allowed by law as additional

damages for loss of use of the money due as damages,

during the lapse of time since the accrual of the claim.”

Id. at 205.

Professor McCormick showed that there is an histori-

‘i

cal distinction between “ ‘conventional’ or promised

interest, on the one hand, and interest as damages, on the

other.” Id. at 206; (emphasis added; citation omitted); see

also Dobbs, Law of Remedies, sec. 3.5 at 164 (1973);

Black’s Law Dictionary 812 (6th ed. 1990).!4 “[A] sharp

distinction must be taken between interest which is

agreed to be paid as one of the terms of a contract and

interest not based on promise, but given by law for the

withholding of money or compensation due.” McCor-

mick, supra at 205.'5

14 See sec. 1.61-7(a), Income Tax Regs., for examples of

onventional interest on various types of contractual and liqui-

dated-claims. The list also includes one type of interest on what

might be considered unliquidated claims, “the interest portion

of a condemnation award”. Sec. 1.61-7(a), Income Tax Regs.; see

also Kieselbach v. Commissioner, 317 U.S. 399 (1943) (interest on

condemnation awards), discussed infra pp. 52-54 and 58-59.

'° The majority rule at common law was that prejudgment

interest was not allowed on personal injury claims, at least with

respect to pain and suffering and other nonfinancial harms. 4

Restatement, Torts 2d, sec. 913(2) (1979); McCormick, Hand-

book on the Law of Damages, sec. 50, at 205 (1935). Some

jurisdictions allowed interest on lost wages between the time of

the injury and the time of the verdict, just as they required lost

future wages to be discounted to present value as of the time of

the verdict. 4 Restatement, supra secs. 913(2) comment, 913A;

McCormick, supra sec. 56.

Be that as it may, the Michigan statutory system for interest

now applies to all types of claims without any distinction

App. 38

B. Nondeductibility of Prejudgment Interest on

Unliquidated Claims

To determine properly the income tax character of

the amount awarded under M.C.L. section 600.6013, the

Court should deconstruct the term “interest”, rather than

simply accept the contention that “interest is interest”.

The common law distinction between conventional inter-

est and interest as damages is brought out by Federal

income tax cases dealing with the deduction under sec-

tion 163(a) for “interest paid or accrued * * * on indebted-

ness”. These cases make clear that prejudgment interest

included in an award on a noncontractual claim is not

deductible by the payor as interest on indebtedness

under section 163(a) and its statutory predecessors. This

is because there is no debtor-creditor relationship

between the parties until the judgment is entered. Midkiff

v. Commissioner, 96 T.C. 724 (1991); Bettendorf v. Commis-

sioner, 3 B.T.A. 378 (1926); see also Jordan v, Commissioner,

60 T.C. 872, 881 (1973), affd. per curiam 514 F.2d 1209 (8th

Cir. 1975); cf. Vertex Investment Co. v, Commissioner, 47

between contractual and noncontractual claims, and between

pecuniary harms and other types of injury. M.C.L. sec. 600.6013

Provides a legislative exception to the common law prohibition

against interest as an element of damages and codifies the

American trend favoring the award of prejudgment interest.

Ramada Development Co. v. U.S. Fidelity & Guaranty Co., 626 F.2d

517, 525 (6th Cir. 1980). However the jury is still instructed that

it can include in the damages interest on financial claims accru-

ing during the time from the date of the injury to the initiation of

the lawsuit. Ryan v. Ford Motor Co., 334 F. Supp. 674, 675-676

(E.D. Mich. 1971); Vannoy v. City of Warren, 182 N.W.2d 65 (Mich.

Ct. App. 1970), affd. 194 N.W.2d 304 (Mich. 1972).

BsKonlly

App. 39

B.T.A. 252 (1942), vacated and remanded per curiam on

other grounds 32 AFTR 1750, 43-2 USTC par. 9602 (9th

Cir. 1943). However, the entry of final judgment on behalf

of the plaintiff creates a debt, and section 163(a) allows

the defendant a deduction for interest paid or accrued on

the judgment. Bettendorf v. Commissioner, supra.'6

C.Recent Developments

In Albertson’s, Inc. v. Commissioner, 95 T.C. 415 (1990),

on appeal (9th Cir., June 6, 1991), we held that amounts

equal to interest accrued on unpaid deferred compensa-

tion were not deductible as interest under section 163(a)

by the accrual basis employer. Rather, these amounts

represented additional deferred compensation for per-

sonal services that were deductible under section 404

only when paid or otherwise included in the income of

the employees.!7 The time value of money element in

these amounts that arguably prevented them from having

the character under section 162(a)(1) of “compensation

for personal services actually rendered” did not prevent

us from characterizing them consistently with the under-

lying statutory purpose of section-404. The teaching of

'© Subject, of course, to the current restrictions on the

deductibility of personal interest under sec. 163(h) and the eco-

nomic performance requirements under sec. 461(h).

'7 This is consistent with respondent’s view that dividends

on restricted stock that is not substantially vested under sec. 83,

as to which the employee-stockholder has not made a sec. 83(b)

election, are treated as compensation and not as dividend

income. See Rev. Proc. 80-11, 1980-1 C.B. 616; cf. Rev. Proc.

83-22, 1983-1 C.B. 680; Rev. Proc. 83-38, 1983-1 C.B. 773.

App. 40

Albertson’s is that an amount that has a time value of

money aspect can also take on another supervening char-

acter from the transaction or circumstances that gave rise

to it.

Unlike conventional interest on indebtedness, pre-

judgment interest as damages takes its character from the

originating claim; in this case a claim for physical per-

sonal injuries. In Miller v. Commissioner, 93 TA. 30

(1989), revd. and remanded 914 F.2d 586 (4th Cir. 1990),

we concluded that punitive damages on a personal injury

claim took their character from the originating claim and

were excluded from gross income under section 104(a)(2).

We so held, despite the general rule of taxability of puni-

tive damages as accessions to wealth enunciated in Com-

missioner v. Glenshaw Glass Co., 348 U.S. 426 (1955), and

the fact that something extra, the defendant’s egregious

conduct, was required in order to entitle the plaintiff to

punitive damages. We recently reaffirmed that view in

Horton v. Commissioner, 100 T.C. __ (1993).

In Downey v. Commissioner, 97 T.C. 150 (1991), we

held that a settlement of a claim for backpay on account

of age discrimination and the liquidated damages added

thereto were both excludable from gross income under

section 104(a)(2). We so treated them even though the

backpay portion restored amounts that would have been

taxable compensation, and the liquidated damages in part

compensated the plaintiff for delay in receiving the back-

pay under the Age Discrimination in Employment Act of

1967 (ADEA), Pub. L. 90-202, 81 Stat. 602-608. Similarly,

statutory interest on a personal injury or wrongful death

award compensates for the delay in payment. But like

liquidated damages under the ADEA, and the punitive

App. 41

damages in Miller v. Commissioner, supra, statutory inter-

est under M.C.L. section 600.6013 also helps to compen-

sate the plaintiff for costs and attorney’s fees, see Downey

v. Commissioner, supra at 172; Old Orchard by the Bay v.

Hamilton Mut. Ins. Co., 454 N.W.2d 73, 75-76 (Mich. 1990);

Denham v. Bedford, 287 N.W.2d 168, 174 (Mich. 1980), as

well as make the plaintiff whole. See Currie v. Fiting, 134

N.W.2d 611, 616 (Mich. 1965).

In United States v. Burke, 504 U.S. __, 112 S. Ct. 1867

(1992), the Supreme Court stated that an amount will be

treated as personal injury damages under section

104(a)(2) if it is received through prosecution of legal

action based on a tort or tort type right or settlement in

lieu thereof. Id. at __, 112 S. Ct. at 1870 (citing sec.

1.104-1(c), Income Tax Regs.). The Supreme Court applied

this rule to backpay awards received under title VII of the

Civil Rights Act of 1964, Pub. L. 88-352, 78 Stat. 241, 253

(current version at 42 U.S.C sections 2000e to 2000e-17

(1988)), and held that such awards were not excluded

from gross income under section 104(a)(2) because the

Civil Rights Act did not provide a full panoply of tort

remedies. Hence, the Court held that the rights protected

by the statute were not tort or tortlike. United States v.

Burke, 504 U.S. at __, 112 S. Ct. at 1873-1874. In so

holding, the Supreme Court agreed with the approach we

adopted in Threlkeld v. Commissioner, 87 T.C. 1294, 1305

(1986), affd. 848 F.2d 81 (6th Cir. 1988), which looks to the

tort or tortlike nature of the claim to determine whether

damages were received on account of personal injuries.

See also Downey v. Commissioner, supra at 160; Glynn v.

App. 42

Commissioner, 76 T.C. 116, 119 (1981), affd. without pub-

lished opinion 676 F.2d 682 (1st Cir. 1982). We should

apply this approach to the case at hand.

The majority conclude, majority op. p. 8, that none of

the interest portion of the award can be treated as dam-

ages because it serves a purpose fundamentally different

from the underlying damages — compensating petitioners

for the C & O’s delay in payment. However, this over-

emphasizes the time value of money aspect of the recov-

ery. The regulation under section 104(a)(2), section

1.104-1(c), Income Tax Regs., which was applied by the

Supreme Court in United States v. Burke, supra, provides

that:

The term “damages received (whether by suit or

agreement)” means an amount received (other

than workmen’s compensation) through pros-

ecution of a legal suit or action based upon tort

or tort type rights, or through a settlement

agreement entered into in lieu of such prosecu-

tion. [Emphasis added. ]

This regulation covers all amounts received and does

not distinguish among the component parts of an award

received by a plaintiff in a tort action, such as lost future

earnings, medical and funeral expenses, pain and suffer-

ing, loss of companionship, etc., or interest. Instead, the

regulation focuses on the nature of the underlying claim.

Once it is found that the personal injury claim is tort or

tortlike, all amounts received from the defendant and its

insurer through the prosecution of the claim are excluded

from gross income. See United States v. Burke, supra;

Downey v. Commissioner, supra; Threlkeld v. Commissioner,

App. 43

supra. Moreover, the regulation and court decisions inter-

preting section 104(a)(2) do not look to how the amount

received would be treated for tax purposes outside the

personal injury context. See Roemer v. Commissioner, 716

F.2d 693 (9th Cir. 1983), revg. 79 T.C. 398 (1982); Downey v.

Commissioner, supra at 163-164; Threlkeld v. Commissioner,

supra at 1300; see also Gideon, Lawsuits and Settlements,

par. 103.04, at 314-315 (1992). Thus, this Court should be

not bound by the “tyranny of labels”!® to assume that an

amount labeled “interest” must be treated as interest

income for tax purposes when it is received through the

prosecution (or settlement) of a tort or tortlike claim for

personal injuries.

As the majority recognize, majority op. p. 6, peti-

tioners’ wrongful death claim against the C & O was for

personal injuries, and sounded in tort. Consequently,

under the Code and regulations, any amount petitioners

received on account of that claim was “damages” for such

personal injuries within the meaning of section 104(a)(2)

and excludable from gross income regardless of how

computed or its purpose of compensating for delay in

payment.

D. Michigan Law

The majority state, majority op. pp. 11-12, that, under

Michigan law, statutory interest is not an element of

damages and therefore must be treated differently from

interest awarded as an element of damages. As support

'® Snyder v. Massachusetts, 291 U.S. 97, 114 (1934) (Opinion

of Cardozo, J.).

App. 44

for this argument, the majority cite McGraw v. Parsons,

369 N.W.2d 251, 254 (Mich. Ct. App. 1985), in which the

Michigan Court of Appeals observed that interest as an

element of damages and statutory interest on a judgment

are different because the former is awarded as part of the

verdict and the latter is computed on and added to the

underlying damages. The majority also argue that statu-

tory interest must be included in gross income as ordi-

nary interest because its purpose, like conventional

interest on indebtedness, is to compensate the plaintiff

for the lost use of funds and not for personal injuries or

sickness.

The majority’s reliance on McGraw v. Parsons, supra,

is misplaced. In that case, a borrower and a lender had

executed an interest-bearing note. The borrower stopped

making payments on the note and the lender brought

suit. The parties entered into a consent judgment. The

trial court approved the consent judgment and awarded

the lender interest under M.C.L. section 600.6013. The

borrower argued that no additional interest should be

awarded because the consent judgment already provided

for interest as specified in the note. On appeal, the Michi-

gan Court of Appeals held that statutory interest under

M.C.L. section 600.6013 was mandatory and must be

added to the consent judgment.

Although the Michigan Court of Appeals, in McGraw

v. Parsons, supra, stated that the statutory interest served a

purpose different from the interest provided in the con-

sent judgment, that case concerned a liquidated claim for

principal and interest, and arose out of a failure to make

payments on an interest bearing note. The court therefore

concluded, inasmuch as interest was already a part of the

- yee

App. 45

parties’ contract, and not a form of additional damages,

that the plaintiff would not be collecting double interest.

By contrast, Michigan courts do not permit plaintiffs in

wrongful death cases, where the damages are unliqui-

dated, to concurrently receive both interest as an element

of common law damage and interest under M.C.L. section

600.6013. Vannoy v. City of Warren, 182 N.W.2d 65 (Mich.

Ct. App. 1970).

According to the majority, “petitioners’ right to ‘dam-

ages’ for wrongful death stems solely from, and is limited

to, what is provided by M.C.L. section 600.2922,” the

Michigan Wrongful Death Act, majority op. p. 11. For this

proposition the majority rely on Endykiewicz v. State High-

way Comm., 324 N.W.2d 755, 757, 758 & n.2 (Mich. 1982).

Subsection 6, the damages provision of the Michigan

Wrongful Death Act, provides that each damage award

must include

reasonable medical, hospital, funeral, and burial

expenses for which the estate is liable; reason-

able compensation for the pain and suffering,

while conscious, undergone by the deceased

person during the period intervening between

the time of the injury and death; and damages

for the loss of financial support and the loss of

the society and companionship of the

deceased. * * * [M.C.L. sec. 600.2922(6).]

The statute also provides that “the court or jury may

award damages as the court or jury shall consider fair

and equitable”. M.C.L. sec. 600.2922(6).

There is nothing in subsection 6 of the Michigan

Wrongful Death Act that prohibits a Michigan court or

jury from including an interest (time value of money)

App. 46

element in its verdict, so long as it’s “fair and equitable”.

The indented language quoted above simply provides

what must be included in the damages for wrongful

death; it does not limit the damage award to those

amounts or prohibit what may be included in addition to

them. Moreover, the Michigan Supreme Court did not say

anything in Endykiewicz v. State Highway Commission,

supra,’? that bears on the question before us other than

the truism that the Wrongful Death Act provides “the sole

vehicle for the recovery of damages occasioned by

death.” Id. at 758.2°

In Currie v. Fiting, 134 N.W.2d 611, 616 (Mich. 1965),

the Michigan Supreme Court held that interest may be

included as an element of damages in a wrongful death

action. Similarly, in Vannoy v. City of Warren, supra, the

Michigan Court of Appeals recognized that interest

awarded pursuant to M.C.L. section 600.6013 in a wrong-

ful death case, although computed on and added to the

underlying damages, serves the same purpose and is

essentially equivalent to the common law interest made a

part of the verdict in Currie v. Fiting, supra. Therefore, |

19 Endykiewicz v. State Highway Commission, 324 N.W.2d 755

(Mich. 1982), holds that the administratrix of a decedent’s estate

could sue under the Wrongful Death Act for damages for loss of

companionship and society in an action that alleged that the

State of Michigan breached its duty to maintain a highway ina

reasonably safe condition even though the State had, in another

statute, limited its liability for highway defects to bodily injury

and property damage.

20 As the majority observe, wrongful death is a purely stat-

utory tort unknown at common law, majority op. p. 11. Prosser

& Keeton, Law of Torts, sec. 127, at 945-947 (5th ed. 1984).

App. 47

do not agree with the majority that Michigan law pre-

cludes a finding that damages received on account of

wrongful death may include an interest, or time value of

money, element.

The majority correctly observe that statutory interest

is awarded under a separate statute from the basic

wrongful death damages. Majority op. pp. 11-12. How-

ever, that does not dispose of the question before us. The

statute providing for interest on damages, M.C.L. section

600.6013, applies to all types of damage awards, not just

tort or wrongful death awards. All this means is that the

Michigan legislature, for the sake of efficiency and conve-

nience, enacted one interest provision rather than a series

of different provisions for the many different types of

civil actions. The fact that there is one interest provision

and that it is separate does not mean that prejudgment

interest cannot be a form of damages and that the interest

element in a personal injury claim is not damages on

account of personal injuries for Federal income tax pur-

poses.

The majority point out that statutory interest is calcu-

lated on and added to the judgment. Majority op. pp.

11-12. In Michigan, when a plaintiff obtains a money

judgment in any civil action, the plaintiff is automatically

entitled to receive interest on the judgment under M.C.L.

section 600.6013. No additional evidentiary showing is

required. Old Orchard by the Bay v. Hamilton Mut. Ins. Co.,

454 N.W.2d 73, 75 (1990). However, this does not impede

the Court from holding that, for tax purposes, statutory

prejudgment interest on a tort claim is part of the under-

"lying damages, rather than conventional interest eo nom-

ine. By following respondent’s approach, the Court has

App. 48

ignored the fact that petitioners’ right to receive interest

on damages under M.C.L. section 600.6013 originated

with and was inextricably tied to their right to be com-

pensated for personal injuries. The fact that interest is

computed on and added to the underlying damages is

simply the way this additional amount is computed. Its

tax character, however, is not properly determined solely

by this characteristic.

E. Congressional Intent

The approach the Court should take in the case is

consistent with the legislative purposes of section

104(a)(2),2! insofar as they are currently understood.

Although the original legislative history is scant, it sug-

gests that Congress viewed compensation received for

personal injuries or sickness as beyond the reach of the

income tax. H. Rept. 767, 65th Cong., 2d Sess. 9-10 (1918),

1939-1 C.B. (Part 2) 86, 92; see Downey v. Commissioner, 97

T.C. 150, 157-158 (1991). One of the theories supporting

the exclusion is that personal injury awards represent a

return of “human capital” and thus simply make the

victim whole by restoring him to the position he was in

prior to the tortious injury. Hence, the recipient has no

taxable gain inasmuch as he is no better off than he was

prior to the injury. See Hawkins v. Commissioner, 6 B.T.A.

1023, 1025 (1927); see also Chirelstein, Federal Income

21 The exclusion for damages received on account of per-

sonal injuries or sickness first appeared in the Revenue Act of

1918, ch. 18, sec. 213(b)(6), 40 Stat. 1057, 1066.

App. 49

Taxation, sec. 2, at 40-41 (6th ed. 1991) (Recovery of

Capital Investment).?2

Another view is that the exclusion of personal dam-

ages is grounded in compassion for the victim. That is,

“taxation of recoveries carved from pain and suffering is

offensive, and the victim is more to be pitied rather than

taxed.” Harnett, “Torts and Taxes”, 27 N.Y.U. L. Rev. 614,

627 (1952); see Norfolk & Western Ry. v. Liepelt, 444 U.S.

490, 501 (1980) (Blackmun, J., dissenting). However, the

compassion justification has no sound theoretical founda-

tion in tax policy. See Gideon, Lawsuits and Settlements,

par. 103.04, at 314 (1990). Compassion for the victim of

personal injury is not a tax reason for excluding damages

from gross income. Instead, the exclusion stems from

supervening nontax notions that tort victims should be

compensated for pain ard suffering and other damages

and costs arising from personal injuries or sickness,

22 The human capital justification for sec. 104(a)(2) has been

criticized as being inconsistent with other principles of taxation.

Blackburn, “Taxation of Personal Injury Damages: Recommen-

dations for Reform”, 56 Tenn. L. Rev. 661 (1989); Dodge, “Taxes

and Torts”, 77 Cornell L. Rev. 143, 152-153 (1992). For example,

if a person receives no damage award after being injured by

another, that person is not entitled to a casualty loss deduction

under sec 165(c)(3). See Bittker & Lokken, Federa! Taxation of

Income, Estates and Gifts, par. 34 (1990). In Downey v. Commis-

ioner, 97 T.C. 150, 159 (1991), we stated that it is doubtful

whether the return of capital theory justifies the exclusion from

income of the full range of damages found to be excludable

under section 104(a)(2), particularly damages received in lieu of

st income.’

App. 50

including lost wages and punitive damages, without pay-

ing tax on the recovery.”

1. Lump sum and periodic payment settlements. To

exclude the interest portion of the award from gross

income would be consistent with Congress’ 1982 amend-

ment to section 104(a)(2), which effectively codified three

of respondent’s revenue rulings** that a victim of per-

sonal injuries who receives damages in periodic pay-

ments, rather than as a lump sum, may exclude from

gross income the entire amount of each payment, includ-

ing the portion attributable to interest. Periodic Payment

Settlement Act of 1982, Pub. L. 97-473, 96 Stat. 2605; H.

Conf. Rept. 97-984 (1982), 1983-1 C.B. 522; S. Rept. 97-646

(1982), 1983-1 C.B., 514; see also H. Rept. 97-832 (1982). If

Congress had intended to bifurcate personal injury dam-

age awards into taxable and nontaxable components, it

would not have specifically excluded from gross income

the interest element of the periodic payments under

structured settlements.

In addition, victims of personal injury who settle

their claims may exclude from gross income amounts that

the parties take account of as interest yet characterize as

23 The compassion justification has also been criticized on

the ground that there is nothing in the legislative history of sec.

104(a)(2) that indicates that Congress intended to bestow a

humanitarian benefit on taxpayers who received damages for

personal injuries or sickness. See Dodge, supra at 148-149. How-

ever, in Downey v. Commissioner, supra at 158-159, we observed

that the emotional justification for. the exclusion was more satis-

factory than the human capital approach.

24 Rev. Rul. 79-313, 1979-2 C.B. 75; Rev. Rul. 79-220, 1979-2

C.B. 74; Rev. Rul. 77-230, 1977-2 C.B. 214.

App. 51

damages in their settlement agreement. See McShane v.

Commissioner, T.C. Memo. 1987-151.25 There is no reason

why the tax law should respect the exclusion of interest

when it is received in a personal injury claim settlement

that purports to disregard it, as in McShane, but not when

it is received pursuant to a final judgment, as in this

case.2° In Downey v. Commissioner, 97 T.C. 150 (1991), we

25 In McShane v. Commissioner, T.C. Memo. 1987-151, the

taxpayers settled their personal injury case while it was on

appeal from a jury verdict in their favor, for an amount in excess

of the basic damages awarded by the jury that obviously

included prejudgment interest. We noted that the interest por-

tion of the settlement would have been awarded as statutory

interest under the applicable Massachusetts law had the case

not been settled and the verdicts rendered in their favor pro-

ceeded to final judgment. We stated that it was ‘undisputed that

if that had been the case, any statutory interest on the final

judgment would have been taxable under section 61.” However,

this statement in McShane is dictum, because the issue of the

taxability of interest on a judgment was not before us, and

inapplicable here, because it appears to have been merely a

statement of what the parties in that case did not dispute rather

than a description of the applicable law

“6 It might be argued that there is a public policy reason for

favoring settlements by providing personal injury plaintiffs

who settle with more favorable tax consequences than if they

pursue their claims to final judgment. Insofar as this tax case is

concerned, however, it could be improper for us to be distracted

by what is essentially a local law consideration that already

appears to have been adequately taken care of by the Michigan

statute. The Michigan statute providing for judgment interest

already has built-in provisions that are designed in a more

discriminating way to favor settlement and to discourage par-

ties who reject reasonable settlements and hold out for final

judgment on the merits. M.C.L. sec. 600.6013(5), provides that if

the plaintiff should reject a bona fide reasonable offer of settle-

ment made by defendant, which is substantially identical to or

App. 52

held that amounts received in settlement of an age dis-

crimination suit were excludable under section 104(a)(2)

and made no distinction between damages received by

reason of a court or jury verdict and those received by

reason of a settlement. This was in accord with the regu-

lation interpreting section 104(a)(2), which specifically

provides that no such distinction should be made. Sec.

1.104-1(a), Income Tax Regs.

Just as there is no reason to distinguish between

damages and interest received by settlement and dam-

ages and prejudgment interest received by verdict, there

is no reason to distinguish between interest when it is

received in a lump sum or in periodic payments. The

jurisprudence of this Court and Congress’ 1982 amend-

ment to section 104(a)(2) tell us that the interest compo-

nent can be packed into an award for personal injuries

and excluded from gross income, even though it is com-

pensation for delay in payment.?7

substantially more favorable to the prevailing party than the

ultimate judgment, then the court is not to allow interest beyond

the time the written offer of settlement was made and rejected

by the plaintiff, and filed with the Court. Similarly, if such an

offer is made by the plaintiff and rejected by the defendant, the

court shall order that interest be calculated from tne date of the

rejection of the offer to the date of satisfaction of the judgment

at a rate of interest 2 percentage points higher than what the rate

would have otherwise been.

27 For a similar analysis that arrives at a contrary conclu-

sion, see Abreu, “Distinguishing Interest from Damages: A Pro-

posal For a New Perspective”, 40 Buff. L. Rev. 373, 390 n.72

(1992).

App. 53

2. Insurance proceeds analogy. The notions that

underlie the statutory exclusion of personal injury dam-

ages, section 104(a)(2), also appear to underlie the total

exclusion in section 101(a) of life insurance proceeds

received on the death of the insured, including the por-

tion of the proceeds attributable to interest on the invest-

ment in the contract (the “inside build-up”). Both

statutory provisions permit recipients to exclude from

gross income the interest that would otherwise be

include " in gross income, but which are received as result

of personal calamity. See Chirelstein, Federal Income Tax-

ation 39-41 (6th ed. 1991).28

3. Canons of construction. The majority argue that

reading section 104(a)(2) to exclude interest on damages

is contrary to the maxim that exclusions from gross

income are to be narrowly construed. See Commissioner v.

Jacobson, 336 U.S. 28, 49 (1949). However, I read the

statute consistently with its broad and sweeping excep-

tion that “any damages” received on account of personal

injuries are not included in gross income. See Miller v.

Commissioner, 93 T.C. 330, 338, 340-341 (1989) (citing

*® A current example of the administrative application and

extension of the compassion approach is the pending proposal

to allow terminally ill beneficiaries (such as AIDS victims) of life

insurance policies to draw down the proceeds free of income

tax. Secs. 1.101-8, 1.7702-2, Proposed Income Tax Regs., concern-

ing qualified accelerated death benefits, 57 Fed. Reg. 59319

(Dec. 15, 1992); see Pear, “Benefit Proposed for Terminally III -

IRS would Allow Tax-Free Payment of Life Insurance While

Person Is Alive”, N.Y. Times, Dec. 16, 1992, at A-29. What this

proposal appears to do is turn the interest earnings on the policy

(the “inside build-up”) into compensation for terminal illness

under sec. 104(a)(2).

App. 54

United States v. American Trucking Associations, Inc., 310

U.S. 534, 543 (1940)), revd. and remanded 914 F.2d 586

(4th Cir. 1990).29 By enacting section 104(a)(2), Congress

provided that amounts ordinarily includable in gross

income, such as amounts equal to interest and lost wages,

may be excludable when received as_ compensation for

personal injuries suffered as a result of a tort or tortlike

activity. See, e.g., Downey v. Commissioner, 97 T.C. 150,

163-164 (1991) (settlement of claim for backpay, including

interest, received in an age discrimination suit under the

ADEA excludable under sec. 104(a)(2)); see also Gideon,

Lawsuits and Settlements, par. 103.04, at 313-314 (1990).

Nor should the doctrine of “reenactment” referred to

by the majority, majority op. p. 10, impede us from prop-

erly deciding this case. There is no valid reason to believe

that Congress reenacted the Board of Tax Appeals’ deci-

sion in Riddle v. Commissioner, 27 B.T.A. 1339 (1933), when

it amended section 104(a)(2) in 1982 and 1989, much less

when it enacted the Internal Revenue Codes of 1939,

29 Although our decision in Miller v. Commissioner, 93 T.C.

330 (1989), was reversed and remanded, 914 F.2d 586 (4th Cir.

1990), the fact that sec. 104(a)(2) is broadly worded has not

changed, even since the statute’s 1989 amendment after our

decision in Miller. Omnibus Budget Reconciliation Act of 1989,

Pub. L. 101-239, sec. 7641, 103 Stat. 2106, 2379 (amending sec.

104 to remove punitive damages for cases involving nonphysi-

cal injuries or sickness from the sec. 104(a)(2) exclusion). More-

over, our decision in Miller that the phrase “any damages”

included punitive as well as compensatory damages was

reversed on the ground that punitive damages were not

received on account of personal injuries because they required an

additional showing of egregious conduct by the defendant.

Commissioner v. Miller, 914 F.2d at 589-592.

App. 55

1954, and 1986. Riddle does not stand for the proposition

that prejudgment interest is not excludable from gross

income under section 104(a)(2), but only that postjudg-

ment interest must be included in gross income.

Riddle concerned the taxability of postjudgment inter-

est on a $15,000 award by the Mixed Claims Commission

for personal injuries suffered by the taxpayer in the sink-

ing of the Lusitania in 1915. The interest had accrued from

November 1, 1923, the date of the award. The award was

not paid until 1928, the taxable year before the Board.

Under the rules of the Mixed Claims Commission, inter-

est was not allowable from the time of loss, but only from

the time the loss was fixed by the Commission. In these

circumstances, the Board held that the interest was not

excludable as part of the personal injury damages

awarded by the Board, but was rather separately stated

postjudgment interest and taxable as such.

Even if the majority properly read Riddle as support-

ing the proposition that all interest on damages for per-

sonal injuries, whether accruing before or after final

judgment, is not excludable from gross income as dam-

ages, there is no reason to believe that Congress has ever

reenacted the result or reasoning of Riddle. As the

Supreme Court said in Commissioner v. Glenshaw Glass Co.,

348 U.S. 426, 431 (1955):

It is urged that re-enactment of § 22(a) with-

out change since the Board of Tax Appeals held

punitive damages nontaxable in Highland

Farms Corp., 42 B.T.A. 1314, indicates congres-

sional satisfaction with that holding. Re-enact-

ment — particularly without the slightest

affirmative indication that Congress ever had

App. 56

the Highland Farms decision before it - is an

unreliable indicium at best. * * * [Citations onut-

ted.°°]

The long-standing judicial view of this subject is, if

anything, contrary to the majority’s reading of Riddle v.

Commissioner, supra. In a reviewed opinion of the Board of

Tax Appeals, decided about 3 years after Riddle, N.V.

Koninklijke Hollandische Lloyd (Royal Holland Lloyd) v. Com-

missioner, 34 B.T.A. 830 (1936), the Board held that no part

of a damage award, which included interest as damages

for delay is payment, was includable in the recipient's

30 In Merrill Lynch, Pierce, Fenner & Smith, Inc. v. Curran, 456

U.S. 353, 381-382 (1982), cited in the majority op. p.10, the

Supreme Court stated that:

the fact that a comprehensive reexamination and sig-

nificant amendment of the CEA left intact the statu-

tory provisions under which the federal courts had

implied a cause of action Is itself evidence that Con-

gress affirmatively intended to preserve that remedy.

A review of the legislative history of the statute per-

suasively indicates that preservation of the remedy

was indeed what Congress actually intended. [Fn. ref.

omitted. ]

Although Congress is presumed to be aware of judicial inter-

pretations of a statute and to adopt them when it reenacts a

statute without change, see Albemarle Paper Co. v. Moody, 422

U.S. 405, 414 n.8 (1975), it is highly unlikely that Congress had

before it the issue in Riddle v. Commissioner, 27 B.T.A. 1339

(1933), when it reenacted sec. 104(a)(2) as it did when it reen-

acted the statute at issue in Merrill Lynch. Similarly, Society of

Plastics Indus. Inc. v. ICC, 955 F.2d 722, 728-729 (D.C. Cir. 1992),

and Cannon v. Univ. of Chicago, 441 U.S. 677, 696-697 (1979) (both

also cited in the majority op. p. 10), concerned situations in

which there was clear evidence or other indications that Con-

gress was actually aware of the prior statutory interpretation

that was in issue.

App. 57

gross income. In that case, the Royal Holland Lloyd ves-

sel Zeelandia, on a voyage from South America to Holland

by way of New York, had been detained in New York

harbor by Federal authorities from October 22, 1917, until

March 21, 1918. Congress granted relief by allowing

Royal Holland Lloyd to sue for compensation in the U.S.

Court of Claims, which in 1931 awarded a recovery of

$446,826.22, which was paid in 1932, the taxable year at

issue, together with interest in the amount of $84,531.73.

The Board first held that the basic award was not taxable,

on the ground that “the sum received by the petitioner

remains the payment of a judgment for damages and

does not constitute rent ‘from property located in the

United States.’ ” Id. at 834. The Board then went on to

hold that no part of the payment was interest from

sources within the United States, on the ground that

the “interest” was included in the judgment as

part of just compensation for damages sus-

tained. * * * Here, the stipulation denominated

the sum of $84,531.73 as the “amount received

for damages measured by interest” and in its

opinion the Court of Claims stated: “The plain-

tiff is entitled to interest, as has been said,

because such allowance is ‘rightful’ and is nec-

essary adequately to compensate it for the dam-

age.” * * * Here the obligation of the United

States is to make just compensation for the

unlawful detention of the vessel. Just compensa-

tion for the damage so suffered requires that the

party damaged be made whole. An integral part

of a payment for such purpose is interest cover-

ing the period of detention. In such a case it is

merely a convenient method of measuring the

amount of one of the factors of damage. It is not

App. 58

a separable item of interest on an obligation. Id.

at 834-835; citations omitted.]

F. Authorities Arguably in Point

In reaching our conclusion in Aames v. Commissioner,

94 T.C. 189 (1990), we relied on cases dealing with interest

on condemnation awards. Id. at 192 (citing Kieselbach v.

Commissiener, 317 U.S. 399 (1943); Tiefenbrunn v. Commis-

sioner, 74 T.C. 1566 (1980); Smith v. Commissioner, 59 T.C.

107, 111-113 (1972); Wheeler v. Commissioner, 58 T.C. 459

(1972)). The question common to those cases was whether

a taxpayer who had received a condemnation award

could treat as capital gain, rather than as ordinary

income, any interest or delay damages for the taking.

Reviewing the taxability of a New York City condemna-

tion award, the Supreme Court, in Kieselbach v. Commis-

sioner, supra, held that any part of the amount received as

“just compensation” that was payment for delay was

ordinary interest income and would not receive capital

gain tax treatment, even though paid as part of an award

for the taking of a capital asset. As such, the interest was

includable as ordinary income under a statutory prede-

cessor of section 61(a)(4). Id. at 403.°!

3! See also Ferreira v. Commissioner, 57 T.C. 866, 872 n.7

(1972), where, in holding “blight damages” under a condemna-

tion award to be taxable ordinary income, we said: “Under

Kieselbach we need not conclude that the payment is ‘interest’ as

such. If the $26,000 award was made because of the delay in

compensatiag the petitioners for the taking of their property, it

constitutes axable income.” Cf. Midkiff v. Commissioner, 96 T.C.

724 (1991).

App. 59

Absent section 104(a)(2) and its requirement that we

focus on the tort or tortlike nature of the taxpayer's

personal injury claim to determine the tax treatment of

amounts received in compensation thereof, United States

v. Burke, 504 U.S. __, 112 S. Ct. 1867 (1992); Downey v.

Commissioner, supra; Threlkeld v. Commissioner, 87 T.C. 1294

(1986), affd. 848 F.2d 81 (6th Cir. 1988); sec. 1.104-1(c),

Income Tax Regs., the reasoning in Kieselbach would not

allow us to exclude the interest included in petitioners’

award from gross income as damages for personal inju-

ries. However, Kieselbach did not concern damages on

account of personal injuries, and the Supreme Court, in

that case, had no occasion to apply section 104(a)(2).

Similarly, Tiefenbrunn v. Commissioner, supra, Smith v. Com-

missioner, supra, and Wheeler v. Commissioner, supra, do not

concern section 104(a)(2) and therefore do not prescribe

the rule to be applied under that provision.%2

G. Stare Decisis

Insofar as Riddle v. Commissioner, 27 B.T.A. 1339 (1933)

and Aames v. Commissioner, supra, can be read to hold that

all interest on personal injury damages is includable in

gross income, we should no longer follow them.33

2 But see Abreu, supra at 388-389 (recognizing that prejudg-

ment interest is damages but that it should be includable in

gross income as compensation for delay in payment).

*’ Petitioners ask us to distinguish Aames v. Commissioner,

94 T.C. 189 (1990), on the ground that it involved not a suit for

damages for personal injuries, but the taxpayer’s malpractice

claim against the attorney who negligently failed to obtain a

proper settlement of the taxpayer’s personal injury claim. It

may also be noteworthy that the interest at issue in Aames did

App. 60

Although we should not lightly decline to follow our

precedents, Riddle and Aames are distinguishable in whole

or in part from the case at hand, and have been undercut

by recent developments. Therefore, taking the course I

suggest would not violate the doctrine of stare decisis or

any of its prudential and pragmatic underpinnings as

outlined by the Supreme Court’s plurality opinion in

Planned Parenthood v. Casey, __ U.S. ___, __, 112 S. Ct.

2791, 2808-2809 (1992).34 In any event, stare decisis is not

an “inexorable command”, Burnet v. Coronado Oil & Gas

Co., 285 U.S. 393, 405-411 (1932) (Brandeis, J., dissenting),

not begin to accrue until 8 years after the accident. I would not

distinguish Aames on these grounds. The taxpayer’s malpractice

suit clearly had its origin in his claim for damages on account of

personal injury, and there was some element of prejudgment

interest in the award that he finally obtained. We should meet

the issue head on and overrule Aames by announcing that we

will no longer follow it with respect to prejudgment interest.

4 In Planned Parenthood v. Casey, 504 U.S. __, 112 S. Ct.

2791, 2808-2809 (1992), the Supreme Court stated that when it

“reexamines a prior holding, its judgment is customarily

informed by a series of prudential and pragmatic considerations

designed to test the consistency of overruling a prior decision

with the ideal of the rule of law, and to gauge the respective

costs of reaffirming and overruling a prior case.” The considera-

tions are (1) “whether the rule has proved to be intolerable

simply in defying practical workability”; (2) “whether the rule

is subject to a kind of reliance that would lend a special hard-

ship to the consequences of overruling and add inequity to the

cost of repudiation”; (3)”whether related principles of law have

so far developed as to have left the old rule no more than a

remnant of abandoned doctrine”; and (4) “whether facts have so

changed or come to be seen so differently, as to have robbed the

old rule of significant application or justification”. This case is

governed by the third consideration set forth above.

App. 61

but a principle of policy. Therefore, in light of latter-day

related developments in the interpretation of section

104(a)(2) excluding from gross income backpay awards

received in actions based upon tort or tortlike rights, as

exemplified by Rickel v. Commissioner, 900 F.2d 655,

661-663 (3d Cir. 1990), affg. in part and revg. in part 92

T.C. 510 (1989), and Pistillo v. Commissioner, 912 F.2d 145

(6th Cir. 1990), revg. T.C. Memo. 1989-329, and to which

we acceded in Downey v. Commissioner, supra at 168, this is

an appropriate occasion to shift course. The correct inter-

pretation of section 104(a)(2) is to exclude from gross

income all amounts received through the prosecution of a

personal injury claim based on tort or tort type rights.

sec. 1.104-1(c), Income Tax Regs. Under this interpreta-

tion, mandatory statutory prejudgment interest on dam-

ages received in a tort or tortlike action for wrongful

death or other “personal injuries or sickness” is excluded

from gross income.

I]. Deductibility _of Attorney's Fees

As the majority point out, the parties have agreed

that if the interest portion of the award is includable in

sfOss income, the attorney's fees allocable to the taxable

interest are deductible under section 212(1). As a result,

the deductible portion of the attorney’s fees is not

leductible “above the line” in arriving at adjusted gross

income, and is subject to the 2- percent floor of section 67

because section 212(1) deductions are not among the

ibove the line” leductions enumerated in section 62.

Following respondent's lead, the majority cite Church

Commissioner, 80 T.C. 1104, 1110-1111 (1983): Metzger v

App. 62

Commissioner, 88 T.C. 834, 860 (1987), affd. without pub-

lished opinion 845 F.2d 1013 (3d Cir. 1988); and Stocks v.

Commissioner, 98 T.C. 1 (1992), apparently for the proposi-

tion that the Church apportionment formula should be

used to determine the correct deduction:

Total Attorney’s Fees

x Nonexempt Income = Deductible Fees

Total Award

Petitioners did not argue this issue other than to preserve

the point that, if any part of the interest should be neld

taxable, the attorney’s fees allocable thereto would be

deductible.

Although it might initially appear that the proper

allocation of the attorney’s fees is a cut-and-dried propo-

sition, some aspects of the question do deserve further

attention. It is not self-evident that a pro rata apportion-

ment should be used to compute the deductible interest.

Petitioners’ contingent fee agreement with the attor-

neys who represented them in the wrongful death action

is not part of the stipulated record in this case. We do

know that the total award of $2,254,741.70 was disbursed

as follows:

Attorney’s Fees $ 749,535.72

Costs 6,134.53

Petitioners’ Receipts (Gross) 1,499,071.45

Total $2,254,741.70

It is clear that the agreed attorney’s fees were one-third

(33-1/3 percent) of the gross award, as it had been

reduced by costs:

App. 63

Gross Award $2,254,741.70

Less: Costs 6,134.53

Net Award before Fees 3)2,248,607.17

Attorney’s Fees $749,535.72

At first blush, this computation would seem to confirm

that a pro rata Church apportionment would be appropri-

ate. The 33-1/3 percent attorney’s contingent fee was

calculated on the entire amount of the award, without

any differentiation between the basic damages and the

statutory interest. See sec. 265(a)(1). However, some addi-

tional observations are in order:

First, the fact that the attorney’s contingent fee agree-

ment did not differentiate between basic damages and

statutory interest in computing the fee reinforces my

view (expressed in Part I) that statutory interest on the

basic damages is part of the damages for the purposes of

the section 104(a)(2) exclusion. Second, the pro rata

Church apportionment is not the only way to go. Two

other possibilities deserve consideration: One would dis-

allow any deduction for attorney’s fees; the other would

allow them as a deduction by applying them, dollar for

dollar, up to (but not in excess of) the taxable interest

portion of the award. There are authorities that could

support either of these approaches.

Authority for total disallowance of the deduction is

found in the treatment of attorney’s fees paid to obtain

condemnation awards. Inasmuch as the majority rely on

Kieselbach v. Commissioner, 317 U.S. 399 (1943), and its

progeny, see majority op. p. 5 and supra pp. 27, 52-54, to

support their conclusion that statutory interest in this

case is taxable as such rather than part of the excludable

damages, authorities on the treatment of attorney’s fees

App. 64

to obtain condemnation awards may be relevant. This

Court’s view is that a property owner’s expenses

incurred to increase a condemnation award are capital

expenditures because they fundamentally relate to the

transfer of property. Mosby v. Commissioner, 86 T.C. 190

(1986); Casalina Corp. v. Commissioner, 60 T.C. 694, 703

(1973), affd. per curiam 511 F.2d 1162 (4th Cir. 1975). This

has led to the surprising conclusion that, because such

fees are capital expenditures, they may not be used to any

extent to offset taxable interest awarded in the condem-

nation proceeding. Madden v. Commissioner, 514 F.2d 1149

(9th Cir. 1975); Fulks v. Commissioner, T.C. Memo.

1989-190. In Fulks we justified this conclusion on grounds

that could be advanced to justify full disallowance of the

attorney’s fees in this case:

Petitioners’ attorney’s fees were for services in

connection with obtaining the jury award. Inter-

est on the jury award accrued as a matter of

right so that it cannot be said that the attorney's

services made any direct contribution to the

interest element. Thus there is no basis for

allocating any part of the fee to the collection of

interest. Petit v. Commissioner, 8 T.C. 228, 236-237

(1947). Therefore, the attorney’s fees in this case

were capital expenses deductible solely from the

jury award. [Fn. refs. omitted. ]

Our views on the treatment of attorney’s fees in

condemnation awards are at variance with our views on

their treatment in personal injury actions. The views

expressed in Fulks also do not apply to the facts of this

case (even though interest accrues as a matter of right

under the Michigan statute) because the fees obviously

increased by 33-1/3 cents for each dollar of interest, a fact

App. 65

that supports a pro rata apportionment of the fees. But

this variance also casts doubt on the correctness of the

majority’s decision on the main issue in this case. The

Court's lack of consistency in deciding the deductibility

of attorney’s fees in personal injury and condemnation

cases reinforces my view that the condemnation cases do

not prevent prejudgment interest in personal injury cases

from being excluded from gross income as part of the

damages.

Irrespective of whether the amount taxable is the

postjudgment interest (approximately $30,000, see supra

note 11), the amount by which the entire interest portion

of the award exceeded the interest that accrued from the

date of the original judgment ($1,253,607.17 - $360,777.41

= $892,829.76), or the entire interest portion of the award

($1,253,607.17), I think there is a proper basis for allowing

the attorney's fees to be deducted, dollar for dollar, from

the taxable interest. There is support for this approach

under Michigan law, in that one of the rationales for

statutory interest advanced by the Michigan Courts is

that it helps to defray costs and attorney’s fees incurred

in order to obtain the award. Old Orchard by the Bay v.

Hamilton Mut. Ins. Co., 454 N.W.2d 73, 75-76 (Mich. 1990);

Denham v. Bedford, 287 N.W.2d 168, 174 (Mich. 1980). This

approach resonates sympathetically with our observation

about the similar purposes of punitive damages in Miller

v. Commissioner, 93 T.C. at 341. This approach would also

be consistent with one of the possible methods of allocat-

ing the elements of the settlement referred to by the U.S.

Court of Appeals for the Fourth Circuit in Commissioner v.

Miller, 914 F.2d at 592, as an alternative to a pro rata

App. 66

apportionment. Under this approach, the punitive dam-

ages awarded by the jury that the Court of Appeals held

taxable could have been reduced dollar for dollar.35 Anal-

ogous authority for such approach to allocating the attor-

ney’s fees between the taxable and nontaxable portions of

the award could be found in Fincke v. Commissioner, 39

B.T.A. 510 (1939).%°

In conclusion, I would hold: (I) That the prejudgment

interest portion or the award is excluded from gross

income under section 104(a)(2) as personal injury dam-

ages; and (II) that the attorney’s fees are deductible dollar

for dollar to the extent of the portion of the award

included in gross income.

COLVIN, J., agrees with this dissenting opinion.

35 Inasmuch as punitive damages are much more specula-

tive, and subject to attack on appeal, it might be reasonable to

expect that it was the punitive damages that were reduced by

agreement of the parties in a post-trial pre-appeal settlement.

But see Miller v. Commissioner, T.C. Memo. 1993-49 (on remand).

36 Fincke v. Commissioner, 39 B.T.A. 510 (1939), applied basis

in full to the sale portion of a part gift-part sale, a result that was

made inapplicable to part charitable contributions-part sales of

appreciated property by sec. 1011(b), enacted by the Tax Reform

Act of 1969, Pub. L. 91-172, sec. 201(f), 83 Stat. 564. Compare sec.

1.1011-2, Income Tax Regs. with sec. 1.1015-4(a), Income Tax

Regs.

App. 67

IN THE UNITED STATES DISTRICT COURT

FOR THE DISTRICT OF COLORADO

Civil Action No. 93-K-2288

MARY BRABSON,

Plaintiff,

Vv.

UNITED STATES OF AMERICA,

Defendant.

MEMORANDUM OPINION AND ORDER

(Filed Aug. 15, 1994)

KANE, J.

Before me on defendant United States’ motion to

dismiss is the complex question of what constitutes

“damages received on account of personal injuries or

sickness” under the exclusion from gross income stated in

Internal Revenue Code § 104(a)(2). In particular I must

determine whether mandatory Statutory prejudgment

interest, added by operation of law to Colorado personal

injury awards under C.R.S. § 13-21-101(1), is an element

of “damages” excludable from income within the mean-

ing of § 104(a)(2) or whether it is taxable “interest” within

the meaning of § 61(a)(4).

Plaintiffs Mary, Helen, and William Brabson initiated

this action against the United States alleging overpay-

ment of their 1988 federal income taxes. The Brabsons

claim they were erroneously taxed on the prejudgment

interest portion of a personal injury award Mary Brabson

obtained against the City of Colorado Springs and others

App. 68

as a result of a gas explosion at the Brabsons’ home in

1981. They seek recovery of the $ 371,000 in taxes

assessed and paid on the portion of their damages award

attributable to prejudgment interest, plus interest and

attorney fees.

The United States moves to dismiss the Brabsons’

complaint, asserting prejudgment interest is separate

from damages and fully taxable as interest income. |

disagree. Based on my review of the Code and caselaw

interpreting it, I conclude mandatory statutory prejudg-

ment interest is an element of compensatory “damages”

available to plaintiffs pursuing personal injury actions

under Colorado law. To the extent this conclusion con-

flicts with the Tax Court’s recent ruling in Kovacs v.

Comm’r, 100 T.C. 124 (1993), aff'd in unpublished disposition,

94 WL 253035 (June 9,1994), I decline to follow the major-

ity’s analysis, and adopt instead the dissent of Judge

Beghe.

I. Facts

The following facts are undisputed:

On July 15, 1981, an explosion damaged Mary Brabson’s

home, injuring Mary and her children, William and Helen.

The explosion was linked to a gas leak. Mary Brabson filed

suit in El Paso County District Court, naming the City of

Colorado Springs, Stratmoor Hills Water District, and Strat-

moor Hills Sanitation District as defendants. The case was

tried to a jury and a verdict rendered in favor of the Brab-

sons. On October 29, 1983, the trial court signed a judgment

awarding Mary Brabson $ 1,502,150.02 for personal injuries,

App. 69

$ 97,840.98 for property damage, and $ 341,159.10 in prejudg-

ment interest from the date of the explosion to the date of

judgment.

The defendants appealed. Before determination of

the case by the Colorado Court of Appeals, the Stratmoor

Hills defendants settled with Mary Brabson for

$ 155,948.87. On November 26, 1986, the Court of Appeals

issued an opinion affirming the trial court’s judgment.

On February 17, 1987, the City of Colorado Springs

filed a petition for writ of certiorari with the Colorado

Supreme Court, seeking review of the Court of Appeals’

decision. The petition was granted on May 11, 1987. On

October 30, 1987, the Brabsons sought leave to execute

partially on the judgment. The request was denied by the

Colorado Supreme Court on November 10, 1987.

After oral argument on April 25, 1988, the Colorado

Supreme Court ordered the petition for writ of certiorari

denied as having been improvidently granted. On June

28, 1988, the parties filed a satisfaction of judgment in the

El Paso County District Court indicating Mary Brabson

received $ 2,888,414.06 in connection with her action

against the City of Colorado Springs. Of this, $ 370,723.12

was attributed to mandatory statutory prejudgment inter-

est on the personal injury award.

The Brabsons did not include the prejudgment inter-

est as income on their 1988 federal income tax returns on

grounds it constituted damages received on account of

personal injuries under 26 U.S.C. § 104(a)(2). The Internal

Revenue Service assessed income tax deficiencies against

each of the Brabsons for the excluded prejudgment inter-

est, which deficiencies the Brabsons paid. The Brabsons

App. 70

now seek to recover the amounts paid, plus interest and

attorney fees.

II. Discussion

As a general rule, “gross income means all income

from whatever source derived.” 26 U.S.C. § 61(a). All

realized accessions to wealth are presumed to be taxable

income, unless the taxpayer can demonstrate an acquisi-

tion is specifically exempt. See Comm’r v. Glenshaw Glass

Co., 348 U.S. 426, 430 (1955); Wulf v. City of Wichita, 883

F.2d 842, 871 (10th Cir. 1989).

Since 1918 Congress has expressly excluded from

gross income tort damages received on account of per-

sonal injuries. Revenue Act of 1918, § 213(b)(6), 40 Stat.

1066, discussed in Roemer v. C.I.R., 716 F.2d 693, 696 (9th

Cir. 1983) (footnote omitted). In its present form at 26

U.S.C. § 104(a)(2), the personal injury damages exclusion

provides:

§ 104. Compensation for injuries and sickness.

(a) In general.— Except in the case of

amounts attributable to (and not in excess of)

deductions allowed under section 213 (relating

to medical, etc., expenses) for any prior taxable,

year, gross income does not include —

* * *

(2) 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 sickness... .

App. 71

26 U.S.C. § 104 (emphasis added).?

Treasury Regulation 1.104-1(c) defines “damages” in

this context as “an amount received .. . through prosecu-

tion 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.” 26 C.ER. § 1.104-1(c) (1991).

With the exception of punitive damage awards,?

excludability under § 104(a)(2) and Treasury Regulation

1.104-1(c) turns solely on the nature of the underlying

claim, not the nature of the injury. United States v. Burke,

—__ U.S. __, 119 L. Ed. 2d 34, 44 (1992), approving analysis

in Burke v. United States, 929 F.2d 1119, 1121 (6th Cir.

1991). If the underlying claim sounds in tort, that is “‘the

beginning and the end of the inquiry.’” Burke, 929 F.2d at

1121 (quoting Threlkeld v. Comm’r, 87 T.C. 1294, 1299

(1986), aff'd, 848 F.2d 81 (6th Cir. 1988)); Horton v. Comm’r,

100 T.C. 93, 96 (1993) (citing Burke). The entire “amount

received” through prosecution of that claim is excludable,

regardless of whether it includes compensation for non-

physical or economic losses, and regardless of whether it

includes elements of damages otherwise taxable.3

' Section 104, entitled “Compensation for injuries or sick-

ness,” also excludes from gross income amounts received for

personal injuries or sickness under worker’s compensation pro-

grams (§ 104(a)(1)), accident or health insurance (§ 104(a)(3)),

and certain federal pension programs (§ 104(a)(4)).

* Punitive damage awards are excludable only if the under-

lying injury is physical. 26 U.S.C. § 104(a)(2) (after 1989 amend-

ment). See 1989 Omnibus Budget Reconciliation Act, P.L.

101-239, 12/19/89 (applicable to punitive damage awards

received after 7/10/89).

* Horton v. Comm'r, i100 T.C. 93, 95-6 (1993) (citing Burke)

(punitive damages excludable); Downey v. Comm'r, 97 T.C. 150,

App. 72

The exclusion from income under § 104(a)(2) thus is

broad, as are the other exclusions in § 104 for “[c]ompen-

sation for injuries or sickness.” For example, the exemp-

tion for “amounts received” through accident or health

insurance for personal injuries or sickness (26 U.S.C.

§ 104(a)(3)) excludes from income all amounts received

under accident or health insurance policies, even if they

are in excess of the insured’s actual medical expenses

(Rev. Rul. 58-602, 1958-2 C.B. 109), and even if they

include items otherwise taxable, such as replacement

income (Rev. Rul. 58-90, 1958-1 C.B. 88). See 4 U.S. Tax

Rep. J 1044.03.4

The Tenth Circuit recognizes the breadth of the exclu-

sion in § 104(a)(2). Once it is determined an underlying

claim sounds in tort, the Tenth Circuit has ruled the entire

160 (1991) (§ 104(a)(2) excludes from income all damages that

substitute for items otherwise taxable or would produce taxable

benefit). See Redfield v. Ins.

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