Summary
holding Roemer v. Commissioner [Dec. 39,301], 79 T.C. 398, revd. [83-2 USTC ¶ 9600] 716 F.2d 693 (9th Cir. 1983), will no longer be followed by this Court and expressing agreement with the reasoning for its reversal by the Court of Appeals for the Ninth Circuit
Summary of this case from Srivastava v. CommissionerOpinion
Docket No. 9270-83.
1986-12-8
JAMES E. THRELKELD, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent
G. Keith Rogers, Jr., for the petitioner. Robert P. Crowther, for the respondent.
Petitioner settled a civil lawsuit for malicious prosecution and other claims for $300,000, of which the parties to the lawsuit allocated $75,000 to injury to petitioner's professional reputation. HELD: There is no valid distinction between damages received for injury to personal reputation and those received for injury to professional or business reputation for purposes of section 104(a)(2), I.R.C. 1954. Roemer v. Commissioner, 79 T.C. 398 (1982), revd. 716 F.2d 693 (9th Cir. 1983), will be no longer followed. HELD FURTHER: Damages received in settlement of a claim for malicious prosecution of a civil proceeding under Tennessee law are damages received on account of ‘personal injuries.‘ Sec. 104(a)(2), I.R.C. 1954. G. Keith Rogers, Jr., for the petitioner. Robert P. Crowther, for the respondent.
GOFFE, JUDGE:
The Commissioner determined deficiencies in petitioner's Federal income taxes for the taxable years 1979 and 1980 in the amounts of $3,225.37 and $18,838.18, respectively. After concessions by the parties, the sole issue for decision is whether the amount of $21,500 received in 1980 in settlement of a suit for malicious prosecution that represented recovery for injury to petitioner's professional reputation is excludable from income under section 104(a)(2).
FINDINGS OF FACT
Some of the facts have been stipulated. The stipulation of facts and accompanying exhibits are incorporated by this reference.
Petitioner filed a Federal income tax return for the taxable year 1980 with the Internal Revenue Service Center, Memphis, Tennessee. Petitioner was a resident of Memphis, Tennessee, at the time he filed his petition in this case.
In May 1975, J.B. Williams (Williams) a Texas resident, filed a lawsuit against petitioner and a codefendant in the Chancery Court of Shelby County, Tennessee, alleging fraud in connection with a real estate sales contract. Petitioner counterclaimed against Williams seeking specific performance of the contract. The court subsequently found for petitioner and his codefendant both upon Williams' claim for rescission and upon defendants' counterclaim for specific performance and awarded the defendants a judgment in the amount of $1,283,527.07. The judgment of the chancery court was upheld on appeal and the Supreme Court of Tennessee denied an application for a writ of certiorari filed by Williams.
On May 10, 1979, petitioner filed suit in the United States District Court for the Western District of Tennessee against Williams with jurisdiction being based upon diversity of citizenship. Petitioner alleged that Williams ‘instituted, continued, and prosecuted his claims‘ in the suit before the Chancery Court of Shelby County, Tennessee, ‘without probable cause and with malice.‘ Petitioner also alleged that Williams' actions in bringing the suit for rescission in the chancery court caused petitioner various injuries described as follows:
* * * Plaintiff was subjected to indignity, humiliation, inconvenience, and pain and distress of mind, was prevented from attending to his usual professional pursuits, incurred expenses and costs in defending Defendant's claims in and pertaining to the chancery suit, suffered injury to his professional reputation, and suffered injury to his credit reputation. Petitioner's complaint included a prayer for compensatory damages in the amount of $250,000 and punitive damages in the amount of $1 million.
After instituting the suit for malicious prosecution against Williams in Federal court, petitioner filed two other lawsuits against Williams, his wife, Jean Proctor Williams, and others. These suits alleged that certain fraudulent conveyances of property were made in an attempt to insulate those properties from petitioner's judgment obtained in the original chancery court suit.
On December 8, 1980, petitioner and the Williamses, entered into an agreement settling the suit for malicious prosecution. As part of the same agreement petitioner agreed to release all other pending claims. Petitioner also agreed to assign the original chancery court judgment. As total consideration in settlement of his various claims, petitioner was to receive $300,000 allocated as follows:
(b) For the release by Threlkeld of his claims against J.B. Williams asserted in »the malicious prosecution action† for damage to Threlkeld's professional reputation, * * * $75,000.00.
(c) For the release by Threlkeld of his claims against J.B. Williams asserted in »the malicious prosecution action† for damage to Threlkeld's credit reputation, * * * $75,000.00.
(d) For the release by Threlkeld of his claims against J.B. Williams asserted in »the malicious prosecution action† for indignity, humiliation, inconvenience, and pain and distress of mind, * * * $74,980.00.
* * *
(f) For the assignment of the Judgment by Threlkeld * * * $75,000.00. The settlement agreement also allocated $10 each as consideration for the release by petitioner of two suits alleging fraudulent conveyances by Williams that were intended to defeat the execution of the judgment for specific performance. No amount was characterized as payment for punitive damages.
In 1980, petitioner received $86,000 of the total settlement of $300,000, of which $21,500 represented a portion of the amount allocated to the damage to professional reputation. He received the remainder of the $300,000 settlement in 1981.
On his individual Federal income tax return for the taxable year 1980, petitioner reported $1,500 as long-term taxable gain from the portion of the settlement relating to the decree of specific performance. He did not report as taxable income for the taxable year 1980 any other portion of the $86,000 he received.
In his statutory notice of deficiency for the taxable years 1979 and 1980, the Commissioner determined deficiencies in petitioner's income tax of $3,225.37 and $18,838.18, respectively. The deficiency for the taxable year 1980 resulted, in part, by increasing petitioner's taxable income in the amount of $55,902 representing unreported income received as part of the settlement agreement. After concessions by the parties, the sole remaining issue is the excludability of the $21,500 received by petitioner in 1980 as payment for injury to his ‘professional reputation.‘
OPINION
We are called upon to decide whether an amount received that was specified as a recovery for injury to petitioner's professional reputation arising out of a claim of malicious prosecution is excludable from taxable income under section 104(a)(2).
Section 61 provides that, except as otherwise provided, gross income means ‘all income from whatever source derived.‘ Section 104(a)(2) provides that ‘the amount of any damages received (whether by suit or agreement) on account of personal injuries or sickness‘ is excludable from gross income. The regulations promulgated under section 104(a)(2) provide that ‘damages received‘ means an amount received from an action based upon tort or tort type rights. Sec. 1.104-1(c), Income Tax Regs. The law is well settled that the tax consequences of an award for damages depend upon the nature of the litigation and on the origin and character of the claims adjudicated, and not upon the validity of those claims. Bent v. Commissioner, 87 T.C. ___ (filed July 28, 1986) (slip opinion at pages 13-14); Glynn v. Commissioner, 76 T.C. 116, 119 (1981), affd. without published opinion 676 F.2d 682 (1st Cir. 1982); Seay v. Commissioner, 58 T.C. 32, 37 (1972). No distinction is made between physical and nonphysical (mental or emotional) injuries. Seay v. Commissioner, supra at 40. However, in the case of damages awarded in defamation suits, this Court has drawn a distinction between damages received for an injury to personal reputation and those received for injury to professional reputation. One of our recent opinions setting forth this distinction was reversed by the Court of Appeals for the Ninth Circuit. Roemer v. Commissioner, 716 F.2d 693 (9th Cir. 1983), revg. 79 T.C. 398 (1982). Based upon our careful consideration of the opinion of the Court of Appeals in Roemer v. Commissioner, supra, and after close scrutiny of all of our decisions in this area, we conclude that, for purposes of section 104(a)(2), there is no justification for continuing to draw a distinction, in tort actions, between damages received for injury to personal reputation and damages received for injury to professional reputation.
The factual setting of Roemer v. Commissioner, 79 T.C. 398 (1982), is fairly straightforward. The Court was confronted with the proper tax treatment of the proceeds of a jury award for compensatory and punitive damages arising from a libel suit filed in a California State court. The libel suit was based upon the publication of a defamatory credit report that resulted in the loss of business opportunities. The allegations contained in his State court complaint and the evidence produced at trial both emphasized the injurious effect of the defamatory report on the taxpayer's business reputation and demonstrated that the report resulted in lost income and business opportunities. The taxpayer sought to exclude the damage award under section 104(a)(2) as an amount received on account for personal injuries.
In our opinion in Roemer v. Commissioner, supra, we addressed, as a threshold question, the necessity for drawing a distinction, for purposes of the exclusion of damages received on account of personal injuries under section 104(a)(2), between personal reputation and business or professional reputation. After deciding that just such a distinction was required, we concluded that the full amount of the compensatory damages received by the taxpayer was includable in his gross income. 79 T.C. at 407.
The Court of Appeals for the Ninth Circuit in the appeal of Roemer held that no distinction between injuries to personal and professional reputation was justified under section 104(a)(2). 716 F.2d at 697. Because the damages at issue were awarded pursuant to a defamation action, the court analyzed the nature of defamation under State law to decide whether the injuries which the taxpayer suffered were ‘personal.‘
After an exhaustive review of the history of defamation under California law, the court concluded that a defamation action involved distinctly personal injuries. The court characterized defamation as follows:
Although there are different types of defamation actions (libel or slander) depending on the form of the defamatory statements, all defamatory statements attack an individual's good name. This injury to the person should not be confused with the derivative consequences of the defamatory attack, i.e., the loss of reputation in the community and any resulting loss of income. The nonpersonal consequences of a personal injury, such as a loss of future income, are often the most persuasive means of proving the extent of the injury that was suffered. The personal nature of an injury should not be defined by its effect. »716 F.2d at 699; fn. ref. omitted.†
The Court of Appeals viewed the problem of recoveries for defamation from the proper perspective. Section 104(a)(2) excludes from income amounts received as damages on account of personal injuries. Therefore, whether the damages received are paid on account of ‘personal injuries‘ should be the beginning and the end of the inquiry. To determine whether the injury complained of is personal, we must look to the origin and character of the claim, Glynn v. Commissioner, supra, Seay v. Commissioner, 58 T.C. at 38, and not to the consequences that result from the injury. No doubt a defamatory statement that injures a person's professional reputation will result in lost income. In such cases, the amount of income lost is an accurate measure of the damages sustained because of the injury to reputation. However, the extent to which income is decreased, even though this may be the best measure of loss, in no way changes the nature of the claim. ‘It is simply not enough that the injury arose in connection with the taxpayer's business or his professional endeavor, or that the injury is somehow remotely capable of affecting his income. ‘ Church v. Commissioner, 80 T.C. 1104, 1109 (1983) (distinguishing Roemer v. Commissioner, 79 T.C. 398 (1982)).
The validity of the distinction between damages received for injuries to personal reputation and those received for injuries to professional reputation is further undermined by considering the disparate treatment given to damage awards received for physical injuries. The exclusion for damages received for personal injuries has long been extended to nonphysical, as well as physical injuries by this Court and respondent. Hawkins v. Commissioner, 6 B.T.A. 1023 (1927); Sol. Op. 132, I-1 C.B. 92 (1922). If a taxpayer receives a damage award for a physical injury, which almost by definition is personal, the entire award is excluded from income even if all or a part of the recovery is determined with reference to the income lost because of the injury. Where, however, the damage award is received for a nonphysical injury, we have previously mounted an inquiry to determine whether the components of the injuries for which the award are made personal or professional.
This inconsistency is graphically illustrated by considering the case of a young surgeon who loses a finger because of the tortious conduct of another. See Roemer v. Commissioner, 79 T.C. at 414 (Wilbur, J., dissenting). This injury will surely cause the surgeon compensable general damages, such as physical and emotional pain and suffering, but it will also undoubtedly cause special damages including loss of future income. In order to prove the extent of the damages flowing from a clearly personal injury, the surgeon will likely produce evidence of both his actual pain and suffering and his loss of income. However, because it is easier to place a present dollar value upon the loss of future income than upon an intangible such as emotional pain, the surgeon will quite predictably place greater emphasis on lost income as a measure of his damages and will perhaps, thereby, receive a greater recovery. In such a case, the entire damage award or settlement amount received will be excluded from income. The fact that the tortious conduct causing the severed digit manifested itself in the loss of future income to the surgeon raises no troubling questions as to the exclusion of the award. Where, however, a taxpayer's injuries are nonphysical we have, in the past, ignored the personal nature of the claim and delved into an inquiry regarding the nature of the consequences of the injury. See Roemer v. Commissioner, 716 F.2d at 700.
Not only does the distinction between damages for injury to personal reputation and those for professional reputation create an inconsistency between physical and nonphysical personal injuries that is analytically irreconcilable, the distinction also lacks a firm foundation in the case law of this Court.
The origin of the personal/professional reputation dichotomy has been attributed to a 1922 opinion of the Solicitor of Internal Revenue. Sol. Op. 132, I-1 C.B. 92 (1922). In that opinion, it was held that amounts received, whether by agreement of the parties or judgment of a court, on account of damages for defamation of personal character do not constitute income. I-1 C.B. at 93. However, the opinion did not extend to the taxability of damages received for defamation of business reputation or property rights. I-1 C.B. at 94. Nevertheless, in a 1958 ruling, the Commissioner cited the 1922 Solicitor's Opinion as authority for distinguishing between damages received for injury to personal reputation and those received for injury to professional reputation. Rev. Rul. 58-418, 1958-2 C.B. 18, 19.
This Court first considered the exclusion from gross income for damages received for personal injuries in Hawkins v. Commissioner, supra. In Hawkins the taxpayer was removed from the office of president of a corporation by its directors. The taxpayer contemplated bringing suit against the corporation and some of its officers because of certain defamatory statements made by the officers. He alleged injury to his ‘reputation, business and health.‘ Before a lawsuit was filed, however, the taxpayer settled his claims with the corporation. In deciding that the settlement award was not taxable, the Court held that the entire amount represented general damages for the personal injury caused by the defamatory statements. 6 B.T.A. at 1024. Although the defamation arose in the context of his employment, the Court stated that the settlement award ‘was compensation for injury to his personal reputation for integrity and fair dealing, including, as the record indicates, the injury to his health. * * * Here there is only the compensation which the law sanctions as the only remedy which has thus far been devised for an injury which in its nature is wholly personal and nonpecuniary.‘ 6 B.T.A. at 1024-1025. Quite notably, however, the Court in no way suggested that it must decide whether the settlement award represented compensation for an injury to the taxpayer's personal reputation or to his professional reputation.
We again confronted the taxability of payments received by a taxpayer in the context of his termination of employment in a Memorandum Opinion of this Court, Agar v. Commissioner, T.C. Memo. 1960-21, affd. 290 F.2d 283 (2d Cir. 1961). In Agar v. Commissioner, supra, the taxpayer submitted his resignation and then informed his former employers he intended to file a suit for damages based upon alleged mistreatment. Before any suit was filed, however, the corporation agreed to pay the taxpayer $45,000. The taxpayer argued before this Court that the amounts received from his former employer represented settlement of a proposed suit for injury to personal reputation and health. As such, he argued that those payments should be excludable from taxable income as compensation for a personal injury under our decision in Hawkins v. Commissioner, supra. The Court, however, found the payments not to be excludable on two grounds. First, the payments were not made in settlement of a claim of defamation, but rather constituted additional compensation to the taxpayer for his many years of service to the corporation. Second, the payments were more properly characterized as compensation for injuries done to the taxpayer's business reputation rather than his personal reputation. The Court of Appeals for the Second Circuit affirmed our decision based upon the first rationale and the payments received were, therefore, taxable. 290 F.2d at 284. More importantly for our purposes today, the Court of Appeals declined to rule upon our distinction between personal and professional reputation:
Since we affirm upon the first ground, we do not have to decide whether whatever tort claim Agar may have asserted was based upon damage to his personal as well as his business reputation, assuming that the dichotomy is realistic, and whether all payments or a portion of them would therefore be tax exempt. * * * »290 F.2d at 284.†
In later opinions we held that a distinction must be drawn between recoveries for injuries to personal reputation and to professional reputation. Glynn v. Commissioner, 76 T.C. at 120; Wolfson v. Commissioner, T.C. Memo. 1978-445, affd. and remanded 651 F.2d 1228 (6th Cir. 1981); Knuckles v. Commissioner, T.C. Memo 1964-33 affd. 349 F.2d 610 (10th Cir. 1965). However, in none of these opinions have we relied upon this distinction to decide the case. In Glynn v. Commissioner, supra, the Court denied an exclusion for amounts received by the taxpayer pursuant to an agreement upon the termination of his employment. Although the Court, in dictum, referred to the personal/professional reputation distinction, the basis for the denial of the deduction was that the gravamen of the settled claim was for recovery of accrued sick leave that would clearly be taxable income under section 61. 76 T.C. at 120-122.