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

COHEN, J.,

concurring in part and dissenting in part: I agree with the majority opinion insofar as it holds that the amount received by petitioner as liquidated damages is excludable from taxable income under section 104(a)(2). I dissent, however, insofar as the majority holds that section 104(a)(2) also excludes from taxation amounts designated wages or backpay in the ADEA, in petitioner’s complaint against his employer, in the settlement documents, on petitioner’s tax return, and in the petition prior to amendment. The majority’s use of the term “nonliquidated damages” (an anomalous term when applied to amounts actually calculated by reference to a wage schedule) is an understandable attempt to disregard labels in redetermining the substantive nature of the award. I submit, however, that the label given to these amounts by the Congress, by the employer, by the employee, and by this Court in prior opinions describes the substance of the payment and should result in taxability. Among other things, the majority disregards previously settled law that the intent of the payor as to the purpose in making the payment must be examined. See Knuckles v. Commissioner, 349 F.2d 610 (10th Cir. 1965), affg. a Memorandum Opinion of this Court; Metzger v. Commissioner, 88 T.C. 834, 847-848 (1987), affd. without published opinion 845 F.2d 1013 (3d Cir. 1988); Fono v. Commissioner, 79 T.C. 680, 694 (1982), affd. without published opinion 749 F.2d 37 (9th Cir. 1984).

In Rickel v. Commissioner, 92 T.C. 510 (1989), affd. in part and revd. in part 900 F.2d 655 (3d Cir. 1990), we focused our attention on the characterization of the liquidated damages awarded under the ADEA, noting that “This Court and others have consistently held that amounts received in lieu of wages, salary, or lost profits are includable in income.” 92 T.C. at 518. Although the characterization of the ADEA claim was one of first impression, we found the situation analogous to claims of sex discrimination in Metzger v. Commissioner, 88 T.C. 834, 851-852 (1987), affd. without published opinion 845 F.2d 1013 (3d Cir. 1988); Thompson v. Commissioner, 89 T.C. 632, 649-650 (1987), affd. 866 F.2d 709 (4th Cir. 1989); and Byrne v. Commissioner, 90 T.C. 1000, 1010-1011 (1988), revd. and remanded 883 F.2d 211 (3d Cir. 1989).

In Riekel, as here, respondent argued that the ADEA creates a contract action, not a tort action, and that the liquidated damages are punitive in nature and therefore taxable. Respondent relied on Rogers v. Exxon Research & Engineering Co., 550 F.2d 834, 838 (3d Cir. 1977), where the Court of Appeals for the Third Circuit had characterized ADEA actions and stated that “A suit for damages consisting of back wages arising out of the breach of an employment agreement is a routine contract action where the parties would be entitled to a jury under the Seventh Amendment.” Rejecting respondent’s contention, we stated:

The holding of * * * [Rogers] neither establishes exclusivity of the contract claim nor negates a tort remedy under the ADEA. Like the FLSA and the Equal Pay Act, the ADEA contains elements of both contract and tort claims. Specifically, while damages in lieu of wages are in the nature of a breach of contract action, liquidated damages are intended as compensation for a tort or tort-like injury. [92 T.C. at 520-521.]

Our conclusion concerning the dual nature of the claims settled was consistent with the analysis and conclusions in our prior opinions in Thompson v. Commissioner, 89 T.C. at 646-647, and Byrne v. Commissioner, 90 T.C. at 1008-1010. In Byrne v. Commissioner, 883 F.2d 211 (3d Cir. 1989), revg. and remanding 90 T.C. 1000 (1988), and in Riekel v. Commissioner, 900 F.2d 655 (3d Cir. 1990), affg. in part and revg. in part 92 T.C. 510 (1989), the Court of Appeals for the Third Circuit rejected our approach of bifurcating the types of claims under the FLSA and ADEA and allocating the wage claims to a contract action and the liquidated damages to a tort action. The Court of Appeals in Riekel v. Commissioner, supra, cited various cases categorizing race discrimination in the workplace as a tort claim for personal injuries. The Court of Appeals for the Third Circuit held that all the damages received by the taxpayer on account of age discrimination are excludable under section 104(a)(2), acknowledging:

Of course, it might be troubling to some that a successful plaintiff in an ADEA suit will make out better, vis-á-vis federal income tax liability, than if the plaintiff had not been discriminated against in the first place. Although this concern is understandable, we note that we are simply following the Treasury regulation that injects into the analysis tort and contract concepts. Moreover, the successful ADEA plaintiff is being treated no better (or worse now) than the typical tort victim who suffers a physical injury. * * * [900 F.2d at 664.]

In Pistillo v. Commissioner, 912 F.2d 145 (6th Cir. 1990), revg. and remanding T.C. Memo. 1989-329, and in Burke v. United States, 929 F.2d 1119 (6th Cir. 1991), the Court of Appeals for the Sixth Circuit followed a similar analysis and reached the same result in cases involving age discrimination and sex discrimination, respectively.

The Court of Appeals for the Third Circuit in Rickel and the Court of Appeals for the Sixth Circuit in Burke suggested that our opinion abandoned the line of cases that had held that all consequences of personal injury, whether economic or physical, are excludable from taxable income under section 104(a)(2). See Roemer v. Commissioner, 716 F.2d 693, 697 (9th Cir. 1983), revg. 79 T.C. 398 (1982); Miller v. Commissioner, 93 T.C. 330 (1989), revd. and remanded 914 F.2d 586 (4th Cir. 1990); Metzger v. Commissioner, 88 T.C. 834 (1987), affd. without published opinion 845 F.2d 1013 (3d Cir. 1988); Threlkeld v. Commissioner, 87 T.C. 1294 (1986), affd. 848 F.2d 81 (6th Cir. 1988); Bent v. Commissioner, 87 T.C. 236 (1986), affd. 835 F.2d 67 (3d Cir. 1987). The disputed payments in these cases, however, did not arise from settlement of claims that could be characterized as contractual. Roemer, Threlkeld, and Miller involved damages for defamation made against third-party tort-feasors, not against the taxpayer’s employer. Bent involved infringement of the taxpayer’s First Amendment freedoms by refusal to rehire him. His contract claims had been expressly rejected by the State court prior to the settlement payment in issue. See the dissenting opinion of Judge Wellford in Burke v. United States, 929 F.2d at 1123.

In Metzger, the taxpayer received payment in settlement of her claim of violation of her rights to be free from discrimination on account of sex and national origin. We stated:

excludability depends on what was the injury complained of, and the loss of income may merely be “an evidentiary factor” (Bent) or “the best measure of loss” (Threlkeld). * * * in the instant case (1) the evidence is clear that no effort was made to calculate an amount of back pay, (2) the evidence is clear that the college and petitioner sought to settle all the claims for a single lump sum, (3) the college believed that petitioner’s contract claim might result in a liability of $15-20,000, and (4) most of petitioners’ claims were tort or tort-type claims on account of personal injuries and were not for back pay * * * . [88 T.C. at 858.]

In Metzger, the taxpayer had not claimed that more than half of the damages received was for tort claims. See the dissenting opinion of Judge Wellford in Burke v. United States, 929 F.2d at 1123.

In Byrne v. Commissioner, 90 T.C. 1000, 1011 (1988), revd. and remanded 883 F.2d 211 (3d Cir. 1989), and in Thompson v. Commissioner, 89 T.C. 632, 649-650 (1987), affd. 866 F.2d 709 (4th Cir. 1989), equal amounts were allocated by this Court to tort claims and contract claims based on the evidence in those cases. The Court of Appeals in Rickel stated:

Neither in Byrne nor the instant case had the taxpayer performed uncompensated services for the employer after the challenged discrimination. On the contrary, both taxpayers were seeking compensation for their inability to earn an income due to the tortious action of their employers. Thus, our decision today does not conflict with Thompson. Of course, we do not decide whether we would adopt the reasoning of Thompson given a similar factual scenario. [900 F.2d at 664-665 n.16; emphasis in original.]

This statement was made in response to a suggestion by the Government that the Third Circuit opinion in Byrne was inconsistent with the Fourth Circuit opinion in Thompson.

In summary, the difference between prior opinions of this Court, on the one hand, and the Courts of Appeals for the Third and Sixth Circuits, on the other, is whether the plaintiffs statutory right in an ADEA lawsuit comprises both contract and tort claims or whether all of the plaintiffs recovery is “on account of” personal injury.

In this case as in its predecessors, we are dealing with statutory rights and remedies that may find analogies in State tort or contract law. Regardless of the labels, however, the tax consequences should be determined by substance. As stated by the majority in this case, “petitioner sought in his complaint, inter aha, reinstatement, retroactive seniority rights, employee benefits as if petitioner’s employment had not been interrupted, backpay plus interest, and liquidated damages.” Petitioner’s employer had contracted to pay wages to petitioner at a specified rate during the period of petitioner’s employment. Historically, employees have been entitled to backwages when employment is wrongfully terminated.. The ADEA establishes age discrimination as a wrongful cause of termination. Thus, the employer’s interruption of petitioner’s employment was unlawful, and the obligation to pay wages continued. The portion of the award labeled backwages is in substance backwages, i.e., it is replacement of lost income, not compensation for personal injury. Thus, it is distinguishable from amounts received from third-party tort-feasors or because of the wrongful conduct of the employer.

With respect to the liquidated damages portion, in Rickel v. Commissioner, 92 T.C. at 521-522, we held that liquidated damages in the hands of the taxpayer were compensatory, notwithstanding language in Trans World Airlines, Inc. v. Thurston, 469 U.S. 111, 125 (1985), that “The legislative history of the ADEA indicates that Congress intended for liquidated damages to be punitive in nature.” Other cases have characterized liquidated damages under the ADEA as punitive damages intended to deter conduct of an employer. Gilchrist v. Jim Slemons Imports, Inc., 803 F.2d 1488, 1494 (9th Cir. 1986); Kelly v. American Standard, Inc., 640 F.2d 974, 979 (9th Cir. 1981). Yet the majority has no trouble characterizing the liquidated damages portion of the award to petitioner as compensatory in the hands of the taxpayer and not treated as punitive damages for tax purposes because of language taken out of the context of other cases. I agree with this approach. I believe that we should follow it also with respect to the backwages rather than merely applying the language of other cases describing the ADEA action as involving tort-type rights.

In a footnote in our opinion in Byrne v. Commissioner, 90 T.C. 1000, 1011 n.10 (1988), revd. and remanded 883 F.2d 211 (3d Cir. 1989), we remarked:

Petitioner, relying on Roemer v. Commissioner, 716 F.2d 693, 696 (9th Cir. 1983), revg. 79 T.C. 398 (1982), argues that once she has shown the existence of tort claims, she is not required to present evidence going to an allocation of the damages between tort and contract claims. Her reliance on Roemer is misplaced. Roemer recognized that when the claim at the root of a damage award was a tort claim, the amount of damages would be measured in part by lost wages, but that the tort award should not be treated as income to the extent it was so measured. This Court has followed that principle. See Metzger v. Commissioner, 88 T.C. at 857-858; Bent v. Commissioner, 87 T.C. at 250; Threlkeld v. Commissioner, 87 T.C. 1294, 1299 (1986). However, the situation here does not fall within the Roemer principle cited by petitioner. Here, we have been unable to find that the claims settled were solely claims of a tort-like nature. Since both personal injury claims and other claims are settled by the release, the burden is on petitioner to present evidence to allocate the settlement payment between includable and excludable amounts.

Neither Rickel v. Commissioner, 92 T.C. 510 (1989), affd. in part and revd. in part 900 F.2d 655 (3d Cir. 1990), nor this case presents difficulty in allocation. Here, the parties expressly agreed that 50 percent of the payment received was for backpay, the employer withheld taxes on that amount, and petitioners originally reported that amount as taxable income on their return. The stipulated facts establish that the employer and the employee each regarded only the amount received as liquidated damages excludable under section 104.

In Rickel v. Commissioner, supra, the Court of Appeals for the Third Circuit’s own prior characterization of an action for backwages as “a routine contract action” was dismissed in a footnote as follows:

We do not believe that Rogers v. Exxon Research & Enq’q Co., 550 F.2d 834 (3d Cir. 1977), cert. denied, 434 U.S. 1022 (1978), compels a different conclusion. First, the Rogers court was characterizing an ADEA action for purposes of determining whether an ADEA plaintiff had the right to a jury trial under the Act, not for tax purposes. Id. at 838-39. Second, the conclusion by the Rogers court that an ADEA action is a “routine contract action” was gratuitous given that the holding was simply that an ADEA action involves rights and remedies of the sort typically enforced in an action at law. Id. And, third, we do not hold today that there are no elements in an ADEA action that do not possess contract type features, only that age discrimination, for purposes of sec. 104(a)(2) of the IRC, is a personal injury and an ADEA action to redress that injury is more like the assertion of a tort type right. [Rickel v. Commissioner, 900 F.2d at 663 n.13.]

I respectfully suggest that this rationale does not justify allocation of 100 percent of the ADEA award to a personal injury.

Nims, Parker, Clapp, Jacobs, and Wells, JJ., agree with this opinion.