Brandriet v. Commissioner ( 2000 )

T.C. Memo. 2000-302
UNITED STATES TAX COURT
DAVID STEVAN AND KAREN ANN BRANDRIET, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 4311-99. Filed September 25, 2000.
David Stevan Brandriet and Karen Ann Brandriet, pro sese.
Melissa J. Hedtke, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
PARR, Judge: Respondent determined a $75,739 deficiency in
petitioners' Federal income tax for the 1993 taxable year.
After concessions,1 the issues for decision are: (1)
1
Respondent concedes that the compensatory damage award of
$41,453.22 that petitioners received in 1993 is excluded from
petitioners' gross income pursuant to sec. 104(a)(2).
Respondent also concedes that petitioners' business, Malligan's
(continued...)
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Whether a punitive damage award of $200,000 that petitioners
received in 1993 is includable in their gross income. We hold it
is.2 (2) Whether petitioners are entitled to deduct interest on
a consumer loan in an amount greater than that allowed by
respondent. We hold they are not.
All section references are to the Internal Revenue Code in
effect for the taxable year in issue, and all Rule references are
to the Tax Court Rules of Practice and Procedure, unless
otherwise indicated. References to petitioner are to David
1
(...continued)
Car Cleaning, had gross receipts of $1,842 in 1993.
Petitioners concede that the $48,440 of interest they
received in 1993 pursuant to a judgment order is includable in
their gross income.
In the notice of deficiency, respondent determined that
petitioners were not entitled to claim deductions of $1,011 for
vehicle expenses and $322 for utility expenses, because of lack
of substantiation and because petitioners did not establish an
ordinary and necessary business purpose for the expenditures.
As we read the petition in this case, we do not construe it
as containing any reference to respondent's determinations
disallowing petitioners' vehicle and utility expense deductions.
See Rule 34(b)(4). Furthermore, petitioners did not address
these determinations at trial or on brief and did not proffer any
evidence to substantiate these claimed deductions. Accordingly,
we consider petitioners to have conceded these amounts.
2
Respondent determined that for the year at issue certain
computational adjustments should be made, which would: (1)
Reduce petitioners' deduction for exemptions, (2) reduce
petitioners' itemized deductions, and (3) preclude petitioners
from claiming the earned income credit.
In their petition, petitioners raised the issue of whether
the punitive damage award is includable in their gross income
and, on the basis of that issue, disputed respondent's
computational adjustments. Our decision of the punitive damage
award issue will resolve the dispute of respondent's
computational adjustments.
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Stevan Brandriet.
FINDINGS OF FACT
Some of the facts have been stipulated and are so found.
The stipulated facts and the accompanying exhibits are
incorporated into our findings by this reference. At the time
the petition in this case was filed, petitioners resided in
Watertown, South Dakota.
On September 18, 1989, petitioners filed suit against
Norwest Bank S.D., N.A. (Norwest) for rejection of petitioners'
application for a Veterans' Administration home mortgage loan.
The original complaint alleged fraudulent misrepresentation,
negligent misrepresentation, and negligent processing of the
application. The pleadings were later amended to include claims
of intentional infliction of emotional distress and punitive
damages. After an 8-day trial, the jury returned a verdict
holding Norwest liable for negligent processing, fraudulent
misrepresentation, and negligent misrepresentation; however,
Norwest was found not liable for intentional infliction of
emotional distress. Petitioners were awarded $41,453.22 in
compensatory damages and $200,000 in punitive damages. The
verdict was affirmed on appeal. See Brandriet v. Norwest Bank
S.D., N.A., 499 N.W.2d 613 (S.D. 1993).
Petitioners received the punitive damages in 1993; however,
they did not report any of this amount on their 1993 Federal
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income tax return.
OPINION
Issue 1. Whether the Punitive Damages Are Includable in
Petitioners' Gross Income
Respondent determined that the punitive damages received by
petitioners are taxable. Petitioners contend that the punitive
damages portion of their award is excludable from gross income
pursuant to section 104(a)(2), because their lawsuit was based
upon tort or tort type rights and the jury "awarded damages it
believed would compensate their civil injuries."
Not Compensatory
Section 104(a)(2) provides that gross income does not
include "the amount of any damages received * * * on account of
personal injuries or sickness". An award of punitive damages is
not paid on account of a personal injury to the extent that the
damages are noncompensatory. See O'Gilvie v. United States, 519
U.S. 79 (1996). Whether damages are noncompensatory rests upon
applicable State law. See Bagley v. Commissioner, 105 T.C. 396,
417 (1995), affd. 121 F.3d 393 (8th Cir. 1997).
The present case involves South Dakota law. See Brandriet
v. Norwest Bank S.D., N.A., supra at 616, 618. In Hulstein v.
Meilman Food Indus., Inc., 293 N.W.2d 889, 891, 892 (S.D. 1980),
the South Dakota Supreme Court stated that, while the "sole
object of compensatory damages is to make the injured party
whole", the "purpose of awarding punitive damages is to punish
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the wrongdoer." See also S.D. Codified Laws sec. 21-3-2 (Michie
Supp. 2000) (the jury, in addition to the actual damage, may give
punitive damages for the sake of example, and by way of punishing
the defendant); Veeder v. Kennedy, 589 N.W.2d 610, 622 (S.D.
1999) (punitive damages may properly be imposed to further
State's legitimate interests in not only punishing unlawful
conduct but also in deterring its repetition). Contrary to
petitioners' assertion, we conclude that the punitive damages
were not compensatory.
No Physical Injury or Physical Sickness
The Omnibus Budget Reconciliation Act of 1989 (OBRA), Pub.
L. 101-239, sec. 7641(a), 103 Stat. 2106, 2379, amended section
104(a) by adding the sentence "Paragraph (2) shall not apply to
any punitive damages in connection with a case not involving
physical injury or physical sickness." OBRA section 7641(b)(2)
provided that the amendment is applicable to amounts received
pursuant to suit filed after July 10, 1989. Because petitioners
filed suit more than 2 months after this date, the amendment is
applicable to the instant case.
The complaint in petitioners' suit was based upon several
claims. Although petitioners claimed to have suffered "emotional
injuries" on account of the defendant's actions, the complaint
did not mention any physical injury or physical sickness
resulting from those actions. The fact that a taxpayer suffers
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"personal" injury from a defendant's conduct is insufficient to
satisfy the "physical injury or physical sickness" requirement.
Kightlinger v. Commissioner, T.C. Memo. 1998-357.
The jury found Norwest liable for fraudulent
misrepresentation, negligent misrepresentation, and negligent
processing of a loan application. Petitioners did not obtain
redress for any physical injury or physical sickness.
Having considered the allegations in the complaint and the
jury's verdict, we find that petitioners did not receive the
punitive damages in connection with a case involving physical
injury or physical sickness. We hold that petitioners' punitive
damages are includable in their gross income.
Issue 2. Whether Petitioners Are Entitled to a Greater Interest
Expense Deduction3
Petitioners claimed a $3,000 deduction for interest paid on
a consumer loan. Respondent determined that petitioners are
entitled to deduct $238 of the claimed interest expense as a
business expense and disallowed the balance.
Respondent's determinations of fact are presumptively
correct, and petitioners bear the burden of proving otherwise.
See Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933).
Taxpayers do not have an inherent right to take tax deductions.
Deductions are a matter of legislative grace, and a taxpayer
3
Petitioners raised this issue at trial. We consider it
tried by consent. See Rule 41(b).
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bears the burden of proving entitlement to any deduction claimed.
See Deputy v. du Pont, 308 U.S. 488, 493 (1940); New Colonial Ice
Co. v. Helvering, 292 U.S. 435, 440 (1934). Moreover, a taxpayer
is required to maintain records that are sufficient to
substantiate his deductions. See sec. 6001.
At trial, petitioner proffered a photocopy of a cashier's
check dated August 6, 1993, made payable to First Federal Savings
Bank in the amount of $10,368.49, as evidence of petitioners'
payment of interest. However, petitioners provided no evidence,
other than petitioner's vague and uncertain testimony, of the
amount of the interest and principal portions of the payment or
of the purpose of the loan. Accordingly, petitioners have not
met their burden of proving entitlement to deduct any expense for
interest in an amount greater than that allowed by respondent.
To reflect the foregoing,
Decision will be entered
under Rule 155.