Cir v. Polone

FOR PUBLICATION
UNITED STATES COURT OF APPEALS
FOR THE NINTH CIRCUIT
GAVIN POLONE, 
Petitioner, No. 04-72672
v.
 Tax Ct. No.
12665-00
COMMISSIONER OF INTERNAL
REVENUE, OPINION
Respondent.

Appeal from a Decision of the
United States Tax Court
Argued and Submitted
April 6, 2006—Pasadena, California
Filed June 5, 2006
Before: Jerome Farris and Sidney R. Thomas, Circuit Judges,
and George Schiavelli,* District Judge.
Opinion by Judge Thomas
*The Honorable George Schiavelli, United States District Judge for the
Central District of California, sitting by designation.
6155
6158 POLONE v. CIR
COUNSEL
James M. Harris, Edwin L. Norris, Jonathan M. Brenner, Sid-
ley Austin Brown & Wood LLP, for appellant Gavin Polone.
Bridget M. Rowan, Kenneth L. Greene, Eileen J. O’Connor,
United States Department of Justice, for appellee Commis-
sioner of the Internal Revenue Service.
OPINION
THOMAS, Circuit Judge:
This appeal presents the question of whether payments
received after the effective date of amendments to 26 U.S.C.
POLONE v. CIR 6159
§ 104(a)(2) based on a defamation settlement agreement exe-
cuted prior to the effective date can be excluded from gross
income. We conclude that the amendments apply to payments
received after the effective date of the amendment, and we
affirm the judgment of the Tax Court.
I
Gavin Polone worked as a talent agent at United Talent
Agency (“UTA”) from 1989 until April 21, 1996, when he
was fired. After terminating Polone, UTA spoke with various
entertainment industry trade publications, and made state-
ments about Polone’s termination. Specifically, UTA alleged
that Polone was terminated for “inappropriate behavior.”
Polone hired counsel, and sent UTA a demand letter on
April 22, 1996. The letter alleged that UTA had made defam-
atory statements about Polone, and requested that UTA “cease
and desist from making further defamatory statements.” On
April 24, 1996, Polone filed a complaint in the Los Angeles
County Superior Court alleging, among other things, wrong-
ful termination and defamation. Polone and UTA settled both
claims on May 3, 1996.
Polone received $2 million as settlement of the wrongful
termination claim, which is not at issue in this case. As part
of the settlement of the defamation claim, UTA issued a press
release retracting its previous statements about Polone’s ter-
mination, and paid Polone $4 million. The $4 million was
paid in four installments of $1 million, which Polone received
on May 3, 1996; November 11, 1996; May 5, 1997; and
November 11, 1998.
Polone, a cash basis taxpayer, did not include the May 1996
payment on his 1996 federal income tax return. He included
the November 1996 payment, but later filed an amended 1996
return seeking a refund. He did not pay taxes on the May
1997 or November 1998 payments. Polone justified his failure
6160 POLONE v. CIR
to pay taxes on this income on our decision in Warren Jones
Co. v. Comm’r, 524 F.2d 788 (9th Cir. 1975), alleging that
Warren Jones Co. required him “to treat his receipt of his for-
mer employer’s promise to pay $4 million as an amount real-
ized in the 1996 taxable year at the time of his receipt of the
promise to pay.”
In September 2000, the IRS sent Polone a deficiency notice
for his failure to pay taxes on the settlement payments he
received in May 1996, May 1997, and November 1998.
Polone petitioned for review in the Tax Court in December
2000. He also filed an amended petition in August 2002,
claiming that the IRS should have reduced his 1996 taxable
income by $1 million because he had erroneously paid taxes
on the November 1996 settlement payment. The Tax Court
held that Polone owed taxes on the May 1997 and November
1998 settlement payments, and that the taxes he paid on the
November 1996 settlement payment were proper. Polone v.
Comm’r, T.C. Memo 2003-339 (2003). The Tax Court also
held that Polone did not owe any taxes on the May 1996 set-
tlement payment. Id. He appeals.
II
[1] Section 61(a) of the Tax Code defines “gross income”
as “all income from whatever source derived.” 26 U.S.C.
§ 61(a). Thus, subject to certain exemptions, which are to be
construed narrowly, § 61(a) applies to all income, including
settlement payments. Comm’r v. Schleier, 515 U.S. 323, 328
(1995) (“the default rule of statutory interpretation [is] that
exclusions from income must be narrowly construed.” (quota-
tions omitted)); Comm’r v. Glenshaw Glass, 348 U.S. 426,
431 (1955) (“The mere fact that payments were extracted
from the wrongdoers as punishment for unlawful conduct can
not detract from their character as taxable income to the recip-
ients.”).
In May 1996, when Polone and UTA settled, 26 U.S.C.
§ 104 exempted “the amount of any damages received
POLONE v. CIR 6161
(whether by suit or agreement and whether as lump sums or
as periodic payments) on account of personal injuries or sick-
ness” from a taxpayer’s gross income. 26 U.S.C. § 104(a)(2)
(1995). The term “personal injuries” in § 104 had been inter-
preted to include damages from settlements of defamation
claims. Roemer v. Comm’r, 716 F.2d 693, 700 (9th Cir.
1983).
[2] Congress amended § 104 in August 1996 so that it
exempted “the amount of any damages (other than punitive
damages) received (whether by suit or agreement and whether
as lump sums or periodic payments) on account of personal
physical injuries or physical sickness.” 26 U.S.C. § 104(a)(1)
(1996) (emphasis added). The amendment legislatively over-
ruled court decisions, like Roemer, that had exempted awards
for nonphysical injuries from a taxpayer’s gross income. See
H.R. CONF. REP. 104-737 at 301 (“Thus, the exclusion from
gross income does not apply to any damages received . . .
based on a claim of . . . injury to reputation.”). The effective
date of the amendments was August 20, 1996, but there was
an exception to the amendment for “amount[s] received under
a written binding agreement, court decree, or mediation award
in effect on (or issued before) September 13, 1995.” 26
U.S.C. § 104, Application of August 20, 1996 Amendments.
Here, the Tax Court held that pre-amendment § 104 applied
to Polone’s May 1996 payment from UTA, but that post-
amendment § 104 applied to the November 1996, May 1997,
and November 1998 payments because Polone received those
payments after the amendment’s effective date. Polone, T.C.
Memo 2003-339 at 66. As a result, it held that the May 1996
payment was tax exempt, but that the other payments were
not. Id. at 68. Polone argues that the pre-amendment § 104
applies to all four settlement payments he received, and thus
that the $4 million in its entirety is tax exempt. Whether the
May 1996 version of § 104 or the amended version of § 104
governs the settlement payments that Polone received after
the amendment’s effective date is a question of statutory
6162 POLONE v. CIR
interpretation that we review de novo. Leslie v. Comm’r, 146
F.3d 643, 648 (9th Cir. 1998).
[3] Applying the plain language of § 104, the Tax Court
properly held that the November 1996, May 1997, and
November 1998 payments were taxable. The amended statute
applies to any damages received after its effective date of
August 20, 1996, unless the parties had contracted prior to
September 13, 1995. P.L. 104-188, Title I, Subtitle F, Part 1,
§ 1605(d).1 Although Polone settled his claims with UTA in
May 1996, he did not actually receive the three payments in
question until well after the effective date of the amendments
to § 104. Because the settlement was not in effect before Sep-
tember 13, 1995, it was not subject to the exception to
amended § 104 for preexisting settlement agreements. Thus,
the amended version of § 104 applies to the payments Polone
received in November 1996, May 1997, and November 1998,
and the Tax Court properly sustained the IRS’s deficiency
notice.
III
Polone, citing our decision in Warren Jones Co., argues
that under 26 U.S.C. § 1001, which explains how to calculate
taxable gain from the “sale or other disposition of property,”
his entire settlement of $4 million was realized on May 3,
1996, the date of settlement, even though UTA paid him in
installments. Therefore, he argues, pre-amendment § 104
applies to the entire $4 million he received from UTA. The
application of § 1001 to Polone’s settlement with UTA is a
question of statutory interpretation that we review de novo.
Leslie, 146 F.3d at 648.
[4] Section 1001 provides that the “gain from the sale or
other disposition of property shall be the excess of the amount
1
September 13, 1995 was the date upon which Congress first proposed
to amend § 104. H.R. 2491 (104th Cong., 1995).
POLONE v. CIR 6163
realized therefrom over the adjusted basis.” 26 U.S.C.
§ 1001(a).2 To fall within its boundaries, property must (1)
have an “adjusted basis” and (2) be transferable. Id. Because
a personal injury claim, such as Polone’s defamation claim,
does not have an adjusted basis and is not transferable, § 1001
does not apply to a settlement of such a claim.
To calculate the “adjusted basis,” § 1001(a) looks to 26
U.S.C. § 1011, which, in turn, looks to 26 U.S.C. § 1012. Sec-
tion 1012 states, “The basis of property shall be the cost of
such property, except as otherwise provided in this subchap-
ter.” 26 U.S.C. § 1012. It then specifically references sections
of the Internal Revenue Code dealing with corporate distribu-
tions, partnerships, and capital gains. Id.
[5] Polone’s defamation claim has no adjusted basis within
the meaning of § 1001. It was not a corporate distribution,
partnership revenue, or a capital gain. Therefore, its “adjusted
basis” would have had to have been calculated pursuant to
§ 1012. A § 1012 calculation, however, is based on cost,
which is antithetical to a defamation claim. As the California
courts have noted, defamation does not “interfer[e] with a
property right, economic relations, or the sale of goods.”
Truck Ins. Exch. v. Bennett, 61 Cal. Rptr. 2d 497, 503 (Cal.
App. 1997). Rather, “defamation invades the interest in per-
sonal or professional reputation and good name. A defamation
claim vindicates personal interests, and is a personal injury.”
Id. Such a personal injury cannot reasonably be said to have
a cost in the traditional market sense that § 1012 requires, in
that one cannot sell one’s dignity as a commodity on the open
market.
2
For purposes of this appeal, we assume, but do not decide, that a legal
claim could be considered property for purposes of § 1001. See, e.g.,
United States v. Stonehill, 83 F.3d 1156, 1159 (9th Cir. 1996) (holding
that a legal claim is property for purposes of the federal tax lien statute,
26 U.S.C. § 6321); Herbert’s Estate v. Comm’r, 139 F.2d 756 (3d Cir.
1943) (noting that a stockholder’s claim against a corporation was prop-
erty for purposes of 26 U.S.C. § 111, the predecessor to § 1001).
6164 POLONE v. CIR
Moreover, “[t]he test for characterizing proceeds of litiga-
tion is stated most simply as ‘In lieu of what were the dam-
ages awarded?’ ” and courts must look to the nature of the
underlying claim when classifying damages awards for tax
purposes. Tribune Pub. Co. v. United States, 836 F.2d 1176,
1178 (9th Cir. 1988) (citation omitted). We have explained
that “[d]amages paid for personal injuries . . . make the tax-
payer whole from a previous loss of personal rights —
because, in effect, they restore a loss to capital.” Starrels v.
Comm’r, 304 F.2d 574, 576 (9th Cir. 1962). As a result, treat-
ing the settlement of a personal injury claim as a “gain” for
purposes of § 1001 would be at odds with this basic concept
of tort law. The money that Polone received as part of his set-
tlement with UTA served to restore any loss to his reputation
caused by UTA’s alleged defamation and to make him whole.
Such a restorative payment cannot be considered an “amount
realized” for purposes of § 1001 because it simply put Polone
in the position in which he would have found himself had the
alleged defamation never happened.
[6] Turning briefly to the issue of transferability, California
Civil Code § 9543 permits a plaintiff to transfer actions arising
out of breach of contract or injuries to personal or real prop-
erty, but not defamation claims, which are “founded upon
wrongs of a purely personal nature such as to the reputation
or the feelings of the one injured.” Goodley v. Wank & Wank,
Inc., 133 Cal. Rptr. 83, 85 (Cal. App. 1976). See also Baum
v. Duckor, Spradling & Metzger, 84 Cal. Rptr. 2d 703, 709
(Cal. App. 1999) (“Thus, causes of action for personal injuries
arising out of a tort are not assignable nor are those founded
upon wrongs of a purely personal nature such as to the reputa-
3
We apply California law to determine whether Polone’s defamation
claim was transferable for purposes of § 1001 because “state law deter-
mines the nature of the legal interest the taxpayer has in the property.
Once the court determines the state-law right possessed by the taxpayer,
then the federal tax consequences are solely a matter of federal law.”
Stonehill, 83 F.3d at 1159.
POLONE v. CIR 6165
tion or the feelings of the one injured.”). Because Polone’s
defamation claim had no adjusted basis and was not transfer-
able under California law, his settlement with UTA could not
have been a “sale or other disposition of property” for pur-
poses of § 1001.
IV
Polone also argues that pre-amendment § 104 should apply
to the settlement payments he received in November 1996,
May 1997, and November 1998 because applying amended
§ 104 to those payments would amount to retroactive legisla-
tion in violation of his Fifth Amendment due process rights.
We review this constitutional claim de novo. Quarty v. United
States, 170 F.3d 961, 965 (9th Cir. 1999).
[7] Retroactive legislation runs the risk of offending the
Due Process Clause of the Fifth Amendment, Landgraf v. USI
Film Prods., 511 U.S. 244 (1994), and the Supreme Court has
provided various formulas for determining whether a particu-
lar statute applies retroactively. For example, the Court has
considered whether a statute “takes away or impairs vested
rights acquired under existing laws,” id. at 269 (quoting Soci-
ety for Propagation of the Gospel v. Wheeler, 22 F. Cas. 756
(CC NH 1814)), or whether a law “changes the legal conse-
quences of acts completed before its effective date,” id. at 269
n.23 (quoting Miller v. Florida, 482 U.S. 423, 430 (1987)).
[8] The thrust of the various tests is that to operate retroac-
tively, a statute must actually “attach[ ] new legal conse-
quences” to completed, past conduct. Id. at 270. It is not
enough that a statute “is applied in a case arising from con-
duct antedating the statute’s enactment,” or that a statute “up-
sets expectations based in prior law.” Id. at 269-270. Thus, for
example, even though “a new property tax or zoning regula-
tion may upset the reasonable expectations that prompted
those affected to acquire property,” a change in the property
tax regime would not be considered retroactive with respect
6166 POLONE v. CIR
to all who had purchased property prior to the effective date
of the amendment. See id. at 270 n.24.
[9] Applying this test to § 104, we hold that amended § 104
was constitutionally applied to the payments Polone received
in November 1996, May 1997, and November 1998. As
explained above, the amendment to § 104 explicitly applied
only to amounts received after its effective date, which was
August 20, 1996. 26 U.S.C. § 104, Application of August 20,
1996 Amendments. Although it is possible for a statute with
a seemingly prospective application to apply retroactively in
some circumstances, Landgraf, 511 U.S. at 258-59, the
amendments to § 104 did not because they did not attach new
legal consequences to completed payments. On the contrary,
the amendments applied only prospectively, to payments
made after their date of enactment. Compare with Untermeyer
v. Anderson, 276 U.S. 440, 445 (1928) (a tax was retroactive
where it applied to “bona fide gifts not made in anticipation
of death and fully consummated prior to” the statute’s effec-
tive date) (emphasis added); Blodgett v. Holden, 275 U.S.
142, 147 (1927) (same).
[10] Polone argues that the amendments to § 104 apply
retroactively because his settlement with UTA was “finalized
on May 3, 1996, more than three months before the enactment
of the statute.” This argument is unconvincing for two rea-
sons. First, although the settlement contract may have been
“finalized” in the sense that both parties signed it, settlement
of Polone’s defamation claim was nowhere near complete as
of August 20, 1996. On the contrary, UTA still had to make
three payments to Polone, and he had to honor his promise to
guard UTA’s confidential information. Thus, the Tax Court
did not apply amended § 104 to a contract that was “fully con-
summated” prior to the amendment’s effective date, as was
the case in Untermeyer and Blodgett. Rather, amended § 104
was applied to a contract whose fulfillment was still a work
in progress. Second, Polone’s argument falls squarely into the
Supreme Court’s warning that “[a] statute does not operate
POLONE v. CIR 6167
‘retrospectively’ merely because it is applied in a case arising
from conduct antedating the statute’s enactment.” Landgraf,
511 U.S. at 269. The fact that Polone’s tax dispute stemmed
from his settlement with UTA — conduct that antedated the
revisions to § 104 — does not mean that § 104 operates retro-
spectively when it is applied to settlement payments that
Polone received after its effective date.
V
For the reasons explained above, we agree with the Tax
Court that the settlement payments received by Polone after
August, 1996 are taxable as ordinary income.
AFFIRMED.