COURT OF APPEALS OF VIRGINIA
Present: Judges Elder, Annunziata and Frank
Argued at Alexandria, Virginia
ROBERT WALTER SMITH
OPINION BY
v. Record No. 2275-99-2 JUDGE LARRY G. ELDER
APRIL 25, 2000
ROBERT W. SMITH AND
STATE FARM FIRE & CASUALTY INSURANCE COMPANY
FROM THE VIRGINIA WORKERS' COMPENSATION COMMISSION
John G. Berry (Berry & Early, on brief), for
appellant.
Kathryn Spruill Lingle (Brenner, Dohnal,
Evans & Yoffy, P.C., on brief), for
appellees.
Robert Walter Smith (claimant) appeals from a decision of
the Workers' Compensation Commission denying his request for
temporary disability benefits following an injury by accident on
April 12, 1997, while he was employed by Robert W. Smith, a sole
proprietorship, which received workers' compensation insurance
coverage through State Farm Fire & Casualty Insurance Company
(hereinafter collectively "employer"). On appeal, claimant
contends the commission erroneously determined that he suffered
no loss of earning capacity even though he was both totally and
partially disabled for various portions of 1997 as a result of
the injuries he sustained in the accident. Given the
uncontradicted evidence that claimant was disabled and unable to
earn his full hourly wage for a portion of 1997, although he
continued to receive "draws" of profit from the business, we
hold the commission erred in relying solely on the fact that the
net profit figure claimant reported to the Internal Revenue
Service for all of 1997 was greater than the figure he reported
in 1996. We also hold that, to the extent the commission
included business profits rather than wages or their equivalent
in its calculation of claimant's pre- or post-injury wage, the
commission erred. Therefore, we reverse the commission's
decision, vacate its denial of benefits and remand for further
proceedings consistent with this opinion.
I.
FACTS
Claimant, a self-employed construction contractor, operated
a sole proprietorship with five employees. As permitted by Code
§ 65.2-101, claimant elected to be covered as an employee under
the Workers' Compensation Act. 1 While working for the sole
proprietorship on April 12, 1997, appellant was injured in a
fall from a balcony. He claimed temporary total disability from
April 12 through June 26, 1997, and temporary partial disability
1
Code § 65.2-101 provides that the definition of an
employee under the Act includes "[a]ny sole proprietor . . .
electing to be included as an employee under the workers'
compensation coverage of such business if the insurer is
notified of this election. Any sole proprietor . . . shall,
upon such election, be entitled to employee benefits and be
subject to employee responsibilities prescribed in this title."
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from July 3 through November 6, 1997. Employer accepted the
injury as compensable but refused to pay temporary disability
benefits on the ground that claimant suffered no wage loss.
Claimant's evidence indicated that immediately prior to the
accident, claimant was working on two "time, materials plus
commission" jobs, which meant he earned income from the business
in two ways. He worked an average of over forty hours per week
and was paid at the rate of $25 per hour for an average total of
$1,000 per week. He also received a fifteen percent commission
on all materials and labor, including his own, charged on the
particular job. After the accident, two of his employees, his
brothers, managed the business while he was unable to work. The
business continued to make money, and claimant continued to
receive a draw from the business during this time.
Claimant and his wife, the business's bookkeeper, offered
testimony about claimant's Exhibit 8, which showed the money
claimant received from the business during the periods of his
total and partial disability. Claimant's Exhibit 8 reflects
that claimant received draws totaling an average of $1,563.02
per week during the eleven weeks for which he sought temporary
total disability. Claimant testified that his draws during that
period were "from my workers working on the job that I had
going," and wife testified that these funds were from
commissions for prior and current jobs. She said they needed
"the draws to live on," but also testified that claimant would
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have received his wages in addition to the commissions if he had
been able to work during that period.
Exhibit 8 reflects draws totaling an average of $1,691.30
per week during the approximately eighteen weeks for which
claimant sought temporary partial disability. Wife testified
that these sums included both commission and income from wages
because claimant was able to work part-time. Claimant's
evidence showed the number of hours he worked during each of
those weeks.
Claimant's 1996 federal income tax return reflected a net
profit of $76,915. Claimant's 1997 federal income tax return
reflected a net profit of $77,915. Claimant and his wife, the
business's bookkeeper, testified that the business paid $30,000
worth of expenses on December 30, 1996, that were not actually
due until January 25, 1997, in order to gain a tax advantage as
against profits from "a big job" on which "[claimant] had made
right much money" in 1996. Had they paid the expenses when due,
they contended the business's income would have been $30,000
higher in 1996 and $30,000 lower in 1997 and that these figures
would more accurately have reflected claimant's wage loss in
1997.
Claimant's wife also testified that she and claimant
prepared their income tax returns based on the cash method of
accounting but that "the accrual method is much more accurate on
what a business does." She testified that she kept the
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business's books using the accrual method, and she prepared
annual profit and loss statements for the business under the
accrual method showing net income of $150,000 for 1996, $26,000
for 1997, and $137,000 for 1998. All funds claimant received
from the business both before and after the accident were listed
on the profit and loss statements as "Owners Draw."
Relying on the evidence of the net business profit reported
to the Internal Revenue Service in 1996 and 1997, the commission
held claimant failed to establish an economic loss and,
therefore, was not entitled to wage loss benefits. The
commission noted that, because the business was a sole
proprietorship rather than a corporation, the profitability of
the business "directly correspond[ed] to the claimant’s economic
situation." It also held that the manner of allocating the
$30,000 in expenses was not determinative under this reasoning,
and it made no finding on this issue.
II.
ANALYSIS
Claimant contends the commission erroneously compared the
income figures he reported to the Internal Revenue Service (IRS)
in 1996 to those he reported in 1997 and refused to consider
undisputed testimony regarding his inability to earn the full
hourly wage component of his pre-injury income for a period of
approximately twenty-nine weeks. He argues that the
commission's use of his annual income reported to the IRS
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deprived him of his entitlement to the benefit of the financial
success of the business during the periods of 1997 when he was
not disabled. 2 We agree that the commission erroneously
calculated claimant's wage loss.
Under settled principles, a workers' compensation claimant
seeking disability benefits must establish each element of his
claim by a preponderance of the evidence. See Sentara Leigh
Hosp. v. Nichols, 13 Va. App. 630, 638, 414 S.E.2d 426, 430
(1992) (en banc); Terry-Kirby v. Horton-Adamson Plastic
Surgeons, No. 174-52-16, 1996 WL 1075792, **2 (Va. Workers'
Comp. Comm'n May 16, 1996).
It [is] the duty of the Commission to make
the best possible estimate of future
impairments of earnings from the evidence
adduced at the hearing, and to determine the
average weekly wage . . . . This is a
question of fact to be determined by the
Commission which, if based on credible
evidence, will not be disturbed on appeal.
Pilot Freight Carriers, Inc. v. Reeves, 1 Va. App. 435, 441, 339
S.E.2d 570, 573 (1986).
"The commission is guided by statute in determining average
weekly wage." Dominion Assocs. Group, Inc. v. Queen, 17 Va.
2
Claimant also contends the commission erroneously failed
to acknowledge evidence that the 1996 and 1997 taxable income
reported to the IRS was skewed because of a payment made
December 30, 1996, that was not due until January 25, 1997. The
commission found that resolution of this factual issue was not
relevant to its determination. Because we reverse and remand on
other grounds, we find it unnecessary to reach this issue.
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App. 764, 766, 441 S.E.2d 45, 46 (1994). Code § 65.2-101
defines "average weekly wage" as follows:
1.a. The earnings of the injured
employee in the employment in which he was
working at the time of the injury during the
period of fifty-two weeks immediately
preceding the date of the injury, divided by
fifty-two . . . . When the employment prior
to the injury extended over a period of less
than fifty-two weeks, the method of dividing
the earnings during that period by the
number of weeks and parts thereof during
which the employee earned wages shall be
followed, provided that results fair and
just to both parties will be thereby
obtained. . . .
b. When for exceptional reasons the
foregoing would be unfair either to the
employer or employee, such other method of
computing average weekly wages may be
resorted to as will most nearly approximate
the amount which the injured employee would
be earning were it not for the injury.
"The reason for calculating the average weekly wage is to
approximate the economic loss suffered by an employee . . . when
there is a loss of earning capacity because of work-related
injury." Bosworth v. 7-Up Distrib. Co., 4 Va. App. 161, 163,
355 S.E.2d 339, 340 (1987). Benefits are for loss of earning
power and are "not necessarily proportional to the bodily
functional disability." J.A. Foust Coal Co. v. Messer, 195 Va.
762, 765-66, 80 S.E.2d 533, 535 (1954) (decided under former
Code §§ 65-51 and 65-52). If the claimant suffers a disability
as a result of the injury, the commission must compare the
claimant's pre-injury average weekly wage to the wage he is able
to earn after the injury to determine whether he is entitled to
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total or partial disability benefits and, if so, at what rate.
See Code §§ 65.1-500, 65.2-502.
Here, claimant's injury occurred on April 12, 1997. The
commission did not expressly calculate his pre- or post-injury
average weekly wage. It relied solely on the fact that claimant
experienced no decrease in annual net profit in 1997 compared to
1996, as reported to the IRS on claimant's federal income tax
returns. Citing Meredith Construction Co. v. Holcombe, 21 Va.
App. 537, 466 S.E.2d 108 (1996), the commission held that
"[b]ecause the claimant was a sole proprietor, this change in
net profit inures directly to his benefit, and provides an
effective gauge for measuring economic impairment." Based on
Holcombe, the commission concluded that "claimant has
established no economic loss that would entitle him to wage loss
benefits."
We agree with the commission's observation that the net
profit earned by claimant's sole proprietorship inured directly
to his benefit. However, we hold the commission's denial of
benefits was erroneous for two reasons.
First, we agree with claimant's assertion that Holcombe
neither requires nor supports the income comparison method
applied by the commission in this case. Because claimant's
injury occurred April 12, 1997, the commission erred in
comparing claimant's business income for 1996 to the business
income for 1997 to conclude that claimant sustained no economic
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loss. Rather, the commission should have compared claimant's
pre-injury average weekly wage, or a comparable calculation as
permitted under Code § 65.2-101, with what he earned or had the
ability to earn during the period of his physical disability
from April 12 through November 6, 1997, or held that it lacked
sufficient credible evidence to make such a comparison.
Holcombe does not support the result reached by the
commission. In Holcombe, the claimant had an ongoing partial
physical disability for which he had been receiving partial
disability compensation. See Holcombe v. Meredith Constr. Co.,
No. 130-27-60, 1994 WL 1040028, *1 (Va. Workers' Comp. Comm'n
Dec. 13, 1994). Several years after his injury, Holcombe began
operating a sole proprietorship. See id. When his former
employer learned of this fact several months later, it sought a
re-calculation of Holcombe's ongoing partial wage loss, if any,
based on his self-employment income. See id. The commission
ruled as follows:
[Holcombe's] earnings should be determined
on a quarterly basis from the time he
commenced operation[] [of the sole
proprietorship]. The average weekly wage
should be based on the net taxable income
reported by the business for federal income
tax purposes. This figure will, of course,
include all allowable expenses, including,
but not limited to, depreciation and
interest. Inasmuch as this is a sole
proprietorship, any draws or salary paid to,
or on behalf of, [Holcombe] from the
business is included as taxable income.
Upon determination of [Holcombe's] net
taxable income for each quarter, that number
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should be divided by the appropriate number
of weeks in that quarter. . . . [Holcombe's]
net taxable income can be calculated at the
end of each quarter. In this regard he
should make available to the employer . . .
all books and records of the sole
proprietorship so that income and expenses
may be verified.
Id.
The employer appealed, claiming the commission's deduction
for depreciation was erroneous. See Holcombe, 21 Va. App. at
538, 466 S.E.2d at 109. Focusing on the propriety of the
depreciation deduction under the facts of that case, we affirmed
the commission's decision to base the average weekly wage
calculation on Holcombe's net taxable income. See id. at
540-42, 466 S.E.2d at 110-11. We also approved of the
commission’s order requiring Holcombe to make available to the
employer his books and records, which would allow the employer
to be sure that the claimed depreciation "is 'an actual business
expense.'" Id. at 541-42, 466 S.E.2d at 111 (citing Semones v.
New Jersey Zinc Co., 68 O.I.C. 1 (1989)).
Holcombe stands for the proposition that net taxable income
may be an appropriate method for determining the income of a
sole proprietor because it takes into consideration depreciation
and other allowable expenses. However, Holcombe does not
require that only this method may be used. See 21 Va. App. at
541, 466 S.E.2d at 110-11 (implicitly approving commission's
method of calculating average weekly wage in Jett v. Jett, No.
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154-35-14 (Va. Workers' Comp. Comm'n Jan. 19, 1994), which did
not include depreciation, because commission believed alternate
method to be more accurate). Further, Holcombe's partial
physical disability was ongoing, and the commission calculated
his post-injury income based on the net taxable business income
he earned quarterly. Here, by contrast, claimant alleged he was
totally disabled for about eleven weeks and partially disabled
for about eighteen weeks. Therefore, the relevant income was
his income during those specific periods of claimed disability,
not during the entire 1997 tax year, unless some reason for
using a different period was established. Cf. Allegheny
Airlines, Inc. v. Merillat, 14 Va. App. 341, 345, 416 S.E.2d
467, 470 (1992) (where evidence established claimant's total
disability for fraction of week, fact that claimant's average
weekly wage for portion of week she was able to work was higher
than pre-injury average weekly wage did not preclude finding of
wage loss "calculated as an appropriate fraction of the weekly
compensation rate").
Here, although claimant was injured on April 12, 1997, and
was disabled for only a portion of 1997, the commission compared
his net business income for that entire year with his net
business income for the previous tax year. We hold that the
commission erred because it failed to consider claimant's wages
during the period of disability and may unfairly have attributed
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to the period of disability income received in 1997 before or
after the period of disability.
We also hold that the commission erred to the extent that
it may have included business profits rather than wages or their
equivalent in its calculation of claimant's pre- or post-injury
wage. The propriety of including all net income of a sole
proprietorship in the average weekly wage calculation, without
differentiating between wages and profits, is a question of
first impression in Virginia. We were not faced with this issue
in Holcombe, in which we considered only whether the commission
erred in allowing the deduction of depreciation expenses from
the gross income of a sole proprietor.
"'The general rule is that profits derived from a business
are not to be considered as earnings and cannot be accepted as a
measure of loss of earning power unless they are almost entirely
the direct result of [the claimant's] personal management and
endeavor.'" The Washington Post v. District of Columbia Dep't
of Employee Servs., 675 A.2d 37, 42 (D.C. 1996) (quoting Clingan
v. Fairchance Lumber Co., 71 A.2d 839, 840 (Pa. Super. Ct.
1950)); cf. Twenty-First Century Concrete, Inc. v. Giacchina, 20
Va. App. 326, 457 S.E.2d 379 (1995) (holding that claimant was
not required to show monetary loss to claimant's corporations in
order to receive wage loss benefits where claimant was unable to
perform his duties and had to reassign other employees to
complete his duties, even though he had authority to draw wages
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from the corporation due to his ownership interest). "[T]he
conduct of a sole proprietorship [may be scrutinized] to
determine if the profits are the functional equivalent of
wages." Hotaling v. St. Johnsbury Trucking Co., 572 A.2d 1351,
1354 (Vt. 1990) (citing 2 Arthur Larson, Larson's Workers'
Compensation Law § 60.12(e)); see The Washington Post, 675 A.2d
at 42; cf. Pishotta v. Pishotta Tile & Marble, Inc., 613 So. 2d
1373, 1375-76 (Fla. Ct. App. 1993) (holding that corporate
profits may be considered personal earnings of sole shareholder
to extent they are fairly attributable to management and/or
labor of sole shareholder rather than labor of others or mere
return on capital).
New York courts hold that "'where a self-employe[d]
claimant performs primarily a supervisory function,'" the
resulting income may be classified as profit from investment
rather than wages for purposes of calculating average weekly
wage. Joyce v. European Auto Serv., 641 N.Y.S.2d 175, 176 (N.Y.
App. Div. 1996) (quoting Cozzi v. Christensen & Nielson, 367
N.Y.S.2d 134, 136 (N.Y. App. Div. 1975)). Where a claimant was
the owner and sole shareholder of a subchapter S corporation but
also performed a considerable amount of work as a mechanic and
received a "regular weekly 'draw' of $500" as well as a separate
"profit-sharing distribution," a New York appellate court upheld
the workers' compensation board's determination that his average
weekly wage included only the $500 he earned from his work as a
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mechanic. See id. at 175-76. The court concluded this was a
factual finding dependent on whether the funds were profits or
earnings. See id.
An Illinois appellate court also has held that the profit
component of a claimant's receipts from the S corporation of
which he was the sole shareholder should not be included in his
average weekly wage. See Paoletti v. Village of Winnetka, 665
N.E.2d 507, 511-12 (Ill. Ct. App. 1996). The applicable
Illinois statute defined "average weekly wage" as "actual
earnings" or "salary, wages or earnings." See Paoletti, 665
N.E.2d at 511-12. Claimant Paoletti had operated a landscaping
business for which he performed both administrative work and
manual labor but received only net profits and no sums
denominated as wages or salary. See id. at 512. In holding
that claimant's business profits should not be included in the
calculation of his average weekly wage, the court noted that it
"would be legislating from the bench if [it] were to hold that
'actual earnings' should be construed to include net profit."
Id. It noted, however, that the claimant may have been entitled
to inclusion of a wage component from his landscaping business
if he had provided evidence of the wage that would have been
earned by another employee performing similar duties. See id.
(citing P & L Constr. Co. v. Lankford, 559 S.W.2d 793, 795
(Tenn. 1978)); see also Oberley v. Oberley Eng'g, Inc., 940
S.W.2d 953, 956 n.3 (Mo. Ct. App. 1997) (citing Mo. Rev. Stat.
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§ 287.250.1(6), which provides that "[i]f the hourly wage has
not been fixed or cannot be ascertained, or the employee earned
no wage, the wage for the purpose of calculating compensation
shall be taken to be the usual wage for similar services where
such services are rendered by paid employees of the employer or
any other employer").
A Louisiana appellate court made a similar distinction in
a case involving a sole proprietorship, holding that profits
earned after the claimant's injury and during a period of total
disability resulted from claimant's wife's efforts and a "return
on the investment" the couple made in the business and could not
be used to determine claimant's post-injury earning capacity.
See Clark v. Bobby L. Clark Trucking, 679 So. 2d 157, 161-62
(La. Ct. App. 1996).
Although Clark involved a sole proprietorship whereas Joyce
and Paoletti involved subchapter S corporations, we hold that
the principles applicable to wholly-owned subchapter S
corporations are equally applicable in cases involving sole
proprietorships. 3 Virginia's Workers' Compensation Act, like
Illinois', see Paoletti, 665 N.E.2d at 511-12, defines wages as
"earnings." See Code § 65.2-101. We hold this definition does
not include profits. But see Oberley, 940 S.W.2d at 957
3
Both a sole proprietor and the sole shareholder of a
subchapter S corporation must pay income taxes on the business's
earnings. See Oberley, 940 S.W.2d at 954.
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(holding that where subchapter S corporation's revenue was
generated from professional accounting services of its sole
shareholder or from personal services performed under him, funds
generated by the business which shareholder withdrew to pay
personal expenses, although not denominated "wages" for purposes
of bookkeeping, could be considered wages for purposes of
calculating pre-injury wage); Thompson v. Harold Thompson
Trucking, 748 P.2d 430, 437-38 (Kan. Ct. App. 1987) (under
statute defining wage as "the total of the money and any
additional compensation . . . for services rendered," holding
that where sole proprietor did not receive a salary, his owner
withdrawals for payment of personal expenses for himself and
wife, the business's bookkeeper, could be used to calculate his
pre-injury average weekly wage); LaFleur v. Hartford Ins. Co.,
449 So. 2d 725, 729 (La. Ct. App. 1984) (in calculating
post-injury wage for claimant who became sole proprietor
following injury while working for employer, holding that
"profits should be treated the same as wages"). Whether a sole
proprietor's business income comprises mainly wages, mainly
profits, or a combination of the two depends on application of
the above principles to the facts of the case. 4
4
We note these principles do not uniformly favor claimants
over employers or vice-versa. Compare Paoletti, 665 N.E.2d at
511-12 (rejecting request of claimant to include profits in
pre-injury average weekly wage calculation, thus lowering wage
loss), with Clark, 679 So. 2d at 161-62 (in calculating
claimant's post-injury earning capacity during period of claimed
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For these reasons, we hold that the commission erred when
it concluded that claimant suffered no economic loss solely
because his taxable business income was higher in 1997 than in
1996. We also hold that, to the extent the commission included
business profits rather than wages or their equivalent in its
calculation of claimant's pre- or post-injury wage, the
commission erred. Therefore, we reverse the commission's
decision, vacate its denial of benefits and remand for further
proceedings consistent with this opinion.
Reversed, vacated and remanded.
total disability, classifying draws claimant received from sole
proprietorship during that disability as profits or return on
investment rather than wages illustrative of post-injury earning
capacity).
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