T.C. Memo. 2000-344
UNITED STATES TAX COURT
RICHARD D. ANDERSON AND MARY L. ANDERSON, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 13327-97. Filed November 8, 2000.
Robert H. Hishon, for petitioners.
Roslyn D. Grand, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
GERBER, Judge: Respondent determined income tax
deficiencies of $30,747 and $18,940 for petitioners’ 1993 and
1994 tax years, respectively. The issue for our consideration is
whether amounts received by petitioners in connection with an
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action for tortious interference with business relations are
excludable from petitioners’ income under section 104(a)(2).1
FINDINGS OF FACT2
Petitioners resided in Chamblee, Georgia, when their
petition was filed. Richard D. Anderson was a director,
officer, shareholder, and employee of ARRE Industries, Inc.,
d/b/a Carrera Shocks (Carrera). Mary Anderson was an officer
and employee of ARRE Industries, Inc.
Carrera Shocks
In 1964, Mr. Anderson started a highly specialized business
to research, develop, and manufacture high performance
suspension component parts for race cars. In particular, he
designed shock absorbers. Mr. Anderson held three patents
related to shock absorbers. Carrera’s main customers were
distributors of racing equipment who in turn would sell the
shock absorbers to auto racing teams. Mr. Anderson’s
familiarity with auto racing permitted him access to the pit
crews and provided him with the opportunity to perform
consultations regarding the most efficient use of Carrera shock
absorbers. While attending approximately 100 races per year
1
All section references are to the Internal Revenue Code in
effect for the years in issue, and all Rule references are to the
Tax Court Rules of Practice and Procedure, unless otherwise
indicated.
2
The stipulation of facts and the attached exhibits are
incorporated herein by this reference.
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over a period of 16 years, petitioner developed a good working
rapport with various race teams. Mr. Anderson used his
accumulated knowledge of shock absorbers as a marketing tool to
curry favor with race teams by providing his consulting
services free of charge. The main thrust of Carrera’s business
was the sale of shock absorbers.
Carrera Employees
In the late 1970's Mr. Anderson hired George Gillespie
(Gillespie) to head Carrera’s technical department as its
director of racing. Gillespie worked first as Mr. Anderson’s
consulting assistant and then as Carrera’s primary racing
consultant.
Timothy Whitehead (Whitehead) began working for Carrera
shortly after Gillespie was hired. Whitehead was responsible
for all of Carrera’s administrative functions, including
accounts payable, accounts receivable, and payroll operations.
Both Whitehead and Gillespie had worked for Carrera for more
than 3 years when Mr. Anderson learned of their plans to leave
Carrera. It was not until after they left Carrera that Mr.
Anderson became aware of the damage Whitehead and Gillespie had
done to his business. In December 1982, while still working
for Carrera, Whitehead and Gillespie conspired to enter into
business for themselves. Using information they acquired while
working for Carrera, Gillespie and Whitehead designed a shock
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absorber for use in the auto racing industry. On January 10,
1983, they formed Pro-Formance, Inc., (Pro-Formance).
Seeking to obtain their own share of the racing market,
Whitehead and Gillespie contacted Carrera’s customers,
suppliers, manufacturers, and company-sponsored race teams.
They used Carrera’s mailing list to solicit and obtain
financing from Carrera’s key customers and manufacturers. They
misled Carrera-sponsored race teams by telling them that
Carrera would no longer offer shock absorbers free of charge
for sponsorship purposes. On at least one occasion, Gillespie
falsely conveyed the idea that Carrera had discontinued
manufacturing the type of shock absorber which had given
Carrera its renown. Whitehead made false statements regarding
Mr. Anderson’s handling of Carrera’s finances. He told
Carrera’s creditors that Mr. Anderson was doctoring the
company’s accounts receivable in order to increase Carrera’s
line of credit. On other occasions Whitehead and Gillespie
told Carrera customers that Mr. Anderson was apathetic towards
the company’s future as a going concern, that he was unwilling
to provide Carrera’s customers with the same personal service
as he had in the past, and that he was embezzling money from an
industry trade show.
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The Lawsuit
On December 15, 1983, Carrera, through Mr. Anderson, filed
a complaint against Pro-Formance; Whitehead; and Gillespie
(defendants) in the Superior Court of Dekalb County, Georgia.
In the complaint, Carrera alleged tortious interference with
business relations, breach of a fiduciary duty, and defamation.
The defendants answered, counterclaimed, and interpleaded the
Andersons in their individual capacity.
The Andersons answered and counterclaimed alleging two
separate counterclaims against the defendants: (1) That
defendants caused “injury to * * * [Mr. Anderson’s] economic
well-being, peace of mind and business reputation”, and (2)
that defendants caused “great injury to * * * [Mr. Anderson’s]
peace, happiness and feelings.” Pursuant to a consolidated
pretrial order, which was drafted by Mr. Anderson’s attorney,
the court issued verdict pro forma to the jury as follows: “As
to count 1 of Richard D. Anderson’s counterclaim against Pro-
Formance Shocks, Inc., Timothy M. Whitehead and George T.
Gillespie for alleged intentional injury as a result of alleged
tortious interference with plaintiff’s business relationships,
we the jury find”; and “As to count 2 of Richard D. Anderson’s
counterclaim against Pro-Formance Shocks, Inc., Timothy M.
Whitehead and George T. Gillespie for alleged slander, we the
jury find”.
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On April 8, 1988, the jury returned verdicts in favor of
Mr. Anderson, awarding him $2.5 million for tortious
interference with business relationships, to be paid equally by
the defendants, and $1 for slander. In addition, the jury
returned a favorable verdict for Carrera on all three of its
claims in the original lawsuit. The jury awarded $3.7 million
to Carrera for tortious interference with its business
relationships and $1 for slander, to be paid equally by the
defendants, and $100,000 for breach of a fiduciary duty, to be
paid in equal shares by Whitehead and Gillespie. A judgment
was entered to reflect the foregoing.
The defendants moved for a judgment notwithstanding the
verdict or in the alternative for a new trial. The court
granted the defendants’ motion for new trial as to damages
only. Ultimately, by means of a stipulation and consent order,
the court reduced the award for Mr. Anderson’s claim for
interference with his business relationships from $2.5 million
to $210,000, to be paid in equal shares by each defendant. The
court did not disturb Mr. Anderson’s $1 award for slander. In
addition, the court reduced the amount awarded for Carrera’s
claim for tortious interference with business relationships
from $3.7 million to $300,000, but it did not disturb Carrera’s
awards for breach of a fiduciary duty or for slander.
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The defendants were unable to pay the judgment and
separately filed voluntary petitions for bankruptcy under
Chapter 11 of the U.S. Bankruptcy Code. On July 12, 1989, the
parties, after considering the bankruptcies and the financial
condition of the defendants, entered into a settlement
agreement under which Carrera received a lump sum payment of
$331,250. Also, defendants issued a promissory note to Mr.
Anderson and Carrera in the amount of $325,000 to be paid over
5 years along with 10.75-percent interest. As part of the
settlement agreement Mr. Anderson and Carrera were to be paid
periodically over 60 months with a stipulation that Carrera
would receive payments until its proportionate share of the
damages, as determined by the original verdict, was satisfied
in full.
During the 1993 tax year petitioners received monthly
payments totaling $74,857. Petitioners did not include the
payments in their 1993 income tax; however, they submitted a
disclosure statement maintaining that the amount received was
on account of personal injuries and therefore excludable under
section 104(a)(2).
During the 1994 tax year petitioners received monthly
payments totaling $47,464. Petitioners did not include the
payments in their 1994 income tax; however, they submitted a
disclosure statement maintaining that the amount received was
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on account of personal injuries and therefore excludable under
section 104(a)(2).
On April 10, 1997, respondent mailed petitioners a
statutory notice of deficiency, determining that the payments
were includable in income for the respective tax years.
OPINION
The issue for our consideration in this case requires an
analysis of whether the payments received fit within the
statutory exclusion provided for in section 104(a)(2). Except
as otherwise specifically provided, gross income includes a
taxpayer’s income from whatever source derived. See sec.
61(a); see also Commissioner v. Glenshaw Glass Co., 348 U.S.
426 (1955). Section 61(a) is broadly construed, whereas
specific exclusions from gross income must be narrowly
construed. See Commissioner v. Schleier, 515 U.S. 323, 327-328
(1995). For 1993 and 1994, section 104(a)(2) specifically
excluded from gross income “the amount of any damages received
(whether by suit or agreement and whether as lump sums or as
periodic payments) on account of personal injuries or
sickness”. Section 1.104-1(c), Income Tax Regs., provides
that “damages received” is an amount received (other than
workmen’s compensation) through prosecution of an action based
upon tort or tort-type rights.
The Supreme Court has held that taxpayers may exclude
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damages received if the underlying cause of action giving rise
to the recovery is based upon tort or tort type rights and the
damages are received on account of personal injuries or
sickness. See Commissioner v. Schleier, supra at 336-337.
Respondent concedes that Mr. Anderson’s claims sounded in tort,
thus satisfying the first prong of the Schleier test.
Therefore, we focus on the second prong of the test, which
requires petitioners to show that the damages received were on
account of personal injuries or sickness.
When damages are received pursuant to a suit or settlement
agreement, the nature of the underlying claim determines
whether such damages are excludable under section 104(a)(2).
See United States v. Burke, 504 U.S. 229, 239 (1992); see also
Metzger v. Commissioner, 88 T.C. 834, 847 (1987). For the
taxable years under consideration, personal injuries included
both physical and nonphysical injuries. See Commissioner v.
Schleier, supra at 329 n.4.
Petitioners argue that the damages they received for
tortious interference with business relationships were on
account of an injury to Mr. Anderson’s business reputation, a
personal injury, and, therefore, are excludable under section
104(a)(2).
The law is well settled that the tax consequences of an
award for damages depend upon the nature of the litigation and
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on the origin and character of the claims adjudicated, and not
upon the validity of those claims. See Bent v. Commissioner,
87 T.C. 236 (1986), affd. 835 F.2d 67 (3d Cir. 1987); 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). In this case, most of the amounts
petitioners received was for tortious interference with Mr.
Anderson’s business relationships and only a nominal amount was
received for slander. Both of Mr. Anderson’s claims of action
existed under Georgia law.
In Georgia, tortious interference with business
relationships requires the plaintiff to show that the
defendant: (1) Acted improperly and without privilege, (2)
acted purposely and with malice with intent to injure, (3)
induced a third party or parties not to enter into or continue
a business relationship with the plaintiff, and (4) caused the
plaintiff financial injury. See Renden, Inc. v. Liberty Real
Estate, Ltd., 444 S.E.2d 814 (Ga. Ct. App. 1994).
Respondent determined that the damages received by Mr.
Anderson for interference with his business relationships were
awarded on account of economic injuries, rather than personal
injuries. Supporting respondent’s determination, under Georgia
law a person’s business is property in the pursuit of which he
is entitled to protection. See NAACP v. Overstreet, 142 S.E.2d
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816 (Ga. 1965). Tortious interference with business relations
involves interference with the plaintiff’s current and future
property rights derived from current or potential customers.
See id. at 823; see also Renden, Inc. v. Liberty Real Estate,
Ltd., supra at 817. Petitioners have not shown that the
damages received were for personal injury under Georgia law.
Damages received in a tort action may be excluded from income
only when received on account of personal injury; therefore,
petitioners’ damages received for tortious interference with
business relationships must be included in income. Even if the
holding in NAACP v. Overstreet, supra, was not intended to
limit tortious interference with business relationships to a
property tort, petitioners have still failed to prove that they
received damages on account of personal injury. Accordingly,
we sustain respondent’s determination on this issue.
Petitioners argue that the personal injury to Mr.
Anderson’s business reputation constituted the requisite
“improper means” element of the tortious interference claim.
Georgia courts have held that in order to satisfy all the
elements in a claim for tortious interference with business
relationships, there must be a finding that the defendant used
improper means. See Contractors’ Bldg. Supply, Inc. v.
Gwinnett, 403 S.E.2d 844 (Ga. Ct. App. 1991). “Improper means”
may be shown in several ways including: Fraud,
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misrepresentation, breach of a fiduciary duty, unauthorized use
of confidential information, defamation, and unwarranted
criminal prosecutions. See id. at 846; see also American Bldg.
Co. v. Pascoe Bldg. Sys., Inc., 392 S.E.2d 860 (Ga. Ct. App.
1990); Architectural Manufacturing Co. of Am. v. Airotec, Inc.,
166 S.E.2d 744 (Ga. Ct. App. 1969) (misrepresentations as to a
company’s financial solvency are improper means and may
constitute an element of tortious interference). Petitioners
would have us assume that out of the evidence submitted to the
jury the only “improper means” employed by the defendants, and
established at trial, was conduct that injured Mr. Anderson’s
business reputation. However, the facts in this case do not
permit us to make such an assumption.
Although the statements by the defendants may have been
slanderous and damaging to Mr. Anderson’s business reputation,
they constituted but one of several sources from which the jury
could have decided the existence of tortious interference with
business relationships. At trial, Mr. Anderson introduced
copious amounts of evidence in the form of customer lists,
invoices, profit/loss statements, tax returns, and witness
testimony to show how the defendants’ improper conduct
contributed to his loss of business and loss of profits. The
jury could have concluded from the evidence that the
defendants: (1) Perpetrated the unauthorized use of Carrera’s
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customer mailing list, (2) engaged Carrera’s employees to
entice them into employment with Pro-Formance, (3) engaged
Carrera’s suppliers for the purpose of manufacturing a
competing product, (4) breached fiduciary duties owed to
petitioner and Carrera, or (5) defamed Mr. Anderson and Carrera
injuring their respective reputations. Petitioners have failed
to show which of these improper acts was considered by the jury
to convince it to reach a verdict for Mr. Anderson.3
Where the award for damages is rendered by a jury verdict
and judgment, and has been clearly allocated to an identifiable
claim, we are guided by the nature of the claim as identified
under State law personal injury concepts. See Threlkeld v.
Commissioner, 87 T.C. 1294, 1305-1306 (1986), affd. 848 F.2d 81
(6th Cir. 1988). We find it most telling that the vast
majority of the jury award was for interference with business
relationships and only $1 was for slander. Petitioners also
argue that their damages were received pursuant to a settlement
agreement and are, therefore, entitled to an alternative
allocation. The facts do not comport with such a finding.
3
Petitioners have offered Fabry v. Commissioner, 223 F.3d
1261 (11th Cir. 2000), revg. 111 T.C. 305 (1998), for the
proposition that injury to business reputation is a personal
injury under sec. 104(a)(2). However, as discussed above,
petitioners have failed to show that Mr. Anderson’s damages
received were on account of a personal injury. Instead, the jury
decided that the vast majority of Mr. Anderson’s injuries
occurred to his property and his property rights associated with
Carrera.
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We cannot accept an allocation based on a settlement
agreement which merely facilitated payment in the face of the
judgment debtor’s bankruptcy. The settlement agreement reduced
the monetary amount of the award, but it did not contain any
language that would establish an allocation contrary to the
jury verdicts or the judgments entered. We note that, in this
case, the jury verdict forms were drafted at the close of trial
and the language used in the verdict forms came from a pretrial
order that was used as a blueprint for the trial. The record
reflects that the jury delivered its verdict using language
that was identical to language in the pretrial order that was
drafted by Mr. Anderson’s attorney. Mr. Anderson was,
therefore, cognizant of and responsible for the formulation of
the claims as they were presented to the jury.
The vast majority of Mr. Anderson’s award for damages was
received for interference with his business relationships and
not for slander. The jury awarded Mr. Anderson $2.5 million
(later reduced to $210,000) for the injuries claimed in count
one for tortious interference with business relationships, but
it awarded only $1 for the injuries claimed in count two for
slander. For the foregoing reasons the award must be allocated
as it was clearly established at trial.
In sum, petitioners have failed to show that the
compensatory damages awarded on Mr. Anderson’s claim for
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tortious interference with business relationships were received
on account of personal injuries within the meaning of section
104(a)(2). Although the facts reflect that the defendants’
conduct may have damaged Mr. Anderson’s business reputation,
the vast majority of the recovery was for property damages
caused by interference with Mr. Anderson’s business
relationships. In Commissioner v. Schleier, 515 U.S. 323
(1995), the Supreme Court cautioned that there must be a direct
link between the cause of harm and its effect for the section
104(a)(2) exclusion to apply. Petitioners have failed to show
such a link between an injury to Mr. Anderson’s business
reputation caused by the defendants’ actions and the economic
loss for which Mr. Anderson recovered. Therefore, petitioners
have failed the second prong of the Schleier test with regard
to the damages received under Mr. Anderson’s claim for tortious
interference with business relationships. Accordingly we
sustain respondent’s determination on this issue.
We must now examine the second claim for which petitioners
received damages. In Mr. Anderson’s second claim, he alleged
that the defendants “intentionally, willfully, and maliciously”
acted to cause injury to petitioner’s ”peace, happiness, and
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feelings.” The pretrial order and the jury verdict forms both
denominated this claim as slander.
Respondent concedes that the damages awarded for slander
constitute an award received for personal injury under section
104(a)(2). Therefore, the $1 in damages petitioners received
for slander is excludable in accord with section 104(a)(2).
Petitioner has raised other arguments that we have
considered in reaching our decision. To the extent that we
have not discussed these arguments, we conclude they are
without merit.
To reflect the foregoing,
Decision will be entered
under Rule 155.