dissenting: The majority opinion reaffirms the expansive view of section 104(a)(2) which was advanced in Miller v. Commissioner, 93 T.C. 330 (1989), revd. 914 F.2d 586 (4th Cir. 1990). In that case, the majority permitted a taxpayer to exclude from gross income the full amount received in settlement of two defamation actions, in which the taxpayer had sought both compensatory and punitive damages, without considering the nature of the taxpayer’s claims for punitive damages under Maryland law.
In this case, the majority permits petitioners to exclude from gross income an amount awarded by the jury as punitive damages without considering the nature of punitive damages under Kentucky law. In the State court action underlying this case, petitioners sued the local gas company for both personal injuries and property damage after their home was destroyed by an explosion of natural gas, which had leaked into the house from a break in the line. In addition to punitive damages of $500,000, the jury awarded aggregate compensatory damages for personal injuries in the amount of $41,552, and aggregate compensatory damages for property damage in the amount of $62,000.
I dissent here, as I did in Miller, because, in my view, the amount awarded to petitioners as punitive damages does not constitute an amount received “on account of personal injuries or sickness” within the meaning of section 104(a)(2). Under general tort law principles and Kentucky law, the subject punitive damages were awarded “on account of” the gross negligence of the gas company, rather than on account of the personal injuries or the property damage which petitioners sustained.
Under general tort law principles,
Punitive damages “are not compensation for injury. Instead, they are private fines levied by civil juries to punish reprehensible conduct and to deter its future occurrence.” * * * [International Brotherhood of Electrical Workers v. Foust, 442 U.S. 42, 48 (1979) (quoting Gertz v. Robert Welch, Inc., 418 U.S. 323, 350 (1974)); fn. ref. omitted.]
See also Molzof v. United States, 502 U.S. _, 112 S. Ct. 711, 715 (1992).
The same is true under Kentucky law. For example, in Harrod v. Fraley, 289 S.W.2d 203, 205 (Ky. 1956), the Kentucky court explained the nature of punitive damages in the following terms:
Exemplary or punitive damages are generally defined as damages which are given in enhancement merely of the ordinary damages on account of the wanton, reckless, malicious, or offensive character of the acts complained of by the plaintiff; 15 Am.Jur., Damages, Section 265. Such damages go beyond the actual damages suffered in the case; they are allowed as a punishment of the defendant and to discourage the defendant and others from similar conduct in the future. Ashland Dry Goods Co. v. Wages, 302 Ky. 577, 195 S.W.2d 312. Restatement of the Law of Torts, Section 908, Subsection (b). [Emphasis added.)
Similarly, in Federal Kemper Ins. Co. v. Hornback, 711 S.W.2d 844, 846 (Ky. 1986), Justice Vance of the Supreme Court of Kentucky explained the nature of punitive damages in his concurring opinion as follows:
The purpose of compensatory damages is to make the claimant whole and to allow him to recover all of the actual damage he has sustained. In cases where punitive damages are allowed, they constitute a windfall to an already fully compensated claimant.
Punitive damages represent a sum over and above the amount a claimant is entitled to receive as compensation for a loss suffered by him. In theory, they are allowed as a punishment of a defendant for outrageous conduct or to deter such conduct in the future.
See also Hensley v. Paul Miller Ford, Inc., 508 S.W.2d 759, 763 (Ky. 1974); Continental Ins. Cos. v. Hancock, 507 S.W.2d 146, 151 (Ky. 1974); Ashland Dry Goods Co. v. Wages, 195 S.W.2d 312, 315 (Ky. 1946); Great Atlantic & Pacific Tea Co. v. Smith, 136 S.W.2d 759, 768 (Ky. 1940); National Bond & Investment Co. v. Whithorn, 123 S.W.2d 263, 266 (Ky. 1938).
A “slight variance” of the above principle is recognized in Kentucky based upon the fact that punitive damages are awarded to the injured party and, to that extent, are remuneration for the aggravated wrong. Hensley v. Paul Miller Ford, Inc., supra at 762-763. The Supreme Court of Kentucky made reference to this slight variance when it considered the gas company’s appeal from the award of punitive damages in the underlying State court action. Horton v. Union Light, Heat & Power Co., 690 S.W.2d 382, 390 (Ky. 1985). Nevertheless, it is evident from the discussion of punitive damages in that case, which is quoted by the majority, that the Kentucky Supreme Court recognizes the general tort law principle that punitive damages are awarded on account of the tort-feasor’s conduct, “as a civil punishment upon the wrongdoer, rather than as indemnity to the injured party”. Majority op. p. 100 (quoting Horton v. Union Light, Heat & Power Co., supra).
Moreover, punitive damages will not be awarded in Kentucky unless the plaintiff shows, beyond mere causation, that the tort was maliciously, wantonly, or wilfully committed by the tort-feasor. See Holloway Construction Co. v. Smith, 683 S.W.2d 248, 250 (Ky. 1984); Harrod v. Fraley, supra at 205. As explained in Home Finance Co. v. Ratliff, 374 S.W.2d 494, 496 (Ky. 1964) (quoting 15 Am. Jur., Damages, sec. 278):
“While every legal wrong entitles the party injured to recover damages sufficient to compensate for the injury inflicted, not every legal wrong entitles the injured party to recover exemplary damages. * * * It is universally recognized that punitive or exemplary damages, if recoverable at all, may be recovered only in cases where the wrongful act complained of is characterized by, or partakes of, some circumstances of aggravation, such as wilfulness, wantonness, malice, gross negligence or recklessness, oppression, contumely and indignity, outrageous conduct, insult, or gross fraud.” [Internal citations omitted.]
Petitioners received their punitive damage award in the State court action on account of the gross negligence of the gas company. Horton v. Union Light, Heat & Power Co., supra at 388. In considering the gas company’s appeal, the Kentucky Supreme Court outlined the specific requirements for an award of punitive damages in cases of gross negligence under that State’s law:
In order to justify punitive damages there must first be a finding of failure to exercise reasonable care, and then an additional finding that this negligence was accompanied by “wanton or reckless disregard for the lives, safety or property of others.” [Id. at 389-390; emphasis added.]
The majority does not consider the nature of punitive damages under Kentucky law. It takes the position that there is no necessity to do so because the sole determinant for eligibility under section 104(a)(2) is whether the taxpayer’s underlying claim was based upon a tort type personal injury. According to the majority:
The beginning and end of the inquiry should be whether the damages were paid on account of “personal injuries”. This inquiry is answered by determining the nature of the underlying claim. * * * [Majority op. p. 96.]
On the subject of determining the nature of the underlying claim, the majority opinion states as follows:
the Supreme Court [in United States v. Burke, 504 U.S. _, 112 S. Ct. 1867 (1992)] * * * focused on the nature of the underlying claim, rather than on the type of damages received. * * *
Relying on section 1.104-1(c), Income Tax Regs., the Supreme Court interpreted the words “damages received” as “an amount received * * * through prosecution of a legal suit or action based upon tort or tort type rights”. Id. at _, 112 S. Ct. at 1870. Therefore, if the taxpayer’s underlying claim was based upon a tort type personal injury and the damages in question were received through prosecution of that claim, they are excludable. [Majority op. p. 97; citations omitted.]
Thus, the majority advances the sweeping proposition that all damages, whether compensatory or punitive, received through the prosecution of a suit involving a tort type personal injury are excludable under section 104(a)(2). According to the majority, its analysis on this point is based on the recent opinion of the Supreme Court in United States v. Burke, 504 U.S. _, 112 S. Ct. 1867 (1992).
I agree that the existence of a personal injury for purposes of section 104(a)(2) is to be determined in accordance with the nature of the underlying claim. E.g., id. at _, 112 S. Ct. at 1872; Downey v. Commissioner, 97 T.C. 150, 164 (1991); Threlkeld v. Commissioner, 87 T.C. 1294, 1305 (1986), affd. 848 F.2d 81 (6th Cir. 1988). However, I do not agree that exclusion under section 104(a)(2) is necessarily established simply by the fact that the nature of the underlying claim involves a tort type personal injury. In my view, the majority misconstrues the opinion of the Supreme Court in arriving at that conclusion, and disregards a second requirement for eligibility under section 104(a)(2), that the amount received be “on account of” personal injuries or sickness. Sec. 104(a)(2). Furthermore, I do not agree that the nature of a claim for punitive damages is to be determined without taking into consideration the nature of punitive damages under State law.
In order to place my disagreement with the majority in context, I start with the language of section 104(a)(2) and the regulations promulgated thereunder. Section 104(a)(2) provides that gross income does not include:
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;
The regulations promulgated under section 104(a)(2), section 1.104-1(c), Income Tax Regs., state as follows:
The term “damages received (whether by suit or agreement)” means an amount received (other than workmen’s compensation) through prosecution of a legal suit or action based upon tort or tort type rights, or through a settlement agreement entered into in lieu of such prosecution.
Thus, the statute imposes at least two requirements for eligibility to exclude an amount from gross income. Downey v. Commissioner, supra at 159-160. First, the amount must have been received through prosecution of a “tort-like personal injury”. See United States v. Burke, 504 U.S. at _, 112 S. Ct. at 1872. Second, the amount at issue must have been paid “on account of” that injury. Sec. 104(a)(2). Petitioners must meet both requirements to qualify for the exclusion.
The Supreme Court’s opinion in United States v. Burke, supra, on which the majority relies extensively, deals only with the first requirement, and not with the second. The issue before the Supreme Court was whether a payment received in settlement of a backpay claim for sex discrimination under title VII of the Civil Rights Act of 1964 is excludable from the recipient’s gross income under section 104(a)(2). In considering that issue, the Court focused on section 1.104-l(c), Income Tax Regs., quoted above, and our opinion in Threlkeld v. Commissioner, supra, which had held that the “‘essential element of an exclusion under section 104(a)(2) is that the income involved must derive from some sort of tort claim against the payor’”. United States v. Burke, 504 U.S. at _, 112 S. Ct. at 1870 (quoting Threlkeld v. Commissioner, supra at 1305). Based upon those authorities, the Supreme Court set about to determine whether a back-pay claim under title VII was tortlike in nature.
In order to make that determination, the Supreme Court compared the remedies available under title VII with the damages available in a common law tort action. It found that the “remedial scheme” under title VII, consisting “of restoring victims, through backpay awards and injunctive relief, to the wage and employment positions they would have occupied absent the unlawful discrimination”, bore no similarity to the “common-law tradition of broad tort damages”, consisting of both compensatory and punitive damages. Id. at_, 112 S. Ct. at 1873 and 1874. Therefore, the Court concluded that the remedial scheme under title VII did not redress a tortlike personal injury, and the Court held that the amounts at issue were not excludable from gross income under section 104(a)(2). Id. at_, 112 S. Ct. at 1874.
I note that in framing the issue to be decided, the Supreme Court stated that the taxpayers “must show that title VII, the legal basis for their recovery of backpay, redresses a tort-like personal injury”. Id. at _, 112 S. Ct. at 1872 (emphasis supplied). In considering that issue, the Court analyzed the damages available to “the victim of a physical injury” and the damages available to “the victim of a ‘dignitary’ or nonphysical tort”. Id. at _n.6, 112 S. Ct. at 1871 n.6. Finally, after concluding that the remedial scheme under title VII was not tortlike, the Court concluded:
Thus, we cannot say that a statute such as Title VII, whose sole remedial focus is the award of backwages, redresses a tort-like personal injury within the meaning of §104(a)(2) and the applicable regulations. [Id. at _, 112 S. Ct. at 1874; fn. refs, omitted; emphasis added.]
Notwithstanding these and other references to “personal injury”, however, the holding of the Supreme Court in United States v. Burke, supra, was based on the taxpayers’ failure to prove that the remedies available under title VII of the Civil Rights Act were tortlike in nature. Thus, the Court concluded that the harm addressed by title VII was not a “tort-like personal injury”. It was not necessary for the Supreme Court to consider whether the remedies had been paid “on account of” any personal injuries that may have been sustained. Justice Scalia recognized the limited basis of the Court’s holding when he stated as follows in his concurring opinion:
The Court accepts at the outset of its analysis the Internal Revenue Service regulation (dating from 1960) that identifies “personal injuries” under this exclusion with the violation of, generically, “tort or tort type rights,” 25 Fed. Reg. 11490 (1960); 26 CFR §1.104-1(c) (1991). * * * Thereafter, the opinion simply considers the criterion for determining whether “tort or tort type rights” are at stake, the issue on which it disagrees with the dissent. [Id. at _, 112 S. Ct. at 1875 (Scalia, J., concurring); fn. refs, omitted.]
Similarly, Justice O’Connor correctly noted the limited basis of the Court’s holding when she stated as follows in her dissenting opinion:
The Court holds that respondents, unlike most plaintiffs who secure compensation after suffering personal injury, must pay tax on their recoveries for alleged discrimination because suits under Title VII of the Civil Rights Act of 1964, 78 Stat. 253, as amended, 42 Stat. §2000e et seq., do not involve “tort type rights.” * * * [Id. at _, 112 S. Ct. at 1878 (O’Connor, J., dissenting).]
I submit that the majority misconstrues the Supreme Court’s opinion in United States v. Burke, supra, in two significant respects. First, the Supreme Court did not hold, expressly or by implication, as suggested by the majority, that “if the taxpayer’s underlying claim was based upon a tort type personal injury”, then all damages received through prosecution of the claim are excludable under section 104(a)(2). Majority op. p. 97. To the contrary, the Supreme Court merely held that the taxpayer had not suffered a tortlike personal injury under section 104(a)(2). The majority’s error consists not only of failing to properly apply the second (“on account of”) requirement in this case, but also of formulating the test for eligibility under section 104(a)(2) in a way which suggests that the second requirement does not exist.
The majority misconstrues the opinion of the Supreme Court in United States v. Burke, supra, in a second important respect. The majority opinion states that “the Supreme Court * *• * focused on the nature of the underlying claim, rather than on the type of damages received.” Majority op. p. 97. The majority opinion thereby suggests that once we determine that the nature of the underlying claim is a tortlike personal injury, we need not further inquire into the type of damages received; i.e., whether anything in addition to compensatory damages was received. The majority cites a District Court case in which that seems to be the thrust of the court’s opinion. O’Gilvie v. United States, 70 AFTR 2d 92-5069, 92-2 USTC par. 50,344 (D. Kan. 1992).
However, the Supreme Court’s opinion does not suggest that the type of damages awarded plays no role in determining the excludability of such damages. In fact, to the contrary, the Supreme Court determined the nature of the title VII discrimination claim at issue in that case by analyzing the “remedial scheme” under title VII. United States v. Burke, 504 U.S. at _, 112 S. Ct. at 1873. Indeed, the majority opinion itself points out:
The [Supreme] Court held that “consideration of the remedies available * * * is critical in determining the ‘nature of the statute’ and the ‘type of claim’”, [504 U.S.] at _n.7, 112 S. Ct. at 1872 n.7, and observed that in tort actions “punitive or exemplary damages are generally available in those instances where the defendant’s misconduct was intentional or reckless.” Id. at _, 112 S. Ct. at 1872 (citing Molzof v. United States, 502 U.S. _, 112 S. Ct. 711 (1992)). The Supreme Court’s analysis establishes that punitive damages are not merely an incidental result of a personal injury claim as suggested by the Fourth Circuit. Rather, they are “inextricably bound up” with the concept of tort type rights, id. at _n.7, 112 S. Ct. at 1872 n.7, and therefore one of the prime determinants of whether a claim is for personal injury. As one of the hallmarks of traditional tort claims, it is logical to conclude that punitive damages are received “on account of’ such claims. [Majority op. p. 99; fn. ref. omitted.]
Thus, as the majority correctly notes, the Supreme Court found it helpful in defining a tort suit to note that, generally, such suits may produce both compensatory and punitive damages. However, the Supreme Court did not suggest, as inferred by the majority, that punitive damages are undifferentiated from compensatory damages. In my view, an underlying claim may be a tort claim, or at least tortlike, but it may also be a claim for more than one type of damages.
I would further note that not every tort involves “personal injuries or sickness”, within the meaning of section 104(a)(2). To the contrary, there are many torts, such as trespass, which do not involve “personal injuries or sickness”, as that phrase is used in section 104(a)(2). In my view, damages received on account of one of those torts are not covered by the exclusion.
For example, in this case, petitioners received compensatory damages of $62,000 as a result of the property damage to their house and its contents, over $20,000 more than the amount which they received for personal injuries. I do not believe that the amount received for property damages is eligible to be excluded from gross income under section 104(a)(2). In my view, that amount was not received “on account of personal injuries or sickness” within the meaning of section 104(a)(2), and does not qualify for exclusion. I suspect that the majority would agree with me on that point. Indeed, the majority opinion makes clear that respondent makes no argument on that point and that the majority expresses no view on it. Majority op. p. 95 note 3.
If the amount received by petitioners for property damage does not automatically qualify for the exclusion under section 104(a)(2), the same should be true of the punitive damages at issue in this case. In both cases, it is not enough that the underlying claim for which they were received involves a tort type personal injury, in whole or in part. Petitioners must also prove eligibility under the second requirement that the amounts received were paid “on account of” the personal injuries sustained.
For the reasons discussed above, I believe that the majority’s analysis of the opinion of the Supreme Court in United States v. Burke, supra, is seriously flawed. Beyond that, the majority opinion adds little to the debate regarding the eligibility of punitive damages for exclusion under section 104(a)(2). That debate is ably joined by our opinion in Miller v. Commissioner, 93 T.C. 330 (1989), which I believe is wrong, and the opinion of the Court of Appeals for the Fourth Circuit in that case, 914 F.2d 586 (4th Cir. 1990), which I believe is correct.
A final point should be noted. While I believe that the holding in United States v. Burke, supra, is not applicable to this case, there is a lesson to be learned from the Supreme Court’s opinion which was overlooked by the majority. By rejecting the expansive application of section 104(a)(2) which had been adopted by the Court of Appeals in that case, the Supreme Court’s opinion is a clarion call to lower courts to restore the proper balance between the definition of gross income in section 61(a), which is to be interpreted broadly, and exemptions from income, which are to be narrowly construed. The opinion of the Court states as follows:
The definition of gross income under the Internal Revenue Code sweeps broadly. Section 61(a), 26 U.S.C. §61(a), provides that “gross income means all income from whatever source derived,” subject only to the exclusions specifically enumerated elsewhere in the Code. As this Court has recognized, Congress intended through §61(a) and its statutory precursors to exert “the full measure of its taxing power,” Helvering v. Clifford, 309 U.S. 331, 334, 60 S. Ct. 554, 556, 84 L.Ed. 788 (1940), and to bring within the definition of income any “accessio[n] to wealth.” * * * Commissioner v. Glenshaw Glass Co., 348 U.S. 426, 431, 75 S. Ct. 473, 477, 99 L.Ed. 483 (1955). [Id. at _, 112 S. Ct. at 1870.]
In his concurring opinion, Justice Scalia touches on the same issue in the following words:
the provision at issue here is a tax exemption, a category of text for which we have adopted a rule of narrow construction, see, e.g., United States v. Centennial Savings Bank FSB, 499 U.S. _, _, 111 S. Ct. 1512, 1519, 113 L.Ed.2d 608 (1991). [Id. at _, 112 S. Ct. at 1876 (Scalia, J., concurring); fn. ref. omitted.]
Finally, Justice Souter, in his concurring opinion, also touches on this point:
the outcome in this case follows from the default rule of statutory interpretation that exclusions from income must be narrowly construed. See United States v. Centennial Savings Bank FSB, 499 U.S. _, _, 111 S. Ct. 1512, 1519, 113 L.Ed.2d 608 (1991); Commissioner v. Jacobson, 336 U.S. 28, 49, 69 S. Ct. 358, 369, 93 L.Ed. 477 (1949). That is, an accession to wealth is not to be held excluded from income unless some provision of the Internal Revenue Code clearly so entails. * * * [Id. at _, 112 S. Ct. at 1878 (Souter, J., concurring).]
For the foregoing reasons, I respectfully dissent.
Jacobs and Halpern, JJ., agree with this dissent.