Estate of Moore v. Commissioner

United States Court of Appeals,

Fifth Circuit.

No. 94-40482.

ESTATE OF Chester H. MOORE, Deceased, Caledonia Moore, Executrix,
and Caledonia Moore, Petitioners-Appellees,

COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellant.

June 2, 1995.

Appeal from the Decision of the United States Tax Court.

Before WISDOM, WIENER, and PARKER, Circuit Judges.

ROBERT M. PARKER, Circuit Judge:

The Commissioner of Internal Revenue (the Commissioner)

appeals from a decision of the United States Tax Court that

punitive damages awarded under Texas law in a malicious prosecution

suit are excludable from gross income under 26 U.S.C. § 104(a)(2).1

After this case was briefed and argued, we released our opinion in

Wesson v. U.S., 48 F.3d 894 (5th Cir.1995), in which we held that

§ 104(a)(2) does not exclude noncompensatory punitive damages such

as those awarded under Mississippi law from gross income. Most of

the issues raised by the parties were answered by Wesson. There

remains only the question whether punitive damages awarded under

Texas law are compensatory in a way that would bring them within §

1
In 1989 Congress amended § 104(a), providing: "paragraph
(2) shall not apply to any punitive damages in connection with a
case not involving physical sickness or physical injury."
However, the amendment applies only to amounts received after
July 10, 1989, in taxable years ending in such date. The only
Payments involved in this case were received during the 1987 and
1988 tax years.

1
104(a)(2)'s exclusion. We hold that they are not and we reverse

the decision of the Tax Court.

Chester Moore was the sole shareholder and president of a

Texas highway construction corporation. Sometime before February

26, 1982, two highway construction contractors and two of their

employees falsely implicated Mr. Moore in a price fixing scheme.

After a trial in which Mr. Moore and his corporation were

acquitted, Mr. and Mrs. Moore filed suit against the two

corporations and the two employees, alleging malicious prosecution

and invasion of privacy. The Moores sought $6 million in actual

damages and $6 million in punitive damages.

The Moores' suit went to trial in 1985. Before the jury

reached its verdict, the Moores settled with two of the defendants

for a lump sum payment of $1 million, which is not in issue in this

case. The jury returned a verdict against the remaining defendants

and awarded the Moores $2,898,000 in compensatory damages and $3

million in punitive damages. After the jury reached its verdict,

but before judgment was entered, the parties agreed that the Moores

would receive a cash payment of $2,750,000 and an annuity contract

that would provide Mr. Moore, or his estate or beneficiaries, with

$233,523.13 per year for 15 years beginning in 1986.

In 1987 and 1988, the Moores received the annuity payments but

did not report them as income on their federal income tax returns.

They attached statements to the tax returns describing the payments

and asserted that they were excluded from income under § 104(a)(2)

2
of the Internal Revenue Code. In 1992, the Commissioner issued a

notice of deficiency to Mr. Moore's estate (Mr. Moore died in 1990)

and Mrs. Moore, asserting deficiencies in the Moores' income tax

for 1987 and 1988. This deficiency was based on the Commissioner's

determination that the annuity payments were taxable gross income.

Moore petitioned the tax court, seeking a review of the

Commissioner's determinations. At the hearing, the parties

stipulated that 49% of the annuity payments ($109,526.33 per year)

represented compensatory damages and that the remaining 51%

($113,996.80 per year) represented punitive damages. The

Commissioner agreed that the compensatory portion of the annuity

payments was excluded from gross income under § 104(a)(2), but

argued that the punitive portion could not be excluded. The tax

court held that the punitive portion of the annuity payments was

excludable from gross income and entered a decision finding no

deficiency for the 1987 tax year and a deficiency totalling

$2,816.00 for the 1988 tax year. The Commissioner appealed.

II.

We review a decision of the tax court using the same

standards that apply to a decision of the district court. Park v.

C.I.R., 25 F.3d 1289, 1291 (5th Cir.1994), cert denied, Jones v.

C.I.R., --- U.S. ----, 115 S.Ct. 673, 130 L.Ed.2d 606 (1994). We

review de novo the tax court's legal conclusions, and the tax

court's fact findings for clear error. Harris v. C.I.R., 16 F.3d

3
75, 81 (5th Cir.1994). As our review turns on a question of

law—the proper interpretation of the Internal Revenue Code—our

standard of review is de novo. Reese v. U.S., 24 F.3d 228, 230

(Fed.Cir.1994). In approaching this case, we are guided by the

policy that exclusions from income must be narrowly construed. See

United States v. Centennial Sav. Bank FSB, 499 U.S. 573, 583, 111

S.Ct. 1512, 1519, 113 L.Ed.2d 608 (1991).

Under § 104(a)(2) of the Internal Revenue Code, "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" is excluded from gross income. 26 U.S.C. § 104(a)(2).

This Court, along with the Ninth, Federal, and Fourth Circuits, has

held that noncompensatory punitive damages do not fall within §

104(a)(2)'s exclusion. See Wesson v. U.S., 48 F.3d 894 (5th

Cir.1995); Hawkins v. U.S., 30 F.3d 1077 (9th Cir.1994); Reese v.

U.S., 24 F.3d 228 (Fed.Cir.1994); C.I.R. v. Miller, 914 F.2d 586

(4th Cir.1990). The Sixth Circuit and the tax court have reached

the opposite conclusion. See Horton v. C.I.R., 33 F.3d 625 (6th

Cir.1994); Miller v. C.I.R., 93 T.C. 330, 1989 WL 104238 (1989),

rev'd 914 F.2d 586 (4th Cir.1990).

We stated in Wesson that "To exclude damages awarded in a suit

or otherwise under 104(a)(2), two requirements must be met. The

taxpayer must show: first, that the underlying cause of action was

tort-like under Burke; and second, that the damages were received

on account of personal injury, that is, to compensate the injured

4
party for the personal injury." Wesson v. U.S., 48 F.3d 894 (5th

Cir.1995). The Commissioner does not dispute that the first prong

of Wesson has been satisfied, but argues that the punitive damages

awarded to Moore did not compensate for personal injury. Moore

contends that exemplary damages awarded under Texas law serve a

compensatory function, and should therefore be excluded from gross

income under § 104(a)(2).2 See Wesson, 48 F.3d at 901

(distinguishing Horton based on Sixth Circuit's determination that

punitive damages in Kentucky serve, in part, a compensatory

function).

Relying principally on the Texas Supreme Court's opinion in

Hofer v. Lavender, 679 S.W.2d 470 (Tex.1984) and the cases cited

therein, Moore contends that punitive damages awarded under Texas

law are at least in part compensatory and should therefore be

excluded from income. In Hofer, the Texas Supreme Court ruled that

the estate of a deceased tortfeasor can be held liable for

exemplary damages despite the futility of trying to punish a dead

person because "Texas case law indicates that the public policy for

exemplary damages includes equally important considerations other

than punishment of the wrongdoer." Id. at 475. The court cited

2
Moore also contends that the under Supreme Court's decision
in United States v. Burke, 504 U.S. 229, 112 S.Ct. 1867, 119
L.Ed.2d 34 (1992), all damages received in connection with a suit
for personal injuries or sickness, whether compensatory or
punitive are excludable from gross income and that the
Commissioner's position is inconsistent with the 1989 amendments
to § 104(a). Because we considered and rejected these arguments
in Wesson, we need not revisit them here. See Wesson v. United
States, 48 F.3d 894.

5
Texas authority going back to the 19th century to the effect that

exemplary damages may serve, inter alia, to compensate for

inconvenience and losses too remote to be considered as elements of

actual damages, and for the plaintiff's litigation expenses. Id.

at 474-75. Moore also cites Celotex Corporation v. Tate, 797

S.W.2d 197, 208-09 (Tex.App.—Corpus Christi 1990, no writ), which

relied on Hofer in rejecting a due process challenge to successive

exemplary damage awards because exemplary damages serve to

compensate for inconvenience and attorney's fees.

Despite Hofer and Celotex, we find Moore's argument

unpersuasive. Notwithstanding any compensatory effect that

punitive damages might have, the Texas Supreme Court has emphasized

at least since 1847 that exemplary damages are awarded not to

compensate the plaintiff for any injury received but to punish the

defendant and to deter others. See, e.g., Smith v. Sherwood, 2

Tex. 461, 464 (1847); Graham v. Roder, 5 Tex. 141, 149 (1850);

Cotton v. Cooper, 209 S.W. 135, 138 (Tex.Com.App.1919, opinion

adopted); Bennett v. Howard, 141 Tex. 101, 170 S.W.2d 709 (1943);

Pace v. State, 650 S.W.2d 64 (Tex.1983); Cavnar v. Quality Control

Parking, Inc., 696 S.W.2d 549, 555-56 (Tex.1985); Lunsford v.

Morris, 746 S.W.2d 471 (Tex.1988); Transportation Insurance Co. v.

Moriel, 879 S.W.2d 10, 16 (Tex.1994). This Court too has

repeatedly stated that exemplary damages are not compensatory under

Texas law. Jenkins v. Raymark Industries, Inc., 782 F.2d 468, 474

(5th Cir.1986) ("The purpose of punitive damages is not to

compensate the victim but to create a deterrence to the defendant,

6
and to protect the public interest."); Maxey v. Freightliner

Corp., 665 F.2d 1367, 1378 (5th Cir.1982) ("[I]t is well

established that the purpose of punitive damages is not to

compensate those who have felt the loss, but it is instead to

create a deterrence to the wrongdoer."); Ratner v. Sioux Natural

Gas Corp., 719 F.2d 801, 804 (5th Cir.1983) ("The award of punitive

damages is unconcerned with compensation; it is intended to punish

the wrongdoer and deter the commission of similar offenses in the

future.").

We also note that the year after the Texas Supreme Court

released its opinion in Hofer, the court determined that

prejudgment interest is not available on exemplary damages

precisely because of their non-compensatory nature. The court

stated: "Punitive damages are intended to punish the defendant and

to set an example to others.... They are assessed over and above

the amount of damages necessary to indemnify the plaintiff. The

plaintiff can thus be made whole even if prejudgment interest is

not awarded on punitive damages." Cavnar v. Quality Control

Parking, Inc., 696 S.W.2d 549, 555-56 (Tex.1985) (citation

omitted).

Texas courts have also rejected arguments that punitive

damages should be reduced in proportion to the percentage of

negligence attributed to the plaintiff. Reduction of punitive

damages is not appropriate because "[t]he purpose of awarding

exemplary damages is not to compensate the plaintiff, but to punish

and set an example to others." Elbar, Inc. v. Claussen, 774 S.W.2d

7
45, 53 (Tex.App.—Dallas 1989, writ dismissed as moot); see also

Otis Elevator Co. v. Joseph, 749 S.W.2d 920, 922 (Tex.App.—Houston

[1st Dist.] 1988, no writ); Turner v. Lone Star Indus., Inc., 733

S.W.2d 242 (Tex.App.—Houston [1st Dist.] 1987, writ ref'd, n.r.e.);

Hondo's Truck Stop Cafe, Inc. v. Clemmons, 716 S.W.2d 725, 726

(Tex.App.—Corpus Christi 1986, no writ); Olin Corp. v. Dyson, 709

S.W.2d 251, 253-54 (Tex.App.—Houston [14th Dist.] 1986, no writ);

Anderson v. Trent, 685 S.W.2d 712, 714 (Tex.App.—Dallas 1984, writ

ref'd n.r.e.); but cf. Pedernales Electric Cooperative, Inc. v.

Schulz, 583 S.W.2d 882 (Tex.Civ.App.—Waco 1979, writ ref'd n.r.e.)

(acknowledging that the "overriding policy consideration in the

award of exemplary damages is as punishment for gross negligence as

distinguished from compensation," but holding that comparative

negligence statute requires reduction of exemplary award in

proportion to the plaintiff's contributory negligence).

Finally, we note that when the jury's award is reviewed for

reasonableness, the court considers: "(1) the nature of the wrong,

(2) the character of the conduct involved, (3) the degree of

culpability of the wrongdoer, (4) the situation and sensibilities

of the parties concerned, and (5) the extent to which such conduct

offends a public sense of justice and propriety." Alamo National

Bank v. Kraus, 616 S.W.2d 908, 910 (Tex.1981). There is no

requirement that exemplary damages bear any relation to the

plaintiff's inconvenience, attorney's fees, or losses too remote to

be considered as elements of actual damages. The jury may consider

such factors, if it so chooses, but need not do so. See, e.g.,

8
Byler v. Garcia, 685 S.W.2d 116, 120 (Tex.App.—Austin 1985, writ

ref'd n.r.e.) (stating that, while it is true that the jury may

include attorney's fees in its exemplary damage award, they are not

a necessary element in the computation of exemplary damages);

Landa v. Obert, 45 Tex. 539, 544 (1876).

The overwhelming weight of Texas authority holds that

exemplary damages are not awarded to compensate the plaintiff for

any injury. The fact that Texas courts may allow the jury to

consider factors such as the plaintiff's litigation costs in

determining the appropriate measure of exemplary damages does not

change the fundamental truth that exemplary damages in Texas are

awarded on account of and in proportion to the defendant's wrongful

conduct. We are satisfied that exemplary damages are not awarded

"on account of" any personal injury as Congress intended in §

104(a)(2).

The decision of the tax court is reversed and this case is

remanded for treatment in accordance with this opinion.

REVERSED AND REMANDED.