United States Court of Appeals,
Fifth Circuit.
No. 94-40482.
ESTATE OF Chester H. MOORE, Deceased, Caledonia Moore, Executrix,
and Caledonia Moore, Petitioners-Appellees,
v.
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.
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104(a)(2)'s exclusion. We hold that they are not and we reverse
the decision of the Tax Court.
I.
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.
A.
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
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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).
B.
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
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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).
C.
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.
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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,
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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
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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.,
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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).
D.
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.
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