United States Court of Appeals,
Fifth Circuit.
No. 94-41023.
Edward E. ROBINSON & Sandra Robinson, Petitioners-Appellees,
Cross-Appellants,
v.
COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellant, Cross-
Appellee.
Dec. 5, 1995.
Appeal from a decision of the United States Tax Court.
Before REYNALDO G. GARZA, GARWOOD and DUHÉ, Circuit Judges.
REYNALDO G. GARZA, Circuit Judge:
I.
BACKGROUND
Edward and Sandra Robinson obtained a $60,000,000 jury verdict
against a bank for wrongful failure to release a lien. This
$60,000,000 included $6,000,000 for lost profits, $1,500,000 for
mental anguish, and $50,000,000 in punitive damages. The Robinsons
then settled their claims against the bank for $10,000,000 plus the
release of a judgment that the bank held against the petitioners in
the amount of $691,972.43 while the trial court was considering the
bank's motion for a new trial. In the final judgment reflecting
the settlement, which was drafted by the parties and signed by the
trial judge, 95% of the settlement proceeds were allocated to
mental anguish and 5% were allocated to lost profits.
The Robinsons received $4,935,152.43 of the settlement
proceeds after paying attorneys' fees and costs. Of that amount,
1
they only reported five percent of the proceeds ($246,758)—the
amount allocated to lost profits—as income on their 1987 joint
income tax return. They contended that the other 95% was
excludable under Section 104(a)(2) of the Internal Revenue Code as
"damages received ... on account of personal injuries or
sickness."1
The Internal Revenue Service ("IRS") considered 95%, rather
than 5%, of the proceeds to be taxable, and recomputed the
Robinsons' taxable income by adding 90% of the proceeds received by
the Robinsons ($4,400,000). This added income eliminated a carried
forward net-operating-loss deduction claimed in the 1988 tax year,
and the IRS noticed deficiencies for the 1987 and 1988 tax years.
The Robinsons then petitioned the Tax Court for redetermination,
arguing that 95% of the settlement proceeds were excludable under
Section 104.
At trial, the IRS discovered and asserted an additional
deficiency based on the Robinson's discharge-of-indebtedness income
from the bank's release of the $691,972.43 judgment in conjunction
with the settlement. The Tax Court allowed the IRS to amend its
pleadings to assert this discharge-of-indebtedness income.
After hearing the evidence and the parties' arguments, the Tax
Court rendered judgment. It first found that the allocation of the
settlement proceeds did not reflect the damages that the Robinsons
suffered. Instead, the Robinsons were allowed to allocate the
settlement proceeds in a manner that minimized their tax liability.
1
26 U.S.C. § 104(a)(2).
2
The Tax Court therefore refused to recognize the allocation
contained in the final judgment, and reallocated the settlement
proceeds among the various elements of damages that the jury
awarded the Robinsons in their suit against the bank.
The Tax Court allocated the settlement proceeds based on the
relationship of certain amounts awarded to the Robinsons by the
jury. Because the Tax Court agreed that the punitive damages may
have been reduced on appeal, it first allocated the proceeds based
on the amounts awarded by the jury for compensatory damages. It
then allocated the remaining balance to punitive damages. Using
this method, the Tax Court allocated the proceeds as follows:
Actual Damages: Damages Percentageof Damages
Lost Profits $6,000,000 60.893
Other Business Damages 175,000 1.776
Injury to Credit Reputation 85,000 .863
Mental Anguish 1,500,000 15.223
Punitive Damages: 2,093,360 21.245
_________ ______
Settlement Less Prejudgment Interest $9,853,360 100 0 0
.0
______
Prejudgment Interest 146,640
_________
Total Settlement Payment $10,000,000
3
_________
The Tax Court then allocated the settlement proceeds based on
the percentage of damages attributed to each item of damage. It
therefore allocated 37.331% of the proceeds—the amounts
attributable to punitive damages (21.245%), mental anguish
(14.223%) and injury to credit reputation (.863%)—to damages for
tort-like personal injuries. The Tax Court then held that
$1,787,599.30—the 37.331% of the net payment (less prejudgment
interest)2 attributable to tort-like injuries—was excludable under
Section 104, and that the balance of the net payment (including
prejudgment interest) was includable in the Robinsons' 1987 gross
income.
The Commissioner of Internal Revenue then appealed the Tax
Court's exclusion of the portion of settlement proceeds allocable
to punitive damages. The Robinsons cross-appealed, arguing that
the Tax Court erred in its allocation of the proceeds, its refusal
to subpoena the trial judge who presided over their suit against
the bank, and its refusal to reopen the record to allow them to
demonstrate deductions that would offset the
discharge-of-indebtedness income.
II.
THE COMMISSIONER'S APPEAL
The Tax Court held that the portion of the Robinsons'
settlement attributable to punitive damages was excludable from
2
The Tax Court held that 100% of the amount allocated to
prejudgment interest was includable in income.
4
their gross income as "damages received ... on account of personal
injuries or sickness" under Section 104(a)(2) of the Internal
Revenue Code.3 The Commissioner appeals from this holding, arguing
that, because they are not intended to compensate plaintiffs for
personal injuries, punitive damages are not excludable from gross
income under Section 104(a)(2). This Court recently held that
punitive damages awarded under Texas law are not intended to
compensate, and are therefore not excludable under Section
104(a)(2).4 Accordingly, we reverse the Tax Court on this issue
and hold that the portion of the Robinsons' settlement proceeds
allocable to punitive damages are not excludable under Section
104(a)(2).
Because the proceeds allocable to punitive damages are not
excludable, the Robinsons must include the 24.241% of
$4,788,511.72, the net settlement payment (less prejudgment
interest),5 as well as 24.241% of the $691,972.43 discharge of
indebtedness. However, because the parties agreed that the
Robinsons were allowed to deduct the non-excludable portions of
part of the discharged indebtedness, namely the $55,337.44 in
interest and $57,875.91 in attorney fees, the Robinsons should be
allowed to deduct an additional 24.241% of these amounts.
3
26 U.S.C. § 104(a)(2).
4
Estate of Moore v. Commissioner, 53 F.2d 712, 716 (5th
Cir.1995).
5
The Tax Court held that 100% of the prejudgment interest
was included in income. The Robinsons did not appeal this
holding.
5
III.
THE ROBINSONS' CROSS-APPEAL
A.
THE ALLOCATION OF THE SETTLEMENT PROCEEDS
The Robinsons contend that the Tax Court erred in reallocating
the settlement proceeds among the various types of damages that
they suffered. They argue that the Tax Court failed to give
"proper regard" to the state court trial judge's allocation of
ninety-five percent of the settlement proceeds to mental anguish
and five percent to lost profits.
Although the Tax Court is not bound by a state court's
allocation of settlement proceeds, it must give "proper regard" to
allocations made by state courts when such allocations are entered
by the court in a bona fide adversary proceeding.6 In the case at
bar, however, the Tax Court found that the allocation was not
entered in a bona fide adversary proceeding. Further, it found
that the state trial court simply "rubber stamped" a judgment
drafted by the Robinsons' attorneys. Therefore, the Tax Court did
not consider itself bound by the state court's allocation, and
reallocated the settlement proceeds.
The Tax Court's findings that the allocation was not entered
into in an adversary proceeding and that the judgment was simply
"rubber stamped" by the state court are findings of fact, which
6
Cf. Commissioner of Internal Revenue v. Estate of Bosch,
387 U.S. 456, 463-64, 87 S.Ct. 1776, 1781-82, 18 L.Ed.2d 886
(1967) (quoting S. REPT. NO. 1013, 80th Cong., 2d Sess., pt. 2, at
4 (1948)).
6
this Court will only disturb upon a finding of clear error.7 We
hold that the trial court did not err in its factual findings. The
testimony of the attorneys who represented the Robinsons in their
suit against the bank supports the Tax Court's finding that the
bank allowed the Robinsons to allocate the settlement proceeds in
any manner they wished.8 This testimony alone supports a finding
that the Robinsons and the bank were not adversarial in the
allocation of the settlement proceeds. The circumstances
surrounding the state court judge's entry of judgment also support
the trial court's findings. The parties presented the final
judgment to the trial judge at his home in the evening. The
meeting at the judge's home lasted no longer than one hour, and
neither the final judgment nor the settlement agreement were
discussed in detail during that meeting. Therefore, the Tax Court
did not err in failing to give proper regard to the state court
judgment's allocation of settlement proceeds.
The Tax Court also did not err in its allocation of the
7
Switzer v. Wal-Mart Stores, Inc., 52 F.3d 1294, 1298 (5th
Cir.1995).
8
The Robinsons' lead counsel testified as follows:
I asked [the Bank's counsel], would there be any
objection on their part on how [a settlement] would be
structured if we went in and set the [judgment based on
the jury verdict] aside. He said, "None."
He said, "We don't care how you do it, just so it
is paid and we can get it over with, and we will
cooperate with you in any way you see fit. If you can
get any tax benefit, fine." If you-you know, he didn't
have any ax to grind. He didn't care. He made it
plain.
7
proceeds. Its allocation was based upon the jury verdict, the best
indication of the worth of the Robinsons' claims. We therefore
affirm the Tax Court's reallocation.
B.
REFUSAL TO SUBPOENA THE STATE COURT JUDGE
The Robinsons contend that the Tax Court erred in refusing to
allow them to subpoena the state court judge to testify as to his
understanding and knowledge of the final judgment and what went
into its determination. The Robinsons served a subpoena on the
state court judge, who in turn moved to quash the subpoena on the
ground that the taxpayers sought to question him regarding the
mental processes employed by him in entering the Final Judgment.
The Tax Court quashed the subpoena. We review the Tax Court's
quashing of a subpoena for abuse of discretion.9
A judge may not be asked to testify about his mental
processes in reaching a judicial opinion.10 The sole reason that
the Robinsons attempted to subpoena the state court judge was to
show that he considered the merits of the allocation contained in
the Final Judgment rather than simply rubber stamping a judgment
drafted by the Robinsons. There is no way that the trial judge
could be asked about such matters without inquiring into his mental
processes. In fact, the whole purpose of the subpoena was to delve
9
Tiberi v. CIGNA Ins. Co., 40 F.3d 110, 112 (5th Cir.1994).
10
Washington v. Strickland, 693 F.2d 1243, 1263 (5th
Cir.1982), rev'd on other grounds, 466 U.S. 668, 104 S.Ct. 2052,
80 L.Ed.2d 674 (1984). See United States v. Morgan, 313 U.S.
409, 421-22, 61 S.Ct. 999, 1004-05, 85 L.Ed. 1429 (1941).
8
into the judge's mental processes. Therefore, we hold that the Tax
Court did not err in quashing the subpoena.
C.
REFUSAL TO REOPEN THE RECORD
The Robinsons contend that the Tax Court erred in refusing to
reopen the record to allow them to present evidence of deductions
that offset the discharge-of-indebtedness income. When the
evidence revealed that the Robinsons received a release of a
$691,971 judgment that the bank held against Taxpayers, the Tax
Court allowed the Commissioner to amend its pleading to assert the
additional discharge-of-indebtedness income. The Robinsons then
moved that the record be left open for additional submissions on
the issue. The Tax Court denied the motion, and later denied a
motion made by the Robinsons to reopen the record for submission of
evidence of offsetting deductions.
The Tax Court's denial of a motion to reopen the record for
admission of additional evidence is "not subject to review except
upon a demonstration of extraordinary circumstances which reveal a
clear abuse of discretion."11 Further, such motions should be
denied where the evidence to be presented was available at trial,
or could have been obtained with reasonable diligence.12
We hold that the Tax Court did not err in denying the motion
to reopen because, through the exercise of reasonable diligence,
11
Devore v. Commissioner, 963 F.2d 280, 282 (9th Cir.1992).
12
See, e.g., Tweeddale v. Commissioner, 841 F.2d 643, 646
(5th Cir.1988).
9
the Robinsons could have obtained the evidence of offsetting
deductions. The Robinsons were made aware—through both the
Commissioner's interrogatories propounded to them during discovery
and through the evidence obtained during the depositions of the
attorneys that represented the Robinsons in the state court
litigation—that discharge-of-indebtedness income was an issue in
the case. Therefore, they should have obtained evidence of
offsetting deductions before the close of trial.
IV.
CONCLUSION
We REVERSE the Tax Court's judgment to the extent that it held
that the punitive damages portion of the settlement proceeds were
excludable under Section 104(a)(2), REMAND this case to the Tax
Court for entry of a judgment in accordance with this opinion, and
AFFIRM the remainder of the Tax Court's opinion.
10