111 T.C. No. 17
UNITED STATES TAX COURT
CARL J. FABRY AND PATRICIA P. FABRY, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 9126-96. Filed December 16, 1998.
Ps sued the manufacturer of an agricultural chemical, claiming tortious injury to their nursery business. The suit was settled and Ps received a payment, of which $500,000 was allocable to their claim of injury to their business reputation. Ps argue that damages received on account of injury to business reputation are, as a matter of law, received on account of personal injuries within the meaning of sec. 104(a)(2), I.R.C. Held: Whether damages received on account of injury to business reputation are on account of personal injuries within the meaning of sec. 104(a)(2), I.R.C., is a question of fact. Held, further, Ps have failed to prove that the $500,000 payment in question was received on account of personal injuries within the meaning of sec. 104(a)(2), I.R.C.
Robert S. MacDonald and Brian J. Moran, for petitioners. - 2 -
Stephen R. Takeuchi, for respondent.
OPINION
HALPERN, Judge:
I. Introduction
By notice of deficiency dated February 14, 1996, respondent
determined a deficiency in petitioners' 1992 Federal income tax
of $201,054 and an accuracy-related penalty of $40,211.
Unless otherwise indicated, all section references are to
the Internal Revenue Code in effect for the year in issue, and
all Rule references are to the Tax Court Rules of Practice and
Procedure.
After concessions, the sole issue for decision is whether
$500,000 received by petitioners in settlement of a lawsuit
alleging injury to business reputation is excludable from
petitioners’ gross income under section 104(a)(2) as damages
received on account of personal injuries.1
1 On their 1992 Federal income tax return, petitioners deducted legal fees incurred in connection with the recovery that is the subject of this case. By amendment to answer, respondent added a claim for a reduced deduction for legal fees if the Court were to conclude that any portion of the recovery was excludable from gross income. By the reply, petitioners denied the accuracy of respondent’s method for determining the legal fees allocable to that recovery. At the conclusion of the trial, the parties stipulated that $100,000 is allocable to the recovery. Since we determine that no portion of the recovery is excludable from gross income, the issue raised by respondent’s amendment to (continued...) - 3 -
Certain facts have been stipulated. The stipulation of
facts filed by the parties, with attached exhibits, is
incorporated herein by this reference. We have need to find few
facts in addition to those stipulated and, accordingly, shall not
separately set forth those findings. We include our additional
findings of fact in the discussion that follows. Petitioners
bear the burden of proof. Rule 142(a).
II. Background
A. Residence
Petitioners resided in Orlando, Florida, at the time the
petition was filed.
B. Patsy's Nursery; Petitioners’ Reputations
In 1976, petitioners started a business known as Patsy's
Nursery, an unincorporated proprietorship located in Orange
County, Florida. In their nursery, petitioners grew Hoya Carnosa
(Hoyas), ornamental plants commonly known as wax plants, and
citrus trees.
Petitioner Patricia P. Fabry quickly developed a reputation
for growing quality plants and, because of the high quality and
vivid color of her Hoyas, became known as the “Hoya Lady”.
Petitioner Carl J. Fabry also enjoyed a good reputation in the
agricultural field.
1 (...continued) answer is moot, and petitioners are entitled to deduct the legal fees in question. - 4 -
C. Benlate Damage
In connection with the operation of Patsy’s Nursery,
petitioners used a fungicide, Benlate, manufactured by
E.I. du Pont de Nemours and Co. (du Pont). From 1988 to 1991,
petitioners suffered extensive damage to their stock of plants,
which they claim was a result of their use of Benlate.
D. The Lawsuit
In 1991, on account of the claimed Benlate damage,
petitioners began a lawsuit against du Pont in the Circuit Court
of the Ninth Judicial Circuit in and for Orange County, Florida
(the lawsuit). Petitioners averred that du Pont had allowed the
Benlate used by petitioners to become contaminated so as to cause
the damage in question. Petitioners demanded a judgment for
monetary damages from du Pont under theories of strict liability
in tort and negligence. Under both theories, petitioners
claimed: “[T]he Fabrys have sustained damages in the form of the
lost value of destroyed or injured plants, damage to their
business reputation, lost income and lost value for their
business, the amount of which exceeds $10,000.” Du Pont answered
the lawsuit, denying knowledge or information sufficient to form
a belief as to the truth of many of petitioners’ allegations and
asserting affirmative defenses. - 5 -
After mediation, the lawsuit was concluded pursuant to a
stipulation of the parties, under which, among other things,
du Pont agreed to pay to petitioners the sum of $3,800,000.
Petitioners executed a general release and received the
stipulated payment. Five hundred thousand dollars of the
stipulated payment (the $500,000 payment) is allocable to
business reputation damages.
E. Income Tax Return
In reporting the proceeds of the lawsuit in their 1992
Federal income tax return, petitioners excluded the $500,000
payment.
III. Discussion
A. Introduction
Petitioners brought the lawsuit against du Pont, claiming
tortious injury to petitioners’ nursery business as the result of
their use of an agricultural chemical (Benlate) manufactured by
du Pont. Petitioners received $3,800,000 from du Pont in
settlement of the lawsuit, of which $500,000 is allocable to
damages on account of petitioners’ claim of injury to their
business reputation (the $500,000 payment). We must decide - 6 -
whether petitioners properly excluded the $500,000 payment from
gross income.
Petitioners bear the burden of proof. Rule 142(a).
B. General Rules
Section 61(a) provides that, except as otherwise provided,
“gross income” means “all income from whatever source derived”.
Sec. 61(a). With an exception not here relevant, section
104(a)(2) provides that “the amount of any damages received
(whether by suit or agreement * * * ) on account of personal
injuries or sickness” is excludable from gross income. The
regulations promulgated under section 104(a)(2) provide: “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.” Sec. 1.104-1(c), Income Tax Regs. To
determine whether any payment received in settlement of a lawsuit
is excludable under section 104(a)(2), we consider the nature of
the claim that was the basis for the settlement, not the validity
of the claim. E.g., Metzger v. Commissioner, 88 T.C. 834, 847
(1987), affd. without published opinion 845 F.2d 1013 (1988).
“If the settlement agreement lacks express language stating that
the payment was (or was not) made on account of personal injury,
then the most important fact in determining how section 104(a)(2) - 7 -
is to be applied is ‘the intent of the payor’ as to the purpose
in making the payment.” Id. at 847-848 (citing Knuckles v.
Commissioner, 349 F.2d 610, 613 (10th Cir. 1965), affg. T.C.
Memo. 1964-33).
Neither the text nor the legislative history of section
104(a)(2) offers any explanation of the term “personal
injuries”.2 Both the courts and the Commissioner long have
recognized, however, that the section 104(a)(2) reference to
“personal injuries” is not restricted to physical injuries but
encompasses nonphysical injuries to the individual, as well, such
as those affecting emotions, reputation, or character. See
United States v. Burke, 504 U.S. 229, 235 n.6 (1992). For
instance, we have on occasion found that damages received on
account of damage to a taxpayer’s business reputation were
excludable damages received on account of personal injury. E.g.,
Threlkeld v. Commissioner, 87 T.C. 1294, 1308 (1986) (based on
the nature of an action for malicious prosecution as an action
for personal injuries under Tennessee law, settlement payment
allocable to injury to professional reputation excludable from
gross income under section 104(a)(2)), affd. 848 F.2d 81 (6th
Cir. 1988). Nevertheless, as the Supreme Court recently made
clear in Commissioner v. Schleier, 515 U.S. 323, 329-330 (1995),
2 United States v. Burke, 504 U.S. 229, 234 (1992); see, e.g., H. Rept. 1337, 83d Cong., 2d Sess. 15 (1954); S. Rept. 1622, 83d Cong., 2d Sess. 15-16 (1954). - 8 -
although it is a necessary condition of exclusion under section
104(a)(2) that the damages (or settlement amount) in question be
received on account of the prosecution (or settlement) of a suit
or action based on tort or tort type rights, that is not a
sufficient condition for exclusion under section 104(a)(2). The
damages or settlement must be received both on account of a
violation of tort or tort type rights and for personal injuries
or sickness. Id. at 330. The parties here disagree as to
whether the $500,000 payment was received on account of personal
injuries.
C. Arguments of the Parties
The arguments of the parties are straightforward.
Respondent, while conceding that the $500,000 payment was
received in settlement of a claim for tortious injury to business
reputation, argues that it was not received on account of a
personal injury. Petitioners argue that injury to business
reputation is, as a matter of law, a personal injury.
D. Discussion
1. Nature of the Inquiry
We do not agree with petitioners that injury to business
reputation is, as a matter of law, a personal injury. In
Threlkeld v. Commissioner, supra, we decided not to follow our
decision in Roemer v. Commissioner, 79 T.C. 398 (1982), revd. 716
F.2d 693 (9th Cir. 1983), in which we distinguished between - 9 -
injury to personal reputation and injury to business reputation
and held that damages awarded on account of defamation resulting
in injury to business reputation did not give rise to damages
received on account of personal injuries within the meaning of
section 104(a)(2). We did not, in Threlkeld, adopt a per se rule
that damages received on account of injury to an individual’s
business reputation are excludable under section 104(a)(2). We
described the necessary determination as presenting a question of
fact. Threlkeld v. Commissioner, supra at 1305. We said that
the determination depended on the nature of the claim presented,
and we looked to all the facts and circumstances of the case,
including the State law characterization of the claim in question
(a claim for malicious prosecution) to determine the nature of
that claim. Id. at 1307-1308. We found that an action for
malicious prosecution is similar to an action for defamation and
concluded that it would be classified as an action for personal
injuries under Tennessee law. Id. at 1307. We concluded that
the payment received for the release of the taxpayer’s claims
against the defendant for damage to the taxpayer’s professional
reputation was excludable under section 104(a)(2).
Petitioners direct our attention to two recent memorandum
opinions, Knevelbaard v. Commissioner, T.C. Memo. 1997-330, and
Noel v. Commissioner, T.C. Memo. 1997-113, for the proposition
that “business reputation damages arising in tort actions are - 10 -
excludable under [section 104(a)(2)]”. Petitioners state: “No
special causation analysis was utilized in the Noel and
Knevelbaard decisions nor was one necessary.” In the Noel case,
the taxpayer had sued PepsiCo, Inc. (PepsiCo), claiming both
breach of contract and tortious interference with contractual
rights and prospective business advantages. The case was
settled, and the taxpayer received an undifferentiated amount in
settlement of all of his claims. We found that PepsiCo’s actions
had caused the taxpayer to suffer emotional distress and had
resulted in damage to the taxpayer’s business reputation. We
also found that the settlement payment was intended to settle
both the taxpayer’s contract claims and the tort claims. We
divided the settlement amount between those two categories and
held that the amount allocable to the tort claims was excludable
under section 104(a)(2). A fair reading of our report is that we
included as a tort claim the claim for damage to the taxpayer’s
business reputation (the business reputation claim). We did not
state how much (if any) of the tort claim recovery was allocable
to the business reputation claim, but it is a fair reading of our
report that some of it was. We did not discuss at length our
reasons for concluding that the unstated allocation to the
business reputation claim was on account of personal injuries
within the meaning of section 104(a)(2). We did find, however,
that, during settlement negotiations, the taxpayer had discussed - 11 -
with a representative of PepsiCo damages suffered by him,
including harm to his business reputation through adverse
publicity in the press. In Noel, we did not hold that, in all
events, damages received on account of injury to professional
reputation that results from a tortious act are damages received
on account of personal injuries within the meaning of section
104(a)(2). Knevelbaard also involved a payment received in
settlement of a lawsuit. The Commissioner argued that the
payment was in settlement of contract claims, while the taxpayers
argued that it was for emotional distress. We agreed with the
taxpayers, stating only in passing that harm to reputation is a
traditional harm associated with personal injury. Knevelbaard
also does not establish the rule of law that petitioners
advocate.
We must consider all of the facts and circumstances to
determine whether the $500,000 payment was received on account of
personal injuries, as that term is used in section 104(a)(2).
2. Facts and Circumstances
The lawsuit was concluded on March 23, 1992, when
petitioners filed their notice of voluntary dismissal with
prejudice in the court in which the lawsuit was commenced (the
dismissal notice). Contemporaneously, petitioners and du Pont
executed the “General Release of All Claims” (the release). The
release recites the consideration to be received by petitioners. - 12 -
It recites that it pertains to the use of certain products during
the cultivation of “Hoya, Carnosa, Citrus Liners and Citrus Trees
During the Years 1988 - 1991". It contains language releasing
du Pont and certain others from all claims relating to the use of
the products in question. It contains certain exclusions
relating to (1) crops cultivated after the date of the release
and (2) land on which the products were used. The release
contains no allocation of the consideration to be received by
petitioners to any cause of action or injury. Previously, on
March 13, 1992, petitioners and du Pont had executed a document
entitled “Stipulation of the Parties” (the stipulation), which
recites the essential terms of the release but contains certain
other terms. Among the terms of the stipulation is the
following: "Excepted from the release shall be: a. Soil
contamination, b. Personal injury, c. Customer claims."
The release lacks specific language from which we can
conclude that the $500,000 payment was received on account of
personal injuries. Although the release purports to be a general
release and contains language releasing du Pont from certain
undisclosed or potential claims, that is not sufficient evidence
on its own that any of the amount paid in consideration of the
release is on account of personal injuries within the meaning of
section 104(a)(2). See Scheele v. Commissioner, T.C. Memo. 1997-
426; Galligan v. Commissioner, T.C. Memo. 1993-605. We may, - 13 -
however, consider extrinsic evidence. Threlkeld v. Commissioner,
87 T.C. at 1306; Church v. Commissioner, 80 T.C. 1104, 1107
(1983); Fono v. Commissioner, 79 T.C. 680, 696 (1982), affd.
without published opinion 749 F.2d 37 (9th Cir. 1984). We must
determine the nature of petitioners’ claims and the intent of the
payor (du Pont) in making the $500,000 payment. We look to
petitioners’ First Amended Complaint for Damages and Demand for
Jury Trial (the complaint) to determine the nature of their
claim. The complaint asks for damages and avers essential facts.
Petitioners claim that the Benlate they purchased was defective
and proved detrimental to their nursery products. They claim
that, as the direct and proximate result of their use of the
defective Benlate, among other things, they suffered damage to
their business reputation. They base their claims for damages
against du Pont on theories of strict liability in tort and
negligence. Nowhere in the complaint, however, do petitioners
use the term “personal injuries” to describe the injuries claimed
to have been suffered as the result of their use of Benlate.
Petitioners have not argued to us (nor do we believe) that
all injuries attributed to a defendant under a theory of strict
liability in tort or caused by a defendant’s negligence
necessarily are personal injuries within the meaning of section
104(a)(2). Moreover, as we said supra in section III.D.1.,
damage to business reputation is not, per se, a personal injury - 14 -
within the meaning of section 104(a)(2). None of the other
injuries alleged in the complaint is a personal injury: plant
damage, lost profits, or loss of going-concern value.
Petitioners do not claim that the cause of injury, defective
manufacture of an agricultural chemical, necessarily results in a
personal injury within the meaning of section 104(a)(2).
Petitioners did not particularize their claim of injury to
business reputation, so we might work backwards to a claim of
defamation or some other “dignatory” or nonphysical (but
personal) tort. The plant damage averred by petitioners no doubt
injured their business and, consequentially, their business
reputation. Nowhere in the complaint, however, is there any
claim of personal injuries as the term is used in section
104(a)(2).
In addition to examining the release and the complaint, we
have considered the mediation that preceded settlement, as well
as the settlement negotiations between du Pont and petitioners.
We have found no evidence of a claim for personal injuries within
the meaning of section 104(a)(2). As part of the mediation,
petitioners filed a statement with the mediators (the statement).
The statement recites petitioners’ injuries in much the same
terms as the complaint (i.e., a discussion of plant damage and
the destruction of the nursery business). None of petitioners’
expert reports accompanying the statement, including the expert - 15 -
report as to damages, describes injuries other than to various
aspects of their business. In the letters of petitioners'
attorney that summarized the mediation, there is only one mention
of personal injury: his assertion that the personal injury
exception to the stipulation of the parties applied only to
physical personal injury. That assertion postdates the release
and fails to explain the absence of a similar exception in the
release. However, even if we were to assume that the release
contained such an exception, that would not establish that any
claim for personal injuries was made by petitioners. It only
would establish that no claim for “personal injury” (whatever
that term was intended to mean) was settled. There is still no
evidence that a claim for personal injury was made during the
lawsuit.3 Our examination of the mediation and settlement
negotiations reinforces our belief that a claim for personal
injuries was not raised in the suit and not addressed by du Pont
in the settlement negotiations (except as noted with respect to
the personal injury exception).
3 The only place that we noted where petitioners asserted a claim that may be a personal injury is in a letter to a private claims adjuster hired by du Pont before commencement of the lawsuit, in which they described their loss of friends who were also customers and their belief that they appeared as "lying, deceiving fools to our customers". That claim never was made within the context of the lawsuit, and petitioners have failed to convince us that, when the release was executed, du Pont had in mind any claim that had been made for personal injuries within the meaning of sec. 104(a)(2). - 16 -
Since the record of the lawsuit that is before us does not
include any claim for personal injuries within the meaning of
section 104(a)(2), we do not believe that the claim for injury to
business reputation was on account of personal injuries, as that
term is used in section 104(a)(2). Indeed, the stipulation on
its face excepts personal injury from its coverage.
3. Conclusion
The $500,000 payment is allocable to business reputation
damages. Nevertheless, petitioners have failed to prove that the
$500,000 payment was received on account of “personal injuries”,
as that term is used in section 104(a)(2).
IV. Conclusion
Petitioners have shown no grounds to exclude the $500,000
payment from gross income. Respondent’s determination of a
deficiency is sustained to the extent attributable to
petitioners' omission of the $500,000 payment from gross income.
Decision will be entered
under Rule 155.