Kovacs v. Commissioner

100 T.C. No. 10, 100 T.C. 124, 1993 U.S. Tax Ct. LEXIS 10

• Court: United States Tax Court
• Decided: February 24, 1993
• Docket: Docket Nos. 5617-90, 5619-90, 5618-90, 5620-90
• Status: Published

Opinions

OPINION

Ruwe, Judge:

Respondent determined deficiencies in petitioners’ 1987 Federal income taxes and additions to tax as follows:

Petitioner

Deficiency Addition to tax sec. 6661

Rosemary S. Kovacs $220,572 $55,143

Lois E. Kovacs 34,992 8,748

Mary Ann Kovacs 33,103 8,276

Kathleen L. Kovacs 30,184 7,546

Respondent has conceded the additions to tax under section 6661.²

The primary issue remaining for decision is whether “interest”, which petitioners received pursuant to Michigan Compiled Laws (M.C.L.) section 600.6013 (1987) on “damages” that were awarded to them in a wrongful death action is excluded from gross income under section 104(a)(2). The deductibility of attorney’s fees paid by petitioners will depend upon our resolution of the primary issue.

Petitioners resided in Fowlerville, Michigan, when they filed the petitions in this case.

The parties submitted this case fully stipulated pursuant to Rule 122. The stipulation of facts and attached exhibits are incorporated herein by this reference.

Rosemary S. Kovacs is the widow of Charles L. Kovacs, who was killed in 1976 when the truck that he was driving was struck by a locomotive operated by the Chesapeake & Ohio Railroad Co. (C&O). On September 25, 1978, Mrs. Kovacs, as administratrix of her husband’s estate, filed a complaint in the Livingston County Circuit Court against C&O and others in accordance with M.C.L. section 600.2922 (the Michigan wrongful death statute).

On May 28, 1982, a Livingston County Circuit Court jury delivered a verdict in favor of Mrs. Kovacs, awarding damages in the amount of $1,500,000, later reduced to $995,000.³ The Michigan Court of Appeals affirmed, as did the Michigan Supreme Court. Kovacs v. Chesapeake & Ohio Ry., 351 N.W.2d 581 (Mich. Ct. App. 1984), affd. 397 N.W.2d 169 (Mich. 1986).

On March 17, 1987, C&O issued a check in the amount of $2,254,741.70, payable to Rosemary Kovacs, administratrix of the Estate of Charles L. Kovacs, deceased, and C. Robert Beltz, her attorney. The check for $2,254,741.70 was full payment for damages in the amount of $995,000, $6,134.53 in costs advanced, and $1,253,607.17 in interest on the damages, pursuant to M.C.L. section 600.6013. Pursuant to M.C.L. section 600.6013, interest was calculated from the commencement of the action until March 17, 1987, the date the judgment was satisfied.

By order of the trial court, Mrs. Kovacs received 66% percent from the net proceeds and her daughters, Lois, Mary Ann, and Kathleen, each received 11% percent. The total award of $2,254,741.70 was disbursed as follows:

Attorney’s fees . $749,535.72

Costs advanced. 6,134.53

Rosemary S. Kovacs. 999,380.96

Mary Ann Kovacs. 166,563.50

Lois Elizabeth Kovacs . 166,563.50

Rosemary S. Kovacs, conservator of the Estate of Kathleen L. Kovacs, a minor. 166,563.50

Petitioners did not report any part of the amounts received on their 1987 Federal income tax returns, nor did they deduct any part of the attorney’s fees. Respondent determined that petitioners should have included the interest portion of the award in gross income. Respondent allocated the interest among the recipients in proportion to the percentages in the trial court’s order. Respondent also determined that, under section 212(1), petitioners were entitled to miscellaneous itemized deductions, subject to the 2-percent floor provided by section 67, for attorney’s fees attributable to the interest portion of the award. Respondent allocated the amounts of interest income and deductions for attorney’s fees, after taking into account the 2-percent floor, as follows:

Interest income Attorney’s fees

Rosemary S. Kovacs $835,730 $260,961.16

Mary Aim Kovacs 139,290 43.448.67

Lois E. Kovacs 139,290 43.251.67

Kathleen L. Kovacs 139,290 43.637.67

Totals 1,253,600 391,299.17

Petitioners filed a timely petition with this Court.

Section 61(a)(4) provides that gross income includes “interest”. See Kieselbach v. Commissioner, 317 U.S. 399, 403-404 (1943); Tiefenbrunn v. Commissioner, 74 T.C. 1566, 1572 (1980); Smith v. Commissioner, 59 T.C. 107, 111-113 (1972); Wheeler v. Commissioner, 58 T.C. 459, 461-462 (1972); Trez v. Commissioner, T.C. Memo. 1976-141. Nevertheless, petitioners argue that the “interest” they received pursuant to M.C.L. section 600.6013 (1987)⁴ is excludable from gross income under section 104(a)(2). 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; [Emphasis added.]

For damages to be excludable under section 104(a)(2), the taxpayer’s underlying claim must be for tortlike personal injury. United States v. Burke, 504 U.S. _, _, 112 S. Ct. 1867, 1870 (1992) (quoting sec. 1.104-l(c), Income Tax Regs.). The underlying claim in the instant case is for wrongful death, which clearly lies in tort, see Prosser & Keeton, Law of Torts, sec. 127, at 945-960 (5th ed. 1984), and it is undisputed that the amount designated as “damages” was awarded on account of a personal injury.

Petitioners take the position that the term “damages” in section 104(a)(2) should be construed expansively so as to include interest on such damages. However, it is a longstanding rule of statutory interpretation that statutes providing exclusions from income must be construed narrowly. Commissioner v. Jacobson, 336 U.S. 28, 49 (1949). Section 104(a)(2) makes no mention of “interest”. In order for us to accept petitioners’ position — that interest on damages is excluded from income by section 104(a)(2) — we would have to interpret the term “damages” broadly and overrule previous opinions. This we decline to do.

There is no more persuasive evidence of the purpose of a statute than the words which the legislature used to give expression to its wishes. United States v. American Trucking Associations, 310 U.S. 534, 543 (1940). This maxim is especially true in interpreting tax statutes. Crooks v. Harrelson, 282 U.S. 55, 61 (1930); United States v. Merriam, 263 U.S. 179, 187-188 (1923); Masonite Corp. v. Fly, 194 F.2d 257, 260-261 (5th Cir. 1952). “[T]he words of statutes — including revenue acts — should be interpreted where possible in their ordinary, everyday senses.” Crane v. Commissioner, 331 U.S. 1, 6 (1947); Miller v. Commissioner, 93 T.C. 330, 338 (1989), revd. on other grounds 914 F.2d 586 (4th Cir. 1990). The term “damages” connotes the “compensation or satisfaction imposed by law for a wrong or injury”. Webster’s Third New International Dictionary (1986). The word “interest” in this context means “the price paid for borrowing [i.e., withholding] money”. Id.⁵ Petitioners had the right to, and did, demand payment of the damages when they filed their wrongful death claim. The Michigan courts upheld the validity of the claim and awarded damages plus statutory interest from the date the claim was filed. The statutory interest from the date on which petitioners filed their claim to the date of payment, therefore, falls within the established definition of interest.⁶ In ordinary parlance, interest requires a principal sum. In the instant case, the damages are the principal sum on which the interest is owed, and ordinary usage suggests the two are separate. See 25 C.J.S., Damages, sec. 1(b), at 614 (1966) (“The term ‘damages’ is to be distinguished from other terms, such as ‘debt’, ‘interest’, ‘penalty’, ‘salary’, and ‘value’.”).

We last analyzed this issue in Aames v. Commissioner, 94 T.C. 189 (1990), in which we held that “interest” was not excludable under section 104(a)(2). In that case, the taxpayer had sued his attorney for malpractice for failing properly to prosecute the taxpayer’s personal injury claim and was awarded damages and interest thereon. We drew a distinction between the damages and the interest on such damages, noting that the nature of interest is that it is paid because of the delay in the receipt of a principal amount. In Aames, the principal amount was the amount awarded as “damages”. Id. at 193.

This issue first arose in Riddle v. Commissioner, 27 B.T.A. 1339 (1933), which concerned the excludability of damages and interest awarded thereon in connection with personal injuries sustained during the sinking of the steamship Lusitania. The Board, applying predecessors of sections 61(a) and 104(a)(2) (subsections (a) and (b)(5), respectively, of section 22 of the Revenue Act of 1928),⁷ held that interest was not a part of damages, observing that the interest was “separately computed and specifically designated as interest * * * and as such is includable in income.” Id. at 1341.

We have found no cases since Riddle was decided in 1933 which suggest that “interest” paid on an award of “damages” received on account of personal injury is excludable under section 104(a)(2). See Church v. Commissioner, 80 T.C. 1104, 1111 n.8 (1983), and Roemer v. Commissioner, 79 T.C. 398, 403-404 (1982), revd. 716 F.2d 693 (9th Cir. 1983), which both involved the exclusion of damages under section 104(a)(2), and in which there was agreement by the parties that interest was taxable.⁸ Since Riddle, the exclusion for personal injury damages has been reenacted and amended numerous times.⁹ Nevertheless, the statute continues to exclude only “damages” and omits any mention of “interest”. This implies a continuing acceptance by Congress of the existing interpretation of the exclusion. Merrill Lynch, Pierce, Fenner & Smith, Inc. v. Curran, 456 U.S. 353, 381, 382 & n.66 (1982) (longstanding judicial interpretation of statute approved by reenactment); see Society of Plastics Indus. v. ICC, 955 F.2d 722, 728-729 (D.C. Cir. 1992) (same).¹⁰ Based on the foregoing, we hold that the statutory “interest” received by petitioners is not excludable as “damages received * * * on account of personal injuries” within the meaning of section 104(a)(2).

The relevant statutory and case law in Michigan is consistent with our holding. The claim underlying petitioners’ interest award was brought under M.C.L. section 600.2922, entitled “Death by wrongful act; action for damages; liability.” At common law, no cause of action for wrongful death existed in Michigan. Hardy v. Maxheimer, 416 N.W.2d 299, 305 (Mich. 1987) (citing In re Olney Estate, 14 N.W.2d 574 (Mich. 1944); Hyatt v. Adams, 16 Mich. 180 (1867)); accord Fisher v. Volkswagenwerk A.G., 321 N.W.2d 814, 815 (Mich. Ct. App. 1982). Thus, petitioners’ right to “damages” for wrongful death stems solely from, and is limited to, what is provided by M.C.L. section 600.2922. See Endykiewicz v. State Highway Commn., 324 N.W.2d 755, 757, 758 & n.2 (Mich. 1982). That statute enumerates several types of damages available for wrongful death in Michigan, including:

reasonable medical, hospital, funeral, and burial expenses for which the estate is liable; reasonable compensation for the pain and suffering, while conscious, undergone by the deceased person during the period intervening between the time of the injury and death; and damages for the loss of financial support and the loss of the society and companionship of the deceased. * * * [M.C.L. sec. 600.2922(6).]

Petitioners received their interest pursuant to M.C.L. section 600.6013, which is a separate statute devoted solely to the “Interest rate on [the] judgment; [or] settlement.” Under M.C.L. section 600.6013(1) and (2), interest is calculated on and added to the judgment and is designed to compensate the plaintiff for the loss of use of the monetary damages.¹¹ McGraw v. Parsons, 369 N.W.2d 251, 254 (Mich. Ct. App. 1985). Statutory interest under M.C.L. section 600.6013 accrues from the date the complaint was filed until the judgment is paid and is not a part of damages. Vannoy v. City of Warren, 182 N.W.2d 65, 69 (Mich. Ct. App. 1970), affd. 194 N.W.2d 304 (Mich. 1972); Banish v. City of Hamtramck, 157 N.W.2d 445, 451 (Mich. Ct. App. 1968); Swift v. Dodson, 149 N.W.2d 476, 478 (Mich. Ct. App. 1967). The distinction between “damages” and “interest” under M.C.L. section 600.6013 is further illustrated by the opinions of the Michigan Supreme Court and Court of Appeals in petitioners’ case, in which the Courts’ references to “damages” clearly do not include “interest” paid pursuant to the statute. Kovacs v. Chesapeake & Ohio Ry., 397 N.W.2d 169, 169 (Mich. 1986); Kovacs v. Chesapeake & Ohio Ry., 351 N.W.2d 581, 592 (Mich. Ct. App. 1984); see also Old Orchard by the Bay v. Hamilton Mut. Ins. Co., 454 N.W.2d 73, 76 (Mich. 1990); Denham v. Bedford, 287 N.W.2d 168, 174 (Mich. 1980); accord Ramada Dev. Co. v. U.S. Fid. & Guaranty Co., 626 F.2d 517, 523-526 (6th Cir. 1980).¹²

Finally, petitioners argue that the Periodic Payment Settlement Act of 1982, Pub. L. 97-473, section 101, 96 Stat. 2605, supports their position that interest is excludable under section 104(a)(2).¹³ The purpose of this act was to codify the position of the Internal Revenue Service as it existed at that time with respect to the excludability of damages received in periodic payments. The Internal Revenue Service’s position was that section 104(a)(2) excluded personal injury damages, regardless of whether they were received in periodic payments or as a lump sum. S. Rept. 97-646 (1982), 1983-1 C.B. 514, 515. Petitioners seem to argue that since the amount of future periodic payments would normally be determined by taking into consideration the time value of money, it would be inconsistent to exclude the entire amount of such periodic payments while taxing petitioners on the “interest” that they received.

The legislative history indicates that the limited purpose of the Periodic Payment Settlement Act of 1982 was to “provide statutory certainty” for the exclusion of “damages” that are paid in “periodic payments.” S. Rept. 97-646 (1982), 1983-1 C.B. 514, 515. Petitioners did not receive “periodic payments” of damages. Therefore, we perceive no relief that they can derive from the Periodic Payment Settlement Act of 1982, and certainly none from the revenue rulings cited in the legislative history to illustrate the legislative objective.¹⁴ Any potential theoretical inconsistency that might arise between taxing statutorily imposed “interest” while excluding “periodic payments” of damages, some part of which may be attributable to the time value of money, is not within our province to remedy. If Congress perceives an inconsistency, and is dissatisfied with the result, it has the power to change the statute. In the meantime, it is our duty to apply the statutory language. Regarding the nonexcludability of interest, application of the relevant statutory language has been consistent since Riddle v. Commissioner, 27 B.T.A. 1339 (1933), was decided in 1933. The legislative history of the Periodic Payment Settlement Act of 1982 states explicitly that “This provision is intended to codify, rather than change, present law.” S. Rept. 97-646 (1982), 1983-1 C.B. 514, 515. Thus, the amendment effected no change to the longstanding precedent established in Riddle, wherein it was held that interest on personal injury damages is not excludable from income.

where * * * Congress adopts a new law incorporating sections of a prior law, Congress normally can be presumed to have had knowledge of the interpretation given to the incorporated law, at least insofar as it affects the new statute. [Lorrilard v. Pons, 434 U.S. 575, 581 (1978).]

Deductibility of Attorney’s Fees

The parties have agreed that if we hold that petitioners’ interest award is includable in income, the attorney’s fees attributable to interest are deductible under section 212(1).¹⁵ Because we have held that the interest is includable in income, petitioners will be allowed to deduct the portion of their attorney’s fees attributable to interest. Stocks v. Commissioner, 98 T.C. 1, 18 (1992); Metzger v. Commissioner, 88 T.C. 834, 860 (1987), affd. without published opinion 845 F.2d 1013 (3d Cir. 1988); Church v. Commissioner, 80 T.C. 1104, 1110-1111 (1983).¹⁶

Decisions will be entered for respondent as to the deficiencies in tax and for petitioners as to the addition to tax.

Reviewed by the Court.

Hamblen, Parker, Shields, Cohen, Clapp, Swift, Gerber, Wright, Parr, Wells, Chiechi, and Laro, JJ., agree with the majority opinion. Jacobs, J., concurs in the result only. Chabot, J., dissents.

2 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.

3 The original verdict of $1,500,000 was reduced one-third due to Charles L. Kovacs’ contributory negligence and further reduced by $5,000 for an amount previously paid by the Board of Road Commissioners for the County of Livingston to settle claims against the board.

4 Michigan Compiled Laws (M.C.L.) sec. 600.6013 (1987), provides:

(1) Interest shall be allowed on a money judgment recovered in a civil action, as provided in this section * * *

(2) For complaints filed before June 1, 1980, in an action involving other than a written instrument having a rate of interest exceeding 6% per year, the interest on the judgment shall be calculated from the date of filing the complaint to June 1, 1980, at the rate of 6% per year and on and after June 1, 1980, to the date of satisfaction of the judgment at the rate of 12% per year compounded annually.

5 See also Kieselbach v. Commissioner, 317 U.S. 399, 403-404 (1943) (interest constitutes “compensation for the delay in payment”); Tiefenbrunn v. Commissioner, 74 T.C. 1566, 1572 (1980) (interest component of a condemnation award constitutes amount separate from price of condemned property); Smith v. Commissioner, 59 T.C. 107, 111-113 (1972) (interest as compensation for delay in payment).

6 Cf. Albertson's, Inc. v. Commissioner, 95 T.C. 415 (1990), where we held that amounts which were deducted as accrued interest in a transaction that did not involve borrowing, withholding of amounts due, or forbearance from demanding payment were not properly characterized as “interest” because there was not, and never had been, a present right to claim the so-called principal amount. Albertson's involved employment contracts, wherein the employer and employees agreed, in advance of the performance of any services, that part of the employees’ compensation would be deferred until retirement or termination of employment. The amounts which were ultimately to be paid were characterized by the employer as deferred compensation plus interest. A deduction for interest on the amount designated as deferred compensation was taken by the employer prior to retirement or termination of the employees, even though the employees had never had a basis upon which they could have filed a claim demanding payment. Under those circumstances, we held that no part of the agreed-upon deferred compensation arrangement constituted interest.

7 The Revenue Act of 1928, ch. 852, sec. 22(b)(5), 45 Stat. 791, 798, excluded from gross income the following:

Amounts received, through accident or health insurance or under workmen’s compensation acts, as compensation for personal injuries or sickness, plus the amount of any damages received whether by suit or agreement on account of such injuries or sickness;

8 Cf. McShane v. Commissioner, T.C. Memo. 1987-151, which involved a one-time settlement payment for a personal injury. In excluding the full amount of that payment, we relied primarily on the taxpayers’ testimony, which indicated that no interest or costs were included in the settlement payment. In addition, we reasoned that no unconditional obligation upon which to compute interest existed until the settlement agreement was reached. We noted, however, that “any statutory interest on the final judgment would have been taxable income under section 61.”

9 See Periodic Payment Settlement Act of 1982, Pub. L. 97-473, sec. 101(a), 96 Stat. 2605; sec. 104(a)(2), I.R.C. 1954, 68A Stat. 30; sec. 22(b)(5), I.R.C. 1939, 53 Stat. 10. The most recent amendment to sec. 104(a)(2) was enacted by the Omnibus Budget Reconciliation Act of 1989, Pub. L. 101-239, sec. 7641(a), 103 Stat. 2106, 2379.

10 See also Cannon v. University of Chicago, 441 U.S. 677, 696-697 (1979) (“It is always appropriate to assume that our elected representatives, like other citizens, know the law;”)-

11 Under the Michigan statute, interest is awarded as a matter of right upon entry of the judgment at a specified rate regardless of the type of claim or the importance of any element thereof. See M.C.L. sec. 600.6013 (1987) (“Interest shall be allowed on a money judgment recovered in a civil action, as provided in this section” (emphasis added)).

12 Historically, judges and commentators have debated over whether interest constitutes an award “in the nature of damages”. See 25 C.J.S., Damages, sec. 51 (1966), and cases cited therein. The historically debated status of interest shows, at a minimum, that it has always been recognized as a concept with its own identity distinct from “damages”.

To permit an award of interest it is necessary that the claim for damages shall represent a pecuniary loss which is susceptible of computation with reasonable certainty, or by means of established market values or other generally recognized standards. [25 C.J.S., Damages, sec. 51, at 790 (1966)]. The cases in Michigan make clear that statutory interest computed from the date of filing a claim until payment pursuant to M.C.L. sec. 600.6013 is not a part of damages. See Vannoy v. City of Warren, 182 N.W.2d 65, 68 (Mich. Ct. App. 1970), affd. 194 N.W.2d 304 (Mich. 1972); Swift v. Dodson, 149 N.W.2d 476, 478 (Mich. Ct. App. 1967).

13 The Periodic Payment Settlement Act of 1982, Pub. L. 97-473, sec. 101, 96 Stat. 2605, amended sec. 104(a)(2) by striking out “whether by suit or agreement” and inserting in lieu thereof “whether by suit or agreement and whether as lump sums or as periodic payments.”

14 The legislative history cites four prior revenue rulings dealing with settlements of personal injury claims. See S. Rept. 97-646 (1982), 1983-1 C.B. 514, 515. In Rev. Rul. 77-230, 1977-2 C.B. 214, periodic payments from a Federal Government trust for a taxpayer’s future medical expenses were ruled fully excludable. In Rev. Rul. 79-220, 1979-2 C.B. 74, all periodic payments from an annuity contract purchased by a tortfeasor’s insurer were ruled fully excludable. In Rev. Rul. 79-313, 1979-2 C.B. 75, 50 consecutive annual payments, to be increased by 5 percent each year, were ruled fully excludable. Finally, in Rev. Rul. 76-133, 1976-1 C.B. 34, involving a lump sum awarded in a personal injury suit, part of which was then ordered by the court to be invested on behalf of a minor until he reached majority, the interest earned on the investment was ruled includable in the minor taxpayer’s gross income. What distinguished Rev. Rul. 76-133, supra, from the other three rulings was that the taxpayer in Rev. Rul. 76-133 was found to have had constructive receipt or the economic benefit of the damages at the time they were invested on his behalf. See S. Rept. 97-646 (1982), 1983-1 C.B. 515 nn, 2 and 3; Rev. Rul. 76-133, supra. It is clear from the legislative history that it was Congress’ intent to provide “statutory certainty” that the type of “periodic payments” described in the first three rulings would continue to be excluded from gross income.

15 Attorney’s fees attributable to the damages excludable from income are not deductible. Sec. 265(a); Metzger v. Commissioner, 88 T.C. 834, 860 (1987), affd. without published opinion 845 F.2d 1013 (3d Cir. 1988).

16 In Church v. Commissioner, 80 T.C. 1104 (1983), we used the following formula to determine the correct deduction:

Total attorney’s fees x Nonexempt income = Deductible fees

Total award