O'Gilvie vs. US: The Final Word on the Taxation of Punitive Damages?
Wells, Wayne R., Kurtz, Janell M., The National Public Accountant
In December, 1996, the United States Supreme Court decided the case of O'Gilvie vs. US. In a six to three decision, the court held that punitive damages received as part of a wrongful death award were not excluded from taxable income by IRC. Sec. 104(a)(2), which excludes "any damages received on account of personal injuries."
The Supreme Court heard the case because US Circuit Courts of Appeal disagreed over the application of IRC. Sec. 104(a)(2) to punitive damages awarded in personal injury cases. The Fourth, Ninth, and Tenth Circuits held such punitive damages were taxable, while the Sixth Circuit held they were excluded. The Supreme Court agreed with the Fourth, Ninth, and Tenth Circuits and held punitive damages were not excluded from gross income by Inc. Sec. 104 (a)(2).
The petitioners in O'Gilvie were the husband and two children of Betty O'Gilvie, who died in 1988 of toxic shock syndrome. They received a jury award of $1,525,000 actual damages and $10,000,000 punitive damages. The petitioners paid the income tax on the punitive damages and sued for a refund in Federal District Court. The District Court held the punitive damages were excluded from income as they were "on account of personal injuries" as provided in IRC. Sec. 104(a)(2). The Tenth Circuit Court of Appeals reversed the District Court, and held the punitive damages were not excluded from taxable income.
The petitioners in O'Gilvie made three primary arguments to the Supreme Court:
That the "any" language in IRC. Sec. 104(a)(2) should be interpreted to include any damages, including punitive; Congress included compensation for lost wages within the 104(a)(2) exclusion because Congress intended injured parties to recover this compensation without tax consequences, and it is often difficult to determine what was lost wages and what was other damages. The same logic should apply to punitive damages as it is often difficult to distinguish punitive damages from compensatory damages, and arguably, Congress intended injured parties to recover these damages without tax consequences; Congress amended 104(a)(2) in 1989 to add "the exclusion shall not apply to any punitive damages in connection with a case not including physical injury or physical sickness." If Congress had intended to tax all punitive damages, such an amendment would not have been necessary.
As to the petitioner's first argument, the Supreme Court stated, "These arguments ... show only that one can reasonably read the statute's language in different ways. They do not overcome our interpretation of the provision in Schleier."
In June, 1995, the US Supreme Court decided the case of C.I.R. vs. Schleier. Also in a six-to-three decision, the Court held that damages received pursuant to the Age Discrimination in Employment Act (ADEA) were fully taxable and not excluded by Sec. 104(a)(2). The Court said, "Whether one treats respondent's attaining the age of 60, or his being laid off on account of his age, as the proximate cause of respondent's loss of income, neither the birthday nor the discharge can fairly be described as a personal injury or sickness."
The Court in Schleier also stated, "In age discrimination, the discrimination causes both personal injury and loss of wages, but neither is linked to the other. The amount of back wages recovered is completely independent of the existence or extent of any personal injury. In short, 104(a)(2) does not permit the exclusion of respondent's back wages because the recovery of back wages was not on account of any personal injury and because no personal injury affected the amount of back wages recovered." As to the liquidated damage part of the money received, the Court used the same analysis and held it was punitive in nature, not on account of personal injury or illness, and therefore not excluded from gross income.
As to the second argument of the petitioners in O'Gilvie: that the reasons that led Congress to exclude lost wages from income would also have led Congress to exclude punitive damages; the Court stated, "Our problem with these arguments is one of degree. …