Gambling With Settlement Proceeds: Confidentiality After Amos v. Commissioner
| Jurisdiction | United States,Federal |
| Citation | Vol. 77 No. 4 Pg. 24 |
| Pages | 24 |
| Publication year | 2008 |
By Mary E. Christopher
I. Introduction
The parties who participate in a settlement conference must weigh the risks presented by taking the case to trial and decide whether to "roll the dice" and accept the decision entered by 12 unknown laypeople on the jury or whether to manage their risk through settlement. The preparations and strategies of the participants, the excitement at the prospect of monetary gain or loss, and emotional highs and lows involved in reaching a compromise may be compared to a show in the days of the famed Rat Pack[1] — no one knows quite where things are headed, who will appear, or when the gathering will end.
Parties to a successful settlement conference or their insurers often insist on confidentiality as one of the terms or conditions of settlement. A defendant may believe the publicity regarding the fact of settlement will set a precedent that will inspire others to file similar claims or false accusations, damage his or her reputation, or outweigh the defendant's assertions that liability was not clearly established.[2] The promise of confidentiality may convince a defendant to relinquish his or her opportunity to go to trial and roll the dice on obtaining a defense verdict. Similarly, a plaintiff may not want his or her identity and the amount of settlement to be known. A plaintiff may wish to minimize subsequent solicitation from opportunists, relatives, or charitable organizations, or to preempt the possibility that the public will perceive that a small settlement meant that his or her suit had no merit.[3] For insurers, confidentiality provisions are seen as a way to protect the insured from adverse publicity that could lead to future litigation.
The inclusion of a confidentiality agreement within a settlement agreement historically was a fairly straightforward process. The "value" of the confidentiality provision was considered more aesthetic than economic, and the consideration for the provision was minimal and mutual. However, recent cases from the tax court suggest the Internal Revenue Service (IRS) may assign "economic value" for a confidentiality provision, leaving many nervous they are taking a gamble by agreeing to incorporate a confidentiality clause. This article will examine the current thought on the value of confidentiality, starting with the defining case of Amos v. Commissioner.[4]
II. How Lucky Can One Guy Be ... Ain't That a Kick in the Head?
In January 1997, viewers watched a televised incident involving more than a figurative "kick in the head" when, during a Timberwolves-Bulls game, basketball's infamous Dennis Rodman fell and landed on top of courtside photographers and a television cameraman named Eugene Amos. Rodman twisted his ankle in the fall and then, as he got up, kicked Amos in the groin.[5]
After the incident, Amos was transported by ambulance to a local medical center. Amos told medical staff that immediately after he was kicked in the groin he experienced shooting pain to his neck, but that the pain was subsiding.[6] Medical personnel noted Amos was limping and complained of pain but was able to walk, and no other physical injuries or trauma were noted.[7] It must have dawned on Amos that opportunity was knocking at his door because, while still at the medical center, Amos contacted a personal injury attorney about representing him in connection with the incident.[8] After a dispute with medical staff, Amos abruptly left without having been discharged. Later that day, Amos filed a police report declaring that Dennis Rodman had assaulted him.[9]
Shortly thereafter, Rodman's attorney contacted Amos' attorney. Following several meetings, the parties agreed to settle the potential claim. In the confidential settlement agreement executed by the parties, Amos agreed to release all potential claims relating to the incident against Rodman, the Chicago Bulls, and the National Basketball Association. In addition, Amos agreed to keep the terms of the settlement confidential; not to publicize the settlement; not to grant any interviews or make any statement regarding the incident; to keep the underlying facts, allegations, and opinions concerning the assault confidential; not to make any public statement regarding either Rodman or the assault; and not to assist authorities in any prosecution of Rodman.[10] Amos received payment from Rodman of $200,000.
When Amos filed his 1997 tax return, he did not include the $200,000 settlement proceeds in his gross income.[11] This did not go unnoticed.[12] The IRS issued a deficiency notice to Amos indicating he was only entitled to exclude $1 of the settlement proceeds from his gross income. This meant Amos would have to pay tax on $199,999.[13] Amos disputed this determination, asserting the entire $200,000 should be excluded under Internal Revenue Code §104(a)(2).
A. Every time it rains ... it rains pennies from heaven — §104(a)(2)
Under the Internal Revenue Code (IRC), compensation received in the form of damages generally must be reported as gross income. If an exemption from taxation applies, however, it rains pennies from heaven for the taxpayer.[14] Section 104(a)[15] of the IRC contains five narrow exemptions from taxation for injuries or sickness received by virtue of workers' compensation, accident or health insurance, pensions, or annuity payments as the result of active service in the armed forces, or disability income received as a direct result of a terroristic or military action.[16] Finally, subsection 104(a)(2) contains a tax exemption for litigation damages received on account of "personal physical injuries or physical sickness."[17]
Two U.S. Supreme Court decisions are significant in understanding the mechanics of §104(a)(2):[18] Burke v. United States[19] and Commissioner v. Schleier.[20]
In Burke, the Court examined §104(a)(2)'s requirement of "personal injury." In the underlying case, Burke argued she was entitled to a refund of the taxes withheld from the settlement award she received following a sex discrimination suit against her employer.[21] In the absence of legislative history, the Court turned to IRS regulation §1.104-1(c)'s definition of excludable damages as amounts received through an action "based upon tort or tort type rights."[22] Grafting the "based upon tort or tort type rights" element onto §104(a)(2), the Court determined the taxpayer must show the legal basis of his or her claim was "a tort-like personal injury."[23] The Court noted Burke's complaint sought redress under Title VII, which offered only the limited remedies of backpay, injunctions, and other equitable relief, not the broad range of compensatory damages available in tort cases. The Court reasoned because Title VII was not designed to redress a tort-like personal injury, Burke could not show the underlying cause of action giving rise to her settlement award was "based upon tort or tort type rights."[24] Therefore, the Court concluded Burke was not entitled to an exclusion under §104(a)(2).[25]
In Commissioner v. Schleier,[26] the U.S. Supreme Court refined its analysis of §104(a)(2). Following a class action suit claiming violations of the Age Discrimination in Employment Act of 1967 (ADEA) challenging United Airline's policy of firing employees upon reaching age 60, Schleier received a settlement, which represented both backpay and liquidated damages.[27] Schleier included the backpay portion of the settlement as gross income on his tax return, but excluded the amount attributable to liquidated damages.[28] The IRS issued a deficiency notice.
Schleier initiated proceedings in U.S. Tax Court, claiming not only did he properly exclude the liquidated damages portion as damages received on account of personal injuries or sickness, but also that he should receive a refund of the taxes he paid on the backpay portion of the settlement under §104(a)(2).[29]
The Court began its analysis of the exclusion in §104(a)(2) by considering the application of the phrase "on account of personal injuries" in a typical personal injury automobile accident case where the taxpayer recovers damages for medical expenses, lost wages, and for pain, suffering, and emotional distress.[30] The Schleier Court reasoned that in personal injury cases, each element was properly excluded from taxation under §104(a)(2) "not simply because the taxpayer received a tort settlement, but rather because each element of the settlement satisfies the requirement set forth in § 104(a)(2) that the damages were received 'on account of personal injuries or sickness.'"[31] In analyzing the application to Schleier's ADEA claim, the Court found there was no psychological or personal injury to Schleier serving as the proximate cause of the unlawful termination leading to his recovery of back wages.[32]Likewise, it found the liquidated damages received under the ADEA were not received "on account of personal injury ..."[33]
Schleier made it plain that, in order to successfully claim exemption from taxation under § 104(a)(2), a taxpayer must satisfy two independent requirements. First, the underlying cause of action must...
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