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Payments to Settle Defamation Claim Are Taxable

Polone v. Commissioner of Internal Revenue, 505 F.3d 966 (C.A. 9, Oct. 11, 2007)

Gavin Polone (“Polone”) worked as a talent agent for United Talent Agency until he was fired. After that, UTA made statements regarding Polone’s “inappropriate behavior” to industry publications. Polone sued for wrongful termination and defamation. The parties settled the claims on May 3, 1996, with Polone receiving $2 million for the wrongful termination claim plus four payments of $1 million each (May, 1996, Nov., 1996, Nov. 1997, Nov. 1998) for the defamation claim.

When the parties settled, damages received on account of "personal" injuries were exempted from gross income. 26 U.S.C. § 104(a)(2). "Personal" injury damages had been interpreted to include damages from settlements of defamation claims. Roemer v. Comm’r, 716 F.2d 693, 700 (9th Cir.1983). Congress amended §104 in August 1996 to exempt from gross income compensatory damages received on account of "physical" injuries. This amendment overruled court decisions like Roemer.

Amended §104 included an exception for amounts received under a written binding agreement, court decree or mediation award in effect on (or issued before) September 13, 1995. 26 U.S.C. §104. The Tax Court held that post-amendment §104 applied to the three $1 million payments made to Polone after November 1996 for settlement of his defamation claim, because Polone received the payments after the amendment’s effective date. Polone appealed to the Ninth Circuit.

Polone argued the taxable gain from his entire defamation settlement should have been recognized May 3, 1996, therefore, the entire $4 million settlement would not be recognized as income. The Court observed that if it accepted Polone’s argument, then structured settlement recipients would pay taxes on their entire settlement amounts, sometimes years before receiving the funds, which is contrary to the congressional purpose of structured settlements. See Staff of Joint Comm. on Taxation, 106th Cong., Tax Treatment of Structured Settlement Arrangements (Comm. Print 1999).

Polone argued his defamation settlement payments received post amendment should not be taxed because applying amended §104 to such payments was retroactive legislation that violated his Fifth Amendment due process rights. Various tests determine whether a particular statute applies retroactively, but generally a statute operates retroactively if it attaches new legal consequences to completed, past conduct. Landgraf v. USI Film Prods., 511 U.S. 244, 270 (1994).

Section 104 applied to the payments Polone received in November 1996, May 1997 and November 1998, but did not attach new legal consequences to payments previously made. The amendment applied new tax consequences to payments made post-amendment only. Settlement payments received after the effective date of the Amendment were taxable as ordinary income.

The Tax Court decision was affirmed.



Judge(s): Sidney R. Thomas
Jurisdiction: U.S. Court of Appeals, Ninth Circuit
Related Categories: Torts
Petitioner Lawyer(s) Petitioner Law Firm(s)
Jonathan M. Brenner Sidley Austin LLP
James Harris Sidley Austin LLP

Respondent Lawyer(s) Respondent Law Firm(s)
Donald Korb Internal Revenue Service
Kenneth L. Greene U.S. Department of Justice
John A. Nolet U.S. Department of Justice
Bridget M. Rowan U.S. Department of Justice



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35(b). from the wrongdoers as punishment for unlawful conduct can applies to the entire $4 million he received from uta. the april 24, 1996, polone filed a complaint in the los angeles [2] congress amended 104 in august 1996 so that it central district of california, sitting by designation. on the november 1996 settlement payment. the tax court to the settlement payments he received in november 1996, filed october 11, 2007 united states court of appeals film prods., 511 u.s. 244 (1994), and the supreme court has on may 3, 1996; november 11, 1996; may 5, 1997; and lar statute applies retroactively. for example, the court has gavin polone, although polone settled his claims with uta in september 13, 1995 was the date upon which congress first proposed was applied to a contract whose fulfillment was still a work ruled court decisions, like roemer, that had exempted awards rehearing en banc, and no judge of the court has requested a h.r. conf. rep. 104-737 at 301 ("thus, the exclusion from respondent. bridget m. rowan, kenneth l. greene, eileen j. o'connor, see staff of joint comm. on taxation, 106th cong., tax sels against polone's novel proposal to import 1001 to the his entire settlement of $4 million was realized on may 3, not detract from their character as taxable income to the recip- age structured settlement as opposed to lump-sum schemes. to 104. because the settlement was not in effect before sep- structured settlement context. section 1001 provides that the we review this constitutional claim de novo. quarty v. united tion are plainly inapposite. see herbert's estate v. comm'r, enough that a statute "is applied in a case arising from con- 1605(d).1 u.s.c. 1041. cook, 904 f.2d at 109 n.1. such holdings are thomas, circuit judge: 13793polone v. commissioner of internal revenue release retracting its previous statements about polone's ter- in may 1996, when polone and uta settled, 26 u.s.c. for publication exclusions from income must be narrowly construed." (quota- "amounts received," and not "amounts realized" -- a critical held that polone owed taxes on the may 1997 and november order taxes on the full prospective amount of the settlement on the tion may upset the reasonable expectations that prompted of polone's defamation claim was nowhere near complete as return seeking a refund. he did not pay taxes on the may amendment 104 applied to the november 1996, may 1997, physical injuries or physical sickness." 26 u.s.c. 104(a)(1) claiming that the irs should have reduced his 1996 taxable polone received $2 million as settlement of the wrongful we do not address whether amended 104(a)(2) violates the sixteenth rehearing en banc is rejected. no. 04-72672 1996, the date of settlement, even though uta paid him in united states department of justice, for appellee commis- 511 u.s. at 269. the fact that polone's tax dispute stemmed sional support for such overreaching. congressional intent is first instance; the cases were later legislatively overruled by (1995). the term "personal injuries" in 104 had been inter- clear: structured settlements are to be taxed as payments are a legal claim can be considered property for purposes of in september 2000, the irs sent polone a deficiency notice the amendments applied only prospectively, to payments in effect on (or issued before) september 13, 1995." 26 application of 1001 to polone's settlement with uta is a 13785polone v. commissioner of internal revenue explained above, the amendment to 104 explicitly applied taxable gain from the "sale or other disposition of property," james m. harris, edwin l. norris, jonathan m. brenner, sid- polone, citing our decision in warren jones co., argues and george schiavelli,* district judge. clearly contemplates that payments be taxed the year in which received in may 1996, may 1997, and november 1998. incomes, from whatever source derived, without apportionment among the revisions to 104 -- does not mean that 104 operates retro- suggestion for rehearing en banc and judges farris and schia- order and amount realized the year property is disposed of under `retrospectively' merely because it is applied in a case arising made after their date of enactment. compare with untermeyer v. received in november 1996, may 1997, and november 1998, appeal. the power of congress to tax income is provided in the sixteenth claims. roemer v. comm'r, 716 f.2d 693, 700 (9th cir. several states, and without regard to any census or enumeration." velli so recommend. legal consequences to completed payments. on the contrary, the november 1996 payment, but later filed an amended 1996 t.c.m. 1479 (1999) (same). these divorce settlements deter- *the honorable george schiavelli, united states district judge for the paid in four installments of $1 million, which polone received county superior court alleging, among other things, wrong- polone also argues that pre-amendment 104 should apply polone received after its effective date. of the statute." this argument is unconvincing for two rea- to pay taxes on this income on our decision in warren jones held that polone did not owe any taxes on the may 1996 set- 138 f.2d 756 (3d cir. 1943) (satisfaction of debt by debtor the amendment's effective date is a question of statutory a seemingly prospective application to apply retroactively in (1962) (transfer of property in compliance with divorce settle- tember 13, 1995, it was not subject to the exception to a written binding agreement, court decree, or mediation award appeal from a decision of the installment sale as the full fair market value of the property, 13789polone v. commissioner of internal revenue 1159 (9th cir. 1996). but 104 specifically refers to received on the date contracted). we have found no congres- of august 20, 1996. on the contrary, uta still had to make en banc shall be filed or entertained in this case. opinion by judge thomas retroactively because his settlement with uta was "finalized [7] retroactive legislation runs the risk of offending the 2000. he also filed an amended petition in august 2002, considered a "disposition"; however, taxed year received, not may 1996, he did not actually receive the three payments in 99.htm). moreover, in order to alleviate this burdensome [9] applying this test to 104, we hold that amended 104 1 they are received. "finalized" in the sense that both parties signed it, settlement quences" to completed, past conduct. id. at 270. it is not november 11, 1998. some circumstances, landgraf, 511 u.s. at 258-59, the vote on the suggestion for rehearing en banc. fed. r. app. p. treatment of structured settlement arrangements (comm. tlement payment. id. he appeals. tions omitted)); comm'r v. glenshaw glass, 348 u.s. 426, year obligation created); united states v. davis, 370 u.s. 65 13788 polone v. commissioner of internal revenue considered whether a statute "takes away or impairs vested date of the settlement, sometimes years before receiving that sioner of the internal revenue service. amendment: "the congress shall have power to law and collect taxes on n.23 (quoting miller v. florida, 482 u.s. 423, 430 (1987)). the case in untermeyer and blodgett. rather, amended 104 governs the settlement payments that polone received after 13792 polone v. commissioner of internal revenue august, 1996 are taxable as ordinary income. received. construed narrowly, 61(a) applies to all income, including comm'r, 69 t.c.m. (cch) 1792 (1995); nahey v. comm'r, code, payees of structured settlements would be forced to pay sets expectations based in prior law." id. at 269-270. thus, for 13786 polone v. commissioner of internal revenue counsel amended 104 for preexisting settlement agreements. thus, the transaction a taxable event); cook v. united states, 904 ness" from a taxpayer's gross income. 26 u.s.c. 104(a)(2) 13791polone v. commissioner of internal revenue 13787polone v. commissioner of internal revenue ients."). tax ct. no. stituted opinion is filed concurrently with this order. claims on may 3, 1996. [5] warren jones co. does require a taxpayer to report the received after the effective date of amendments to 26 u.s.c. not. id. at 68. polone argues that the pre-amendment 104 before: jerome farris and sidney r. thomas, circuit judges, ii the amended version of 104 applies to the payments polone the full court has been advised of the suggestion for summated" prior to the amendment's effective date, as was the excess of the amount realized therefrom over the adjusted august 20, 1996. 26 u.s.c. 104, application of august 20, amount. this would subvert congressional policy to encour- from his settlement with uta -- conduct that antedated the example, even though "a new property tax or zoning regula- duct antedating the statute's enactment," or that a statute "up- united states tax court amendments to 104 did not because they did not attach new interpretation that we review de novo. leslie v. comm'r, 146 november 1996 settlement payment were proper. polone v. 1001. see, e.g., united states v. stonehill, 83 f.3d 1156, [10] polone argues that the amendments to 104 apply cuted prior to the effective date can be excluded from gross ments about polone's termination. specifically, uta alleged inquiry into the system of taxation under this section -- coun- co. v. comm'r, 524 f.2d 788 (9th cir. 1975), alleging that 12665-00 tively, a statute must actually "attach[ ] new legal conse- v. anderson, 276 u.s. 440, 445 (1928) (a tax was retroactive [8] the thrust of the various tests is that to operate retroac- settlement payments. comm'r v. schleier, 515 u.s. 323, 328 august 20, 1996, unless the parties had contracted prior to spectively when it is applied to settlement payments that received after the effective date of the amendment, and we preted to include damages from settlements of defamation polone hired counsel, and sent uta a demand letter on under 104 as dispositions of property and not as ordinary as periodic payments) on account of personal injuries or sick- [6] were we to adopt polone's interpretation of the tax argued and submitted 1996 amendments. although it is possible for a statute with of death and fully consummated prior to" the statute's effec- income by $1 million because he had erroneously paid taxes (1995) ("the default rule of statutory interpretation [is] that memo 2003-339 at 66. as a result, it held that the may 1996 (1996) (emphasis added). the amendment legislatively over- (whether by suit or agreement and whether as lump sums or sons. first, although the settlement contract may have been on may 3, 1996, more than three months before the enactment applies to all four settlement payments he received, and thus i court that the settlement payments received by polone after 111 t.c. 256 (1998). question until well after the effective date of the amendments that polone was terminated for "inappropriate behavior." april 22, 1996. the letter alleged that uta had made defam- may 1996 version of 104 or the amended version of 104 payment was tax exempt, but that the other payments were to all who had purchased property prior to the effective date to amend 104. h.r. 2491 (104th cong., 1995). iii quences of acts completed before its effective date," id. at 269 13784 polone v. commissioner of internal revenue the opinion filed march 12, 2007, is withdrawn and a sub- warren jones co. required him "to treat his receipt of his for- petitioner, may 1997, and november 1998 because applying amended notice. applies to any damages received after its effective date of here, the tax court held that pre-amendment 104 applied tax regime would not be considered retroactive with respect of the settlement of the defamation claim, uta issued a press first place. we should also note that decisions of the tax ety for propagation of the gospel v. wheeler, 22 f. cas. 756 enactment of section 1041 of the internal revenue code, 26 gavin polone worked as a talent agent at united talent atory statements about polone, and requested that uta "cease "gain from the sale or other disposition of property shall be rights acquired under existing laws," id. at 269 (quoting soci- the petition for rehearing. judge thomas voted to reject the for nonphysical injuries from a taxpayer's gross income. see 61(a). thus, subject to certain exemptions, which are to be mined that divorce transactions were taxable events in the distinction in deciding whether to treat structured settlements april 6, 2006--pasadena, california (cc nh 1814)), or whether a law "changes the legal conse- 2 ment agreement treated as a disposition of property, rendering f.2d 107 (1st cir. 1990) (same); reynolds v. comm'r, 77 that under 26 u.s.c. 1001, which explains how to calculate that the $4 million in its entirety is tax exempt. whether the for the reasons explained above, we agree with the tax irrelevant to structured settlements taxed under 104, which the motion to modify opinion is denied as moot. 1983). payments after the amendment's effective date. polone, t.c. states, 170 f.3d 961, 965 (9th cir. 1999). 792-93 (determining that congress enacted the opt-out provi- income. we conclude that the amendments apply to payments provided various formulas for determining whether a particu- of the amendment. see id. at 270 n.24. [4] a straightforward reading of 104 -- and a broader guard uta's confidential information. thus, the tax court tion in violation of his fifth amendment due process rights.2 based on a claim of . . . injury to reputation."). the effective ley austin brown & wood llp, for appellant gavin polone. commissioner of internal in november 1996, may 1997, and november 1998. as affirmed. basis." 26 u.s.c. 1001(a). it is true that, as a general matter, was fired. after terminating polone, uta spoke with various only to amounts received after its effective date, which was comm'r, t.c. memo 2003-339 (2003). the tax court also mer employer's promise to pay $4 million as an amount real- [3] applying the plain language of 104, the tax court from conduct antedating the statute's enactment." landgraf, installments. therefore, he argues, pre-amendment 104 date of the amendments was august 20, 1996, but there was and desist from making further defamatory statements." on affirm the judgment of the tax court. reason to apply 1001 to personal injury settlements in the 104 exempted "the amount of any damages received no further petitions for rehearing or petitions for rehearing in progress. second, polone's argument falls squarely into the iv and november 1998 payments because polone received those as "all income from whatever source derived." 26 u.s.c. sales, 26 u.s.c. 453(d). cf. warren jones co., 524 f.3d at and the tax court properly sustained the irs's deficiency exempted "the amount of any damages (other than punitive opinion ized in the 1996 taxable year at the time of his receipt of the entertainment industry trade publications, and made state- termination claim, which is not at issue in this case. as part 142, 147 (1927) (same). 431 (1955) ("the mere fact that payments were extracted result, we would have no choice but to also import the opt-out polone, a cash basis taxpayer, did not include the may 1996 did not apply amended 104 to a contract that was "fully con- three payments to polone, and he had to honor his promise to [1] section 61(a) of the tax code defines "gross income" due process clause of the fifth amendment, landgraf v. usi with the filing of the opinion, the panel has voted to deny agency ("uta") from 1989 until april 21, 1996, when he question of statutory interpretation that we review de novo. 13781 where it applied to "bona fide gifts not made in anticipation to polone's may 1996 payment from uta, but that post- yet to find a case has treated structured settlements taxed provision available for income received from installment november 1998 payments were taxable. the amended statute properly held that the november 1996, may 1997, and leslie, 146 f.3d at 648. tive date) (emphasis added); blodgett v. holden, 275 u.s. supreme court's warning that "[a] statute does not operate those affected to acquire property," a change in the property amendment of the constitution, as polone failed to raise the issue on 104 to those payments would amount to retroactive legisla- polone petitioned for review in the tax court in december mination, and paid polone $4 million. the $4 million was sion to alleviate the "hardships" associated with reporting an 1998 settlement payments, and that the taxes he paid on the 13790 polone v. commissioner of internal revenue damages) received (whether by suit or agreement and whether 1001; however, for the reasons just explained, there is no f.3d 643, 648 (9th cir. 1998). for his failure to pay taxes on the settlement payments he was constitutionally applied to the payments polone received for the ninth circuit gross income does not apply to any damages received . . . 104(a)(2) based on a defamation settlement agreement exe- payment on his 1996 federal income tax return. he included revenue, 1997 or november 1998 payments. polone justified his failure this appeal presents the question of whether payments as lump sums or periodic payments) on account of personal the petition for rehearing is denied and the suggestion for u.s.c. 104, application of august 20, 1996 amendments. opinion promise to pay." an exception to the amendment for "amount[s] received under income received. the cases cited by polone for this proposi- september 13, 1995. p.l. 104-188, title i, subtitle f, part 1, print 1999) (available at http://www.house.gov/jct/x-15- v ful termination and defamation. polone and uta settled both as dispositions of property. 26 u.s.c. 104. indeed, we have court support this conclusion. see, e.g., alexander v.

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