SCOTUS Reports

Tag: Wrongful Termination

  • Biehl v. Comm’r, 118 T.C. 467 (2002): Reimbursement Arrangements and Accountable Plans Under IRC Section 62

    Biehl v. Commissioner, 118 T. C. 467 (2002)

    In Biehl v. Commissioner, the U. S. Tax Court ruled that a payment made by a former employer directly to an ex-employee’s attorney for wrongful termination claims did not qualify as a reimbursement under an accountable plan. This decision means the payment must be included in the ex-employee’s gross income and treated as an itemized deduction, potentially increasing their tax liability due to the alternative minimum tax (AMT). The case highlights the strict criteria for reimbursement arrangements under IRC Section 62, impacting how legal fees in employment disputes are taxed.

    Parties

    Frank and Barbara Biehl (Petitioners) v. Commissioner of Internal Revenue (Respondent). The Biehls were the plaintiffs at the trial level, and the Commissioner of Internal Revenue was the defendant. The case was appealed to the United States Tax Court.

    Facts

    Frank Biehl was an employee, officer, shareholder, and director of North Coast Medical, Inc. (NCMI), while Barbara Biehl was also a shareholder. In March 1994, the Biehls filed a lawsuit against NCMI and its other shareholders in Santa Clara County, California, Superior Court. The lawsuit included a claim for wrongful termination of Frank Biehl’s employment and a claim for dissolution of NCMI. Following a jury verdict of $2. 1 million in favor of Frank Biehl on his wrongful termination claim, the parties negotiated a global settlement in December 1996. Under the settlement, NCMI paid $799,000 directly to Frank Biehl and $401,000 directly to the Biehls’ attorney. The Biehls did not report the $401,000 payment to their attorney on their 1996 tax return, arguing it was a reimbursement under an accountable plan.

    Procedural History

    The Biehls filed a petition in the United States Tax Court challenging the Commissioner’s determination of a $97,833 deficiency in their 1996 federal income tax. The Commissioner argued that the $401,000 payment to the Biehls’ attorney should be included in their gross income and treated as a miscellaneous itemized deduction, subject to the 2% floor and disallowed for AMT purposes. The case was submitted to the Tax Court fully stipulated under Rule 122. The Tax Court held for the Commissioner, ruling that the payment did not qualify as a reimbursement under an accountable plan.

    Issue(s)

    Whether the payment made by NCMI directly to the Biehls’ attorney for wrongful termination claims qualifies as a reimbursement under a “reimbursement or other expense allowance arrangement” as defined in IRC Section 62(a)(2)(A) and (c), allowing it to be excluded from gross income or deducted in arriving at adjusted gross income?

    Rule(s) of Law

    IRC Section 62(a)(2)(A) allows a deduction from gross income in arriving at adjusted gross income for expenses paid or incurred by an employee in connection with the performance of services as an employee under a reimbursement or other expense allowance arrangement with the employer. To qualify as an accountable plan under Section 62(c), the arrangement must satisfy three requirements: (1) the expense must be deductible under Section 162(a); (2) the employee must substantiate the expenses to the employer; and (3) the employee must return any excess amounts to the employer. The regulations under Section 62(c) incorporate the “business connection” requirement of Section 62(a)(2)(A), requiring the expense to be incurred by the employee in connection with the performance of services as an employee of the employer.

    Holding

    The Tax Court held that the payment made by NCMI directly to the Biehls’ attorney did not qualify as a reimbursement under an accountable plan. The court concluded that the payment failed to satisfy the “business connection” requirement of IRC Section 62(a)(2)(A) and the accountable plan regulations, as it was not incurred in connection with the performance of services as an employee of NCMI. Therefore, the payment must be included in the Biehls’ gross income and treated as a miscellaneous itemized deduction.

    Reasoning

    The court’s reasoning focused on the interpretation of the “business connection” requirement under IRC Section 62(a)(2)(A) and the accountable plan regulations. The court emphasized that a reimbursed expense must be incurred by an employee on behalf of the employer during the course of an ongoing employment relationship. The payment to the Biehls’ attorney was not incurred in connection with the performance of services as an employee of NCMI, as Frank Biehl was no longer employed by NCMI when the expense was incurred. The court rejected the Biehls’ argument that the settlement agreement and shareholders agreement constituted a reimbursement arrangement, finding that these agreements did not establish a connection to the performance of services as an employee. The court also noted the absence of any evidence that NCMI instructed Frank Biehl to incur the attorney’s fee on its behalf or that the payment served a business purpose of NCMI. The court acknowledged the potential injustice of the result but concluded that the plain meaning and original intent of Section 62(a) required the holding.

    Disposition

    The Tax Court entered a decision for the Commissioner, sustaining the determination that the $401,000 payment to the Biehls’ attorney must be included in their gross income and treated as a miscellaneous itemized deduction.

    Significance/Impact

    Biehl v. Commissioner clarifies the strict criteria for reimbursement arrangements under IRC Section 62, particularly the “business connection” requirement. The decision has significant implications for former employees seeking to exclude payments for legal fees from gross income, as it establishes that such payments must be made during an ongoing employment relationship and for the benefit of the employer. The case also highlights the potential tax consequences of treating legal fees as itemized deductions, including the impact of the 2% floor and the alternative minimum tax. Subsequent cases and regulations have followed the reasoning in Biehl, reinforcing the importance of the business connection requirement in determining the tax treatment of reimbursed expenses.

  • Byrne v. Commissioner, 90 T.C. 1000 (1988): Taxability of Settlement for Claims Including Personal Injury and Contractual Damages

    Byrne v. Commissioner, 90 T.C. 1000 (1988)

    Settlement payments received in resolution of claims encompassing both personal injury and other types of damages, such as contractual claims, must be allocated between taxable and non-taxable portions for federal income tax purposes; only the portion attributable to damages received on account of personal physical injuries or physical sickness is excludable from gross income under Section 104(a)(2) of the Internal Revenue Code.

    Summary

    Christine Byrne received a $20,000 settlement from her former employer, Grammer, Dempsey & Hudson, Inc. (Grammer), following her termination after she was perceived to be involved in an EEOC investigation into wage disparities. The EEOC had filed suit seeking Byrne’s reinstatement, but the matter was settled with Grammer paying Byrne $20,000 in exchange for a release of all claims. The Tax Court considered whether this settlement was excludable from Byrne’s gross income under Section 104(a)(2) as damages received on account of personal injuries. The court held that because the settlement encompassed both tort-like personal injury claims and contractual claims, it must be allocated, with only the portion attributable to personal injury excludable from income, estimating that 50% was excludable.

    Facts

    Christine Byrne worked for Grammer for 12 years in the billing department and had a good employment record.

    In 1980, the EEOC initiated an investigation into wage disparities at Grammer, focusing on the sales department, not Byrne’s department.

    Grammer officials suspected Byrne of informing the EEOC, though she was not in the sales department and had no direct interest in the investigation’s outcome regarding back pay.

    Shortly after the EEOC investigation began, Grammer terminated Byrne’s employment.

    The EEOC concluded Byrne’s termination was retaliatory and filed a complaint in federal district court seeking preliminary relief, including Byrne’s reinstatement, arguing Grammer was impeding the EEOC’s investigation and intimidating employees.

    Grammer and Byrne eventually settled. Grammer paid Byrne $20,000, and Byrne signed a release waiving all claims against Grammer related to the EEOC action, her employment, and her termination.

    Byrne did not report the $20,000 settlement as income on her 1981 tax return. The IRS determined it was taxable income.

    Procedural History

    The Commissioner of Internal Revenue determined a deficiency in Byrne’s 1981 income tax.

    Byrne petitioned the Tax Court, contesting the deficiency, specifically regarding the taxability of the $20,000 settlement.

    The Tax Court issued an opinion holding that a portion of the settlement was excludable under Section 104(a)(2).

    Issue(s)

    1. Whether the $20,000 payment received by Byrne from Grammer pursuant to a settlement agreement is excludable from her gross income under Section 104(a)(2) of the Internal Revenue Code as “damages received…on account of personal injuries or sickness.”

    2. If the settlement payment encompasses both damages for personal injuries and other types of damages, whether the payment should be allocated between taxable and non-taxable portions.

    Holding

    1. No, not entirely. The court held that the entire $20,000 payment is not excludable because the settlement encompassed claims beyond just personal injuries.

    2. Yes. The court held that when a settlement resolves multiple claims, including both personal injury and other claims (like contract claims), the payment must be allocated. In this case, the court allocated 50% of the settlement to tort-like personal injury claims and 50% to other, taxable claims.

    Court’s Reasoning

    The court began by noting that Section 104(a)(2) excludes from gross income “the amount of any damages received…on account of personal injuries or sickness.” The key issue was whether the $20,000 settlement was paid “on account of personal injuries.”

    The court acknowledged that the settlement arose from an EEOC action alleging unlawful discrimination, which could give rise to tort-like claims under state law, such as wrongful discharge and defamation. Byrne argued her claims were tort-like, analogous to New Jersey personal injury torts.

    However, the court pointed out that the release Byrne signed was broad, covering not only claims related to the EEOC action but also “any and all liability arising out of…Releasor’s employment by Releasee, and Releasor’s separation therefrom.” This broad language suggested the settlement could encompass contractual claims as well, such as breach of an implied contract not to terminate employment for reasons violating public policy, which New Jersey law also recognized.

    Because the release covered a range of potential claims, some tort-like (excludable) and some contractual (taxable), the court concluded the entire settlement could not be deemed solely for personal injuries. The court relied on precedent, including Eisler v. Commissioner, to justify allocating the settlement payment.

    The court found that the claims settled included “tort-like claims or had tort-like elements to the extent of 50 percent, and that the balance is taxable.” This allocation was based on the court’s judgment, doing “the best we can on the record before us” due to the lack of precise evidence distinguishing between the different types of claims within the settlement.

    The court rejected Byrne’s argument that because the EEOC did not seek back pay, the settlement couldn’t include contractual damages. The court emphasized the broad language of the release as more indicative of the company’s intent than the EEOC’s specific requests in its complaint.

    Practical Implications

    Byrne v. Commissioner underscores the importance of clearly defining the nature of claims being settled, especially in employment-related disputes, to determine the taxability of settlement proceeds. Settlement agreements should, where possible, explicitly allocate portions of the settlement to specific types of damages, particularly distinguishing between personal physical injury damages and other forms of compensation, such as lost wages or contractual damages.

    This case illustrates that broad releases, while offering comprehensive closure, can create ambiguity regarding the tax treatment of settlement funds. If a settlement release encompasses both personal injury and contractual or other claims, taxpayers must be prepared to demonstrate what portion of the settlement is attributable to excludable personal injury damages. In the absence of clear allocation, courts may undertake their own apportionment, potentially leading to less favorable tax outcomes for the recipient.

    Later cases have cited Byrne for the principle of allocation in settlements involving multiple types of claims and for the methodology of using the intent of the payor and the nature of the claims released to determine the taxability of settlement proceeds. It highlights the need for careful drafting of settlement agreements and releases to ensure the intended tax consequences are achieved and defensible.