Gerbec v. U.S.

Page 1015

164 F.3d 1015

83 A.F.T.R.2d 99-422, 99-1 USTC P 50,194,

22 Employee Benefits Cas. 2297,

Pens. Plan Guide (CCH) P 23,951A

Robert E. GERBEC and Elizabeth W. Gerbec (97-3224/3269) Raymond E. Morgan and Jennifer L. Morgan (97-3225/3269) Plaintiffs-Appellants/Cross-Appellees, v. UNITED STATES of America, Defendant-Appellee/Cross-Appellant (97-3269).

Nos. 97-3224, 97-3225 and 97-3269.

United States Court of Appeals Sixth Circuit.

Argued June 16, 1998.

Decided Jan. 15, 1999.

Richard A. Cordray, Grove City, OH, K. Peter Schmidt (briefed), Arnold & Porter, Stephen L. Hester (argued and briefed), Washington, DC, for Plaintiffs-Appellants/Cross-Appellees.

Michael W. Davis, U.S. Department of Justice, Tax Division, Kenneth L. Greene (briefed), Kenneth W. Rosenberg (argued and briefed), U.S. Department of Justice, Appellate Section Tax Division, Washington, DC, Brenda L. Dodrill, Office of the U.S. Attorney, Columbus, OH, for Defendant-Appellee/Cross-Appellant in Nos. 97-3224 and 97-3225.

Kenneth W. Rosenberg (argued and briefed), U.S. Department of Justice, Appellate Section Tax Division, Washington, DC, for Defendant-Appellee/Cross-Appellant in No. 97-3269.

Before: WELLFORD, MOORE, and CLAY, Circuit Judges.

CLAY, J., delivered the opinion of the court, in which MOORE, J., joined. WELLFORD, J. (pp. 1027-29), delivered a separate dissenting opinion.

OPINION

CLAY, Circuit Judge.

In this case of first impression in this Circuit, we are asked to decide whether settlement proceeds paid to members of a class action suit by their former employer for its violation of § 510 of the Employee Retirement Income Security Act ("ERISA"), 29 U.S.C. § 1140, are subject to taxation as "income" or are exempt under Internal Revenue Code ("IRC") § 104(a)(2) as proceeds from a tort or "tort type" remedy; as well as whether these proceeds are subject to Federal Insurance Contributions Act ("FICA") taxes under 26 U.S.C. § 3101 et seq. To the extent set forth below, we find that the proceeds are exempt from income taxation under IRC § 104(a)(2), and are not subject to FICA taxation under 26 U.S.C. § 3101 et seq.

I. Background

Plaintiffs, Robert E. Gerbec and Raymond E. Morgan, both worked for Continental Can Company ("Continental"). These men (along with approximately 7,000 similarly situated employees) were "laid-off" shortly before they were eligible to vest in Continental's "Magic Number" health and pension benefits. ¹ As a result, two separate classes of plaintiffs brought actions against Continental claiming that they were wrongfully discharged as part of Continental's illegal scheme to avoid paying pension benefits. ²

The class action suits alleged that Continental violated § 510 of ERISA by engaging in a "liability avoidance" scheme designed to prevent their employees from realizing pension benefits. ³ Continental eventually settled the class action suit in December of 1990, for a sum total of $415,000,000. The settlement funds were distributed among the class members using a formula devised by a Special Master appointed to the case. Under the distribution plan, each class member received a Basic Award, "defined by age and years of service at layoff," that was designed to "compensate for the dignitary loss suffered by the alleged discrimination on grounds of age and work experience as employees reached the Continental pension benefit thresholds." The members also received an Earnings Impairment Additur that was designed not only to provide compensation for loss in earnings capacity, but also "to approximate ... the long-term loss in employment prospects that faced most former Continental employees whose skills and opportunities were diminished for their lifetimes." Under this distribution plan, Gerbec received a total pre-tax award of $60,765; Morgan received a total pre-tax award of $94,410; and the parties paid both federal income tax as well as FICA tax on the award. ⁴

On December 22, 1995, Plaintiffs filed the instant suit against the United States ("the Government") seeking reimbursement of the federal income and FICA taxes paid on their awards. They argued that their class action settlement award should not have been subject to federal income tax because I.R.C. § 104(a)(2) excludes "the amount of any damages received ... on account of personal injuries or sickness" from gross income, ⁵ 26 U.S.C.A. § 104(a)(2) (West 1988) (pre-1996 amendment), and that, under Treasury Regulation § 1.104-1(c), § 104(a)(2), this exclusion includes "an amount received ... through prosecution of a legal suit or action based upon tort or tort type rights, or through a settlement agreement entered into in lieu of such prosecution." 26 C.F.R. § 1.104-1(c) (1994). Plaintiffs also argued that a refund of FICA taxes paid was warranted because the settlement proceeds were not "wages" or "remuneration for employment" subject to tax under 26 U.S.C. § 3121(a). Plaintiff filed a motion for summary judgment arguing that they were entitled the relief sought as a matter of law.

The Government filed a cross-motion for summary judgment, arguing that under Mertens v. Hewitt Associates, 508 U.S. 248, 113 S.Ct. 2063, 124 L.Ed.2d 161 (1993), damages for ERISA violations were strictly limited to equitable remedies. The Government maintained that, as such, the proceeds Plaintiffs received from the class-action settlement could not be considered damages based upon tort or "tort type" rights, and therefore could not be considered exempt under § 104(a)(2). The Government also argued that FICA taxes were properly withheld from Plaintiffs' settlement proceeds as a matter of law.

On January 10, 1997, the district court granted the Government's motion in part, finding that Plaintiffs' awards were subject to federal income taxation. The court reasoned that Plaintiffs' compensatory damages arose from Continental's violation of ERISA § 510, and under Mertens, did not fit within the "tort or tort-type rights" exclusion of I.R.C. § 104(a)(2). Gerbec v. United States, 957 F.Supp. 122, 125 (S.D.Ohio 1997). However, the court also granted Plaintiff's motion in part, finding that, as a matter of law, Plaintiffs' award should not have been subject to FICA taxes because, "[p]laintiffs had already received full payment for the services they performed for Continental; thus, the settlement could not represent wages or remuneration for employment." Id. The parties filed their respective appeals and cross-appeals.

II. Standard of Review

We review a district court's grant of summary judgment de novo. Henegar v. Banta, 27 F.3d 223, 225 (6th Cir.1994). Summary judgment is appropriate where "the pleadings, depositions, answers to interrogatories, and admissions on file, together with the affidavits, if any, show that there is no genuine issue as to any material fact and that the moving party is entitled to a judgment as a matter of law." Fed.R.Civ.P. 56. The moving party has the initial burden of showing the absence of a genuine issue of material fact as to an essential element of the non-moving party's case. Street v. J.C. Bradford & Co., 886 F.2d 1472, 1476 (6th Cir.1989) (citing Celotex Corp. v. Catrett, 477 U.S. 317, 106 S.Ct. 2548, 91 L.Ed.2d 265 (1986)). We apply the same legal standard utilized by the district court. Hankins v. The Gap, 84 F.3d 797, 800 (6th Cir.1996).

III. Analysis

A. Federal Income Taxation

Mertens v. Hewitt Associates Interpretation of Relief Available Under § 502(a)(3)

The district court held that inasmuch as Mertens limits the relief available under § 502(a)(3) to traditional forms of equitable relief and does not allow for compensatory damages, Plaintiffs' settlement proceeds could not be characterized as being from a tort or "tort-like" remedy, and therefore were not excludable from taxation under § 104(a)(2). ⁶

In Mertens, several former employees of the Kaiser Steel Company lost a significant portion of their pensions because of the alleged breach of fiduciary duties by Hewitt Associates, an actuarial services company. 508 U.S. at 250-51, 113 S.Ct. 2063. The petitioner, William Mertens, was one of a class of former Kaiser employees who sued Hewitt for breach of fiduciary duty. Id. The class also sued Hewitt as a non-fiduciary, claiming that ERISA § 502(a)(3) allowed a plan participant to sue a non-fiduciary and also permitted the court to order whatever equitable relief the court deemed necessary. ⁷ Id. At the time, the Supreme Court had not interpreted the precise meaning of the phrase "other appropriate equitable relief" as it is found in § 502(a)(3). Id. at 253-55 113 S.Ct. 2063.

In a five to four opinion, Justice Scalia narrowly construed the phrase "other appropriate equitable relief" as found in § 502(a)(3) as only permitting the categories of relief that were typically available in equity; those forms of relief such as injunctions, mandamus, and restitution. Mertens, 508 U.S. at 256-58, 113 S.Ct. 2063. In doing so, Justice Scalia acknowledged that the Court had not interpreted the precise phrase "other appropriate equitable relief" in the context of ERISA's § 502(a)(3), but that the Court had "construed the similar language of Title VII of the Civil Rights Act of 1964 (before its 1991 amendments)--'any other equitable relief as the court deems appropriate,' 42 U.S.C. § 2000e-5(g)--to preclude 'awards for compensatory or punitive damages.' " Id. at 255, 113 S.Ct. 2063 (citing United States v. Burke, 504 U.S. 229, 238, 112 S.Ct. 1867, 119 L.Ed.2d 34 (1992)). The Justice went on to conclude that it was appropriate to likewise limit the relief available under ERISA inasmuch as doing otherwise, would

require us either to give the term a different meaning these than it bears elsewhere in ERISA, or to deprive of all meaning the distinction Congress drew between "equitable" and "remedial" relief in § 409(a), and between "equitable" and "legal" relief in the very same section of ERISA, see 29 U.S.C. § 1132(g)(2)(E); in the same...