                     T.C. Memo. 1999-124



                   UNITED STATES TAX COURT



NORRIS O. AND BETTY J. WHITLEY, Petitioners v. COMMISSIONER OF
                 INTERNAL REVENUE, Respondent



   Docket No. 12947-97.            Filed April 15, 1999.



        P commenced a lawsuit in 1987, alleging that the
   defendant was liable to him for breach of contract and
   conversion. As to the conversion claim, the jury
   awarded P actual and punitive damages. P received the
   punitive damages in 1992. P argues primarily that sec.
   104(a)(2), I.R.C., excludes the punitive damages from
   his gross income because, he states, punitive damages
   are awarded under applicable State (South Carolina) law
   as compensation for a personal injury. P directs the
   Court to numerous cases where the South Carolina
   Supreme Court has stated that South Carolina law allows
   an award of punitive damages to "vindicate a private
   right" and that this right is compensatory in nature.
        Held: The punitive damages are not excludable
   from P's gross income under sec. 104(a)(2), I.R.C.,
   because punitive damages are noncompensatory under
   applicable law. Although the ultimate effect of a
   punitive damage award made under South Carolina law is
   compensatory in nature, such an award does not have a
   compensatory purpose in the sense of reimbursing the
   plaintiff for actual damages.
                                - 2 -


     James Richard Cox, for petitioners.

     Jeanne Gramling, for respondent.



                          MEMORANDUM OPINION


     LARO, Judge:    This case is before the Court fully

stipulated.   See Rule 122.   Norris O. and Betty J. Whitley

petitioned the Court to redetermine deficiencies of $75,694 and

$263 in their 1992 and 1993 Federal income tax, respectively.

Following petitioners' concessions, we must decide whether their

1992 gross income includes $250,000 in punitive damages that they

received during 1992.   We hold it does.   Unless otherwise

indicated, section references are to the Internal Revenue Code in

effect for 1992.    Rule references are to the Tax Court Rules of

Practice and Procedure.    Although Betty J. Whitley is a

copetitioner, we hereinafter refer to Norris O. Whitley as the

sole petitioner.

                              Background

     All facts have been stipulated and are so found.      The

stipulation of facts and exhibits submitted therewith are

incorporated herein by this reference.     Petitioner and Betty J.

Whitley are husband and wife.    They filed joint 1992 and 1993

Federal income tax returns.    They resided in Sumter, South

Carolina, when they petitioned the Court.

     Petitioner began working as an agent for Academy Life

Insurance Company (Academy) in the late 1970's.    He worked for it
                               - 3 -


as an independent contractor under a contract between the two.

Academy fired him in July 1986.   When it did, it was

contractually obligated to pay him renewal commissions on

policies that he or an agent under his supervision had sold.

After his firing, Academy remitted to him reduced monthly

commissions.   It also stopped sending to him the paperwork

documenting his commissions.

     In September 1987, petitioner sued Academy for breach of

contract and conversion, praying in his complaint for an award of

actual and punitive damages.   Petitioner alleged that Academy was

liable to him for:   (1) An unlawful termination of contracts with

resulting failure to pay money due thereunder (breach of contract

and conversion), (2) unfair trade practices (also seeking treble

damages and attorney’s fees), (3) a termination of resident

counselor status, (4) a failure to pay commissions, and (5) the

fraudulent filing of Federal tax forms reporting income not paid

to him.   Following a jury trial, the United States District Court

hearing the case directed a verdict against Academy for breach of

contract and sent the issues of conversion and resulting damages

to the jury.   The judge instructed the jury as follows with

respect to punitive damages:

          The plaintiffs [petitioner and another person not
     relevant herein] are also seeking punitive damages in
     their conversion cause of action.

          The law permits the jury, under certain
     circumstances, to award punitive damages in order to
     punish a wrong-doer for some extraordinary misconduct,
     and to serve as a warning not to engage in such conduct
     in the future.
                               - 4 -


          Thus, if you find that the plaintiffs have shown
     by a preponderance of the evidence, that the defendant
     converted the plaintiffs' money with malice, ill will,
     a conscious indifference to the rights of others, or a
     reckless disregard for the rights of others, you may
     award the plaintiffs punitive damages.

          If you so find, it becomes your right to award
     punitive damages in such an amount as you unanimously
     agree to be proper in light of the character of the
     wrong committed, the punishment which should be
     applied, and the ability of the defendant to pay.

     The jury found against Academy on the conversion claim and

awarded $25,390 in actual damages for unpaid commissions and

$250,000 in punitive damages, together with interest and costs.

That verdict was affirmed upon appeal.

     Academy paid $250,000 in punitive damages to petitioner in

1992.   Petitioner did not report any of this amount on his 1992

Federal income tax return.

                             Discussion

     We must decide whether petitioner received the punitive

damages on account of a personal injury.   To the extent that he

did, the funds are excludable from his gross income.    See sec.

104(a)(2).   To the extent that he did not, the funds are

includable in his gross income.   See sec. 61(a).   Because

respondent determined that the punitive damages are includable in

petitioner's gross income, petitioner must prove otherwise.    See

Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933).

     Petitioner concedes that his gross income includes the

actual damages of $25,390 which were awarded to him for unpaid

commissions.   As to the punitive damages, petitioner argues that
                                 - 5 -


these damages are excludable from his gross income under section

104(a)(2).     Petitioner asserts that he received the punitive

damages on account of his claim of conversion, which, he states,

is a tort under applicable State (South Carolina) law, and that

he received the punitive damages on account of a personal injury.

Petitioner asserts that South Carolina law provides that punitive

damages are compensatory in nature in that they reimburse a

plaintiff for personal injury.     Respondent agrees with

petitioner's characterization of conversion as a tort under South

Carolina law but asserts that the punitive damages were not paid

to petitioner on account of a personal injury.     Respondent

asserts that Academy paid the punitive damages to petitioner on

account of its reprehensible behavior.

        We agree with respondent that the punitive damages are not

excludable from petitioner's gross income under section

104(a)(2).     Section 104(a)(2) sets forth a narrowly construed

provision under which proceeds from a lawsuit are excluded from

gross income to the extent:     (1) The cause of action underlying

the recovery of the proceeds is based upon tort or tort type

rights, and (2) the proceeds are received on account of a

personal injury or sickness.1    That section is inapplicable when



    1
     Sec. 7641(a) of the Omnibus Budget
Reconciliation Act of 1989, Pub. L. 101-239, 103 Stat.
2106, 2379, amended sec. 104(a)(2) to provide that the
personal injury exclusion contained therein does not
apply where the punitive damages are received in
connection with a case not involving physical injury
or physical sickness. This amendment does not apply
herein. Id. (amendment inapplicable to any lawsuit
filed before July 10, 1989).
                                 - 6 -


either requirement is not met.    See sec. 104(a)(2);

Commissioner v. Schleier, 515 U.S. 323, 336-337 (1995); United

States v. Burke, 504 U.S. 229, 233 (1992); sec. 1.104-1(c),

Income Tax Regs.

     In O'Gilvie v. United States, 519 U.S. 79 (1996), the

Supreme Court held that section 104(a)(2) did not reach punitive

damages which were awarded under Kansas law to the taxpayers, the

husband and two children of a woman who died of toxic shock

syndrome.   The taxpayers had recovered those damages in a tort

action filed against the maker of a product that caused the

decedent's death.   The Court held that the taxpayers did not

receive the punitive damages on account of personal injury

because the damages were not awarded as compensation for the

injury suffered by them or by the decedent but to punish and

deter the tortfeasor's reprehensible conduct.    See id.

     Petitioner recognizes the holding in O'Gilvie v. United

States, supra, but argues that it is inapplicable.      First,

petitioner states, South Carolina law provides that punitive

damages are compensatory in nature, whereas Kansas law provides

that punitive damages are entirely punitive.    Second, petitioner

states, the fact that many decisions prior to O'Gilvie were

inconsistent with the decision there requires that we apply

O'Gilvie prospectively.   Petitioner makes a similar argument for

a prospective application of Commissioner v. Schleier, supra, and

United States v. Burke, supra.
                               - 7 -


     We disagree with petitioner's assertion that Academy paid

him the punitive damages on account of a personal injury.    The

award of punitive damages to him was not paid on account of a

personal injury to the extent that the damages are

noncompensatory in nature.   See O'Gilvie v. United States, supra.

Whether the damages are noncompensatory in nature rests on

applicable State law, see Bagley v. Commissioner, 105 T.C. 396,

417 (1995), affd. 121 F.3d 393 (8th Cir. 1997), which, in this

case, is the law of South Carolina.    Under South Carolina law, an

award of punitive damages is based upon the defendant's

wrongdoing, rather than the extent of the plaintiff's injury; an

award of compensatory damages, on the other hand, is based upon

the extent of the plaintiff's injury, rather than the defendant's

wrongdoing.   See South Carolina Farm Bureau Mut. Ins. Co. v. Love

Chevrolet, Inc., 478 S.E.2d 57, 59 (S.C. 1996) (a claim for

punitive damages may go to the jury only if "the defendant's

conduct rises to the level of culpability warranting a punitive

damage award"); Laird v. Nationwide Ins. Co., 134 S.E.2d 206, 210

(S.C. 1964) (quoting Bowers v. Charleston & W. C. Ry. Co., 42

S.E.2d 705 (S.C. 1947) ("compensatory damages are damages in

satisfaction of * * * loss or injury sustained.   Punitive damages

are allowed in the interest of society in the nature of

punishment and as a warning and example to deter the wrongdoer

and others from committing like offenses in the future.")); see

also Clark v. Cantrell, 504 S.E.2d 605, 609 (S.C. Ct. App. 1998)

(punitive damages are not compensatory in nature under the law of
                               - 8 -


South Carolina) (citing Hubbard & Felix, Comparative Negligence

in South Carolina: Implementing Nelson v. Concrete Supply Co.,

43 S.C. L. Rev. 273, 314 (1992)).2     Punitive damages serve under

South Carolina law to punish the defendant and to deter

unacceptable behavior.   See Gamble v. Stevenson, 406 S.E.2d 350,

354 (S.C. 1991); Macmurphy v. South Carolina, 367 S.E.2d 150, 151

(S.C. 1988); Laird v. Nationwide Ins. Co., supra at 210; Bowers

v. Charleston & W. C. Ry., supra; see also Gilbert v. Duke Power

Co., 179 S.E.2d 720, 723 (S.C. 1971) (citing Davenport v.

Woodside Cotton Mills Co., 80 S.E.2d 740 (1954) (punitive damages

serve to punish a wrongdoer when the plaintiff proves that the

wrongdoer violated the plaintiff's rights in a "wanton, willful

or malicious" way).   Punitive damages do not serve under South

Carolina law to reimburse a victim for actual damages.     See Laird

v. Nationwide Ins. Co., supra at 210; Bowers v. Charleston & W.

C. Ry., supra; cf. Kewin v. Massachusetts Mut. Life Ins. Co., 295

N.W.2d 50, 55 (Mich. 1980) (In Michigan, exemplary damages are

recoverable as compensation to the plaintiff, not as punishment

of the defendant); Doroszka v. Lavine, 150 A. 692, 692-693 (Conn.

1930)("in this state the purpose [of punitive damages] is not to




    2
     We are mindful that we are bound only by the
decisions of the South Carolina Supreme Court in
construing the law of that State. See Commissioner v.
Estate of Bosch, 387 U.S. 456, 465 (1967). The
opinion in Clark v. Cantrell, 504 S.E.2d 605 (S.C. Ct. App.
1998), is helpful to our understanding of South Carolina law as
construed by the South Carolina Supreme Court.
                                - 9 -


punish the defendant for his offense but to compensate the

plaintiff for his injuries").

     Petitioner observes that the South Carolina Supreme Court

has stated repeatedly that punitive damages may also be awarded

to "vindicate a private right" and that this vindicative quality

adds a compensatory purpose.    See, e.g., Harris v. Burnside,

199 S.E.2d 65, 68 (S.C. 1973); Hughey v. Ausborn, 154 S.E.2d 839,

844 (S.C. 1967)(Brailsford, J., concurring); Hicks v. Herring,

144 S.E.2d 151, 155 (S.C. 1965); Rogers v. Florence Printing Co.,

106 S.E.2d 258, 261 (S.C. 1958); Mock v. Atlantic C. L. R. Co.,

87 S.E.2d 830, 840 (S.C. 1955); Davenport v. Woodside Cotton

Mills Co., supra at 743; Hull v. Seaboard Air Line Ry., 57 S.E.

28, 29 (S.C. 1907); Beaudrot v. Southern Ry., 48 S.E. 106, 107

(S.C. 1904); Griffin v. Southern Ry., 43 S.E. 445, 447 (S.C.

1903); Watts v. South Bound R.R., 38 S.E. 240, 242 (S.C. 1901).

By virtue of these statements, petitioner concludes, punitive

damages are compensatory in nature under South Carolina law.     We

disagree.   We do not understand the South Carolina Supreme Court

to have used the verb "vindicate" to mean "compensate".    See

Shuler v. Heitley, 39 S.E.2d 360, 361-62 (S.C. 1946); see also

Clark v. Cantrell, supra at 609.    See generally 22 Am. Jur. 2d

Damages secs. 3, 23-24, 731, 733 (1988) (different functions of

compensatory and punitive damages).     As we understand the court's

use of the latter verb, it describes the ultimate effect of

punitive awards as a form of remedy.    To this end, we have found

no case where the South Carolina Supreme Court has used the verb
                              - 10 -


"vindicate" to describe a compensatory purpose for punitive

damages in the sense of reimbursing a victim for an actual loss.

See Clark v. Cantrell, supra at 609.    As a matter of fact, the

South Carolina Supreme Court has stated specifically that

"punitive damages are not given with a view to compensation, but

* * * in addition to compensation".     Shuler v. Heitley, supra at

361-362.   The court has also stated:

          Compensatory damages relate mainly to the
     situation of the injured party, the plaintiff
     generally. But he should not receive, nor should he be
     entitled to obtain, thereby more than sufficient
     recompense for his injuries- just enough to restore him
     to his former position, a sum only to make him whole.
     He, and he alone, usually is particularly affected in
     that regard.

          Exemplary damages have relation to the injured
     party in only one respect, to vindicate his right,
     recklessly, willfully, maliciously, or wantonly
     invaded. They relate more to the situation of the
     wrongdoers, the defendants, usually. One of the chief
     purposes in awarding damages of this class is to punish
     the wrongdoer, not only to prevent by him a recurrence
     of the wrongful act, but to deter others from conduct
     of the same or similar kind. They are not intended for
     the sole good of the injured party. And not for the
     improvement of the disposition and character alone of
     the willful tort-feasor is it that our law has looked
     with favor upon the assessment of punitive damages
     under certain circumstances. But the object is to
     protect every man, woman, and child from those who
     consciously disregard the rights of their fellows.
     * * * [Johnson v. Atlantic Coast Line R. Co., 140 S.E.
     443, 447 (S.C. 1927).]

     According to the South Carolina Supreme Court, factors to

consider in passing on a punitive damage award under the law of

that State include:   (1) The character of the tort committed,

including the wrongdoer's degree of recklessness, (2) the

punishment which should be meted out, bearing in mind that
                             - 11 -


punitive damages are meant to punish the defendant, or to deter

or stop him or her and others from similar conduct in the future,

and (3) the ability of the wrongdoer to pay.    See Gamble v.

Stevenson, supra at 354; Hicks v. Herring, supra at 155; Fennell

v. Littlejohn, 125 S.E.2d 408 (S.C. 1962).     The fact that South

Carolina law measures an award of punitive damage by the

financial status of the wrongdoer, see South Carolina Farm Bureau

Mut. Ins. Co. v. Love Chevrolet, Inc., 478 S.E.2d 57 (S.C. 1996);

McCourt v. Abernathy, 457 S.E.2d 603, 608 (S.C. 1995); Gamble v.

Stevenson, supra at 354; Reid v. Kelly, 262 S.E.2d 24 (1980);

Hicks v. Herring, supra at 155, adds to our belief that a

punitive damage award under that law is tied directly to

inflicting punishment upon the defendant, rather than

compensating the plaintiff for his or her loss.    South Carolina

law also provides no formula under which punitive damages are to

be measured, leaving the amount of a punitive damage award up to

the judgment and discretion of the jury, subject, of course, to

the power held by a trial judge to change the jury's verdict.

See Gilbert v. Duke Power Co., 179 S.E.2d 720, 723 (S.C. 1971).

The amount of the award, therefore, lacks any direct nexus to the

extent of the personal injury suffered by the plaintiff on

account of the defendant's wrongdoing.

     Nor do we agree with petitioner's argument that the trilogy

of O'Gilvie v. United States, 519 U.S. 79 (1996), Commissioner v.

Schleier, 515 U.S. 323 (1995), and United States v. Burke,

504 U.S. 229 (1992), should be applied only prospectively.
                             - 12 -


Although petitioner states correctly that one or more courts had

adopted positions that were ultimately rejected by the U.S.

Supreme Court in deciding those cases, that does not mean, as

petitioner asks us to hold, that we should apply the prior

positions in lieu of the high Court's decisions.    According to a

recent mandate of the Court on the retroactive effect of its

decisions:

     When this Court applies a rule of federal law to the
     parties before it, that rule is the controlling
     interpretation of federal law and must be given full
     retroactive effect in all cases still open on direct
     review and as to all events, regardless of whether such
     events predate or postdate our announcement of the
     rule. * * * [Harper v. Virginia Dept. of Taxation,
     509 U.S. 86, 97 (1993).]

     We apply the Supreme Court's decisions in O'Gilvie,

Schleier, and Burke to hold that petitioner's punitive damages

are includable in his gross income.    In so holding, we have

considered all arguments made by petitioner and, to the extent

not discussed above, find them to be without merit.     To reflect

the foregoing,

                                           Decision will be entered

                                      for respondent.
