ERISA damages not tax exempt.

In 1989, several class action suits filed against Continental Can Company for violations of Section 510 of the Employee Retirement Income Security Act of 1974 (ERISA) were consolidated and a settlement agreement was reached under the supervision of a Special Master. The plaintiffs in these suits alleged that Continental Can had undertaken a plan to limit pension plan liabilities by terminating employees before they earned enough years of service to qualify for special pension benefits. As a result of the agreement Report and Recommendation of the Special Master, a total of $415 million was awarded to the members of the class in the final settlement agreement.

In 1992, the Dotsons received their settlement payment, which had income tax and FICA tax withheld. On their 1992 income tax return, they reported the settlement amount as wages, but late in 1993, amended their return, claiming the payment was excludible from income under Sec. 104(a) as a "tort-like" personal injury recovery. They also requested a refund of FICA taxes paid on these amounts on Form 843, Claim for Refund and Request for Abatement. The IRS denied the claims for refund and the taxpayers brought suit in district court.

In support of their claim, the taxpayers cited the findings of the Special Master that the settlement award included significant "tort-like" elements. The award constructed by the Special Master included compensation for "dignitary injuries" and "earnings impairment." Since damages received by suit or settlement agreement caused by tort or tort-type actions are excludible under Regs. Sec. 1.104-1(c), the Dotsons asserted that the findings of the Special Master qualified the settlement payments as income excludible from gross income.

The district court awarded summary judgment in favor of the Service in Dotson, DC Tex., 1995. Despite the findings of the Special Master, ERISA Section 502(a) (the civil enforcement statute the class action claim was brought under) provides that civil actions brought by a beneficiary or participant for the enforcement of rights under the terms of a plan do not allow for the recovery of extra contractual or punitive damages.

The Supreme Court in Mertens v. Hewitt Assoc., 113 Sup. Ct. 2063 (1993), held that the reference in ERISA Section 502(a) to "other appropriate relief" was limited to traditional forms of equitable relief and did not include compensatory or punitive damages. The Special Master had interpreted the court's ruling in Ingersoll-Rand Co. v. McClendon, 111 Sup. Ct. 478 (1990), to allow for extra contractual and punitive damages for ERISA claims. The district court found no conflict with Ingersoll-Rand, since that decision addressed substantially different issues unrelated to claims for punitive or compensatory damages.