Joseph P. DELANEY and Jane H. Delaney, Petitioners, Appellants, v. COMMISSIONER OF INTERNAL REVENUE, Respondent, Appellee, 99 F.3d 20

CYR, Circuit Judge. Joseph J. and Jane H. Delaney (“appellants” or “the Delaneys”) challenge a United States Tax Court ruling upholding a determination by the Commissioner of Internal Revenue that a portion of their $250,000 settlement recovery in a tort-based action for personal injuries is subject to federal income tax as statutory prejudgment interest. We affirm the Tax Court ruling, without deciding whether prejudgment interest is ever ex-cludable as “damages received on account of personal injuries” under

Section 104(a)(2) of the Internal Revenue Code. I BACKGROUND In 1988, the Delaneys commenced a tort action in Rhode Island Superior Court, demanding damages for personal injuries sustained by Mr. Delaney in a fall from the second-floor porch of their Apple Valley condominium in Smithfield, Rhode Island. Ap-pie Valley Associates, Inc., the condominium developer; Apple Valley Condominium Association, Inc., the condominium owners association; and Condominium Management, Inc., the management firm responsible for maintaining the condominium properties, were named as defendants.

On October 12,1990, a jury awarded $150,-000 to Mr. Delaney for personal injuries and $25,000 to Mrs. Delaney for loss of consortium, assigning fault among the three defendants as follows: Apple Valley Associates 25%; Apple Valley Condominium Association and Apple Valley Condominium Management, jointly, 75%. As required under Rhode Island law, the clerk of court added $112,000 in statutory prejudgment interest to the jury award, bringing the total judgment to $287,000. The defendants appealed the judgment to the Rhode Island Supreme Court.

In 1991, while their appeal was still pending, Apple Valley Condominium Association, Inc. and Condominium Management, Inc. entered into a settlement agreement to pay the Delaneys $250,000 for a release of “any and all past, present, or future .'.. claims ... arising out of bodily injuries sustained by Joseph P. Delaney....” The agreement itself mentioned neither prejudgment nor postjudgment interest;- furthermore, it failed to indicate what, if any, understanding, the settling parties had reached regarding any apportionment of the settlement amount as between prejudgment interest and compensatory damages.

Subsequently, however, the settling parties filed a stipulation of dismissal with the Rhode Island Superior Court, which stated: “No interest. No costs.” The stipulation was silent as to whether the term “interest” meant prejudgment interest, post-judgment interest, or both. The Delaneys did not declare the $250,000 on their 1991 federal income tax return. Ultimately, the Commissioner assessed a $20,-580 deficiency for tax year 1991, which was calculated by allocating 39 percent — or $97,-561 — of the settlement proceeds to prejudgment interest.

The IRS based its 39 percent allocation on the fact that 39 percent (or $112,000) of the $287,000 superior court judgment constituted prejudgment interest. The Delaneys initiated proceedings in the Tax Court, alleging that the entire $250,000 settlement had been properly excluded from gross income as “damages received ... on account of personal injuries or sickness” pursuant to

Section 104(a)(2) of the Internal Revenue Code. The Commissioner has conceded that the settlement amount attributable to compensatory damages for personal injuries is excludable, but not the statutory prejudgment interest. Through the testimony of their counsel in the underlying tort action, their letter proposing settlement to the defendants, the settlement agreement itself, and the stipulation of dismissal, the De-laneys attempted to show the Tax Court at trial that none of the settlement amount had been intended as prejudgment interest.

After determining that the Delaneys had not met their burden of proving the Commissioner’s assessment incorrect, the Tax Court ruled that the settlement included a prejudgment interest component amounting to $97,-561, or 39% of the $250,000 settlement. Delaney v. Commissioner of Internal Revenue, 70 T.C.M. (CCH) 353 (1995). II DISCUSSION This case concerns the inherent tension between two sections of the Internal Revenue Code governing exclusions from gross income.

Section 61(

a) of the Internal Revenue Code states: “[ejxcept as otherwise provided in this subtitle, gross income means all income from whatever source derived.” 26 U.S.C. § 61(a) (emphasis added). On the other hand,

section 104(a)(2) of the Internal Revenue Code provides that “damages received ... on account of personal injuries or sickness” are excludable from gross income. 26 U.S.C. § 104(a)(2). The courts have accorded

section 61(

a) wide sweep. Commissioner v. Schleier, — U.S.-,-, 115 S.Ct. 2159, 2167, 132 L.Ed.2d 294 (1995); Brabson v. United States, 73 F.3d 1040, 1042 (10th Cir.1996); O’Gilvie v. United States, 66 F.3d 1550, 1555 (10th Cir.1995), cert. granted, — U.S. -, 116 S.Ct. 1316, 134 L.Ed.2d 469 (1996); see also 26 U.S.C. § 61(a)(4) (including “interest” within definition of “gross income”). Thus, gain constitutes gross income under

section 61(

a) unless the taxpayer can demonstrate a specific exclusion. Brabson, 73 F.3d at 1042 (citing Schleier, — U.S. at -, 115 S.Ct. at 2163 (1995); Commissioner v. Glenshaw Glass Co., 348 U.S. 426, 430, 75 S.Ct. 473, 476, 99 L.Ed. 483 (1955); Wesson v. United States, 48 F.3d 894, 898 (5th Cir.1995)). In determining exclusions under 104(a)(2), courts are “guided by the corollary to § 61(a)’s broad construction, the ‘default rule of statutory

interpretation that exclusions from income must be narrowly construed.’ ” Id. (quoting Schleier, — U.S. at -, 115 S.Ct. at 2163). The present appeal revolves around two principal claims. First, the Delaneys claim that the Tax Court improperly second-guessed their settlement agreement with the defendants in the tort action by treating a portion of the $250,000 settlement as statutory prejudgment interest despite the explicit language in their subsequent stipulation of dismissal: “No interest.

No costs.” The Délaneys insist that the stipulated settlement term “no interest” unambiguously provides that the settlement amount included no interest component of any type. Second, appellants maintain that any prejudgment interest in a settlement recovery for personal injuries comes within the

section 104(a)(2) exclusion for “damages” resulting from personal injuries. We find neither claim availing. A. Settlement Agreement It is settled law that taxpayers bear the burden of proving that a tax deficiency assessment is erroneous. United States v. Rexach, 482 F.2d 10, 16 (1st Cir.), cert. denied, 414 U.S. 1039, 94 S.Ct. 540, 38 L.Ed.2d 330 (1973); Tax Court Rule 142(a). The Supreme Court has held that the Commissioner’s “ruling has the support of a presumption of correctness, and the petitioner has the burden of proving it to be wrong.” Welch v.

Helvering, 290 U.S. 111, 115, 54 S.Ct. 8, 9, 78 L.Ed. 212 (1933); see also United States v. Janis, 428 U.S. 433, 439, 96 S.Ct. 3021, 3025, 49 L.Ed.2d 1046 (1976); Estate of Todisco v. Commissioner, 757 F.2d 1, 6 (1st Cir.1985) (the basic rule in all tax eases places the burden of proof with the taxpayer).' The rationale for this rule is more deeply rooted than the conventional regimen that places the burden of proof on the moving party. See Rexach, 482 F.2d at 16.

Thus, in a tax deficiency suit “the burdens of going forward and of ultimate persuasion are always on the taxpayer and never shift to the Commissioner.” Id. at 16-17. Ultimately, of course, a tax deficiency assessment is subject to reversal if the taxpayer establishes by a preponderance of the evidence that it was erroneous. Estate of Whitt v. Commissioner, 751 F.2d 1548, 1556 (11th Cir.), cert. denied, 474 U.S. 1005, 106 S.Ct. 523, 88 L.Ed.2d 456 (1985). Viewed simply as a linguistic exercise, appellants’

interpretation has a certain appeal. Since the settlement agreement language itself suggests no differentiation between damages and prejudgment interest, its silence plainly permits the

interpretation that the entire $250,000 constituted recompense for personal injury. Moreover, the subsequent stipulation of dismissal executed by the parties to the tort action purports to fill the void by precluding — with the language “No interest. No costs.” — the

interpretation urged by the Commissioner. The difficulty with appellants’ approach lies in the fact that the required inquiry encompasses much more than the mere language subscribed to by the parties, whether in the settlement agreement proper, the stipulation of dismissal, or both, because under established precedent the Tax Court must determine “in lieu of what were damages awarded” or paid. Alexander v. I.R.S., 72 F.3d 938, 942 (1st Cir.1995) (emphasis added) (quoting Raytheon Production Corp. v. Commissioner, 144 F.2d 110, 113 (1st Cir.), cert. denied, 323 U.S. 779, 65 S.Ct. 192, 89 L.Ed. 622 (1944)).

See Getty v. Commissioner,- 913 F.2d 1486, 1490 (9th Cir.1990) (utilizing Raytheon’s “in lieu of’ test to classify, for tax purposes, components comprising settlement amount). See also Bent v. Commissioner, 87 T.C. 236, 1986 WL 22165 (1986), aff'd, 835 F.2d 67 (3d Cir.1987). Moreover, the courts repeatedly have held that the intent of the payor is a key determinant whether a settlement recovery is ex-cludable from gross income. See Knuckles v. Commissioner, 349 F.2d 610, 613 (10th Cir.1965); Ray v. United States, 25 Cl. Ct. 535, 540 (1992), aff'd, 989 F.2d 1204 (Table) (Fed.Cir.1993); Stocks v.

Commissioner, 98 T.C. 1, 10, 1992 WL 189 (1992); Agar v. Commissioner, 290 F.2d 283, 284 (2d Cir.1961), affg per curiam 19 T.C.M. (CCH) 116 (1960). Thus, while acknowledging the importance of the terms employed in the stipulation of dismissal, the Tax court appropriately inquired, inter alia, whether a portion of the settlement amount represented prejudgment interest, by looking beyond the language utilized by the parties.

Accordingly, confronted with a $250,000 postjudgment settlement literally allocating nothing to statutory prejudgment interest notwithstanding the $112,000 prejudgment interest component concededly included in the $287,000 superior court judgment, the Tax Court reasonably considered, inter alia, the intent of the parties in context. The Tax Court’s approach seems especially apt in these circumstances, where a relevant indicator extrinsic to the settlement documentation suggested that their choice of settlement language may have been driven by tax considerations. See Taggi v.

United States, 35 F.3d 93, 96 (2d Cir.1994); Glynn v. Commissioner, 76 T.C. 116, 121, 1981 WL 11320. (1981), aff'd, 676 F.2d 682 (Table) (1st Cir.1982); Robinson v. Commissioner, 102 T.C. 116, 126, 1994 WL 26303 (1994), aff'd. in part, rev’d. in part, 70 F.3d 34 (5th Cir.1995), cert. denied, — U.S. -, 117 S.Ct. 83, 136 L.Ed.2d 40 (1996); Threlkeld v. Commissioner, 87 T.C. 1294, 1306-1307, 1986 WL 22061 (1986), aff'd, 848 F.2d 81 (6th Cir.1988); Fono v. Commissioner, 79 T.C. 680, 694, 1982 WL 11175 (1982), aff'd, 749 F.2d 37 (Table) (9th Cir.1984); see also Mitchell v.

Commissioner, 60 T.C.M. (CCH) 1368 (1990) (allocation in settlement documentation not binding where taxpayer drafted document without participation or approval of adversary), aff'd, 992 F.2d 1219 (Table) (9th Cir.), cert. denied, 510 U.S. 861, 114 S.Ct. 177, 126 L.Ed.2d 136 (1993). Moreover, viewed in context the settlement term “no interest” is not without ambiguity as the Delaneys would have it. Rather, it may fairly be read either to provide for no interest, as the Delaneys suggest, or no interest in addition to the $250,000 settlement amount. Under the latter

interpretation, the stipulation of dismissal left open whether the $250,000 settlement amount included statutory prejudgment or postjudgment interest. Thus, in ascertaining the tax consequences of the final settlement, the Tax Court appropriately, went beyond the explicit “no interest” allocation memorialized in the stipulation of dismissal, see Bent, 87 T.C. at 244, to consider any extrinsic evidence probative of the true nature of the settlement.

The Tax Court was presented with a markedly similar situation on a prior occasion, where the taxpayers had obtained a $1,275,-000 jury award in a personal injury action under a state-law regime that entitled them to statutory prejudgment interest. McShane v. Commissioner, 53 T.C.M. (CCH) 409 (1987). As in our own case, the taxpayers in McShane eventually settled with the tort-action defendants while their case was on appeal, for an amount greater than the jury award, Id.

In the deficiency suit subsequently brought by the taxpayers, the Tax Court decided that it “must carefully review the settlement agreements and all other evidence in the record in order to determine whether the payments ultimately received included interest.” Id. Its approach simply mirrors other Tax Court rulings requiring that all relevant facts and circumstances receive careful consideration in resolving such disputes. See Byrne v. Commissioner, 90 T.C. 1000, 1007, 1988 WL 46847 (1988), rev’d. on other grounds, 883 F.2d 211 (3d Cir.1989); Glynn, 76 T.C. at 120; Robinson, 102 T.C. at 126; cf. Miller v.

Commissioner, 65 T.C.M. (CCH) 1884 (1993), supplemented by 66 T.C.M. (CCH) 1568 (1993) (absent explicit allocations in settlement agreement itself, Tax Court may consider pleadings, jury award, and any court order or judgment in determining settlement payor’s intent), aff'd, 60 F.3d 823 (Table) (4th Cir.1995); Fitts v. Commissioner, 67 T.C.M. (CCH) 2136 (1994) (if no-lawsuit has been filed, court considers all relevant documents, letters and testimony), aff'd, 53 F.3d 335 (Table) (8th Cir.1995). The McShane court considered a combination of factors.

First, the term “without costs and interest” had been included in the settlement agreement at the insistence of counsel for the principal defendant in the tort action. Second, the intentions of all parties to the underlying tort action, as stated by their attorneys, were most consistent with an intention to pay.no interest. Third, the Tax Court credited the testimony of all counsel in the tort action that the settlement amounts for each plaintiff had been arrived at by assessing the risks on appeal and that the tax consequences had never been discussed. Id.

The Tax Court in the present case pursued a similarly inclusive approach by probing beyond the settlement agreement terms, examining all relevant evidence including the testimony of the Delaneys’ counsel in the underlying tort action, who stated that the ex-cludability of the $250,000 settlement amount from gross income was never taken into account in the settlement agreement, only the risks on appeal.

In addition, however, the Tax Court considered a letter from the- Delaneys’ counsel proposing settlement to the tort-action defendants and noting that interest was continuing to accumulate on the superior court judgment. There was no testimonial evidence regarding the relevant intentions of any tort-action defendant. Finally, the Tax Court considered the appropriateness of the parallel utilized by the Commissioner in apportioning the undifferentiated settlement amount as between prejudgment interest and compensatory damages.

The Commissioner had allocated 39% of the $250,000 settlement to statutory prejudgment interest, representing the identical proportion by which the clerk of court, pursuant to Rhode Island law, had increased the jury’s personal injury award. The Fifth Circuit has noted in similar circumstances that a jury verdict provides “the best indication of the worth” of the taxpayers’ original tort claims. Robinson v.

Commissioner, 70 F.3d 34, 38 (5th Cir.1995) (approving Tax Court’s allocation of settlement proceeds based on percentage of damages represented by each element in jury award, where Tax Court went beyond terms .of agreement settling action against bank for wrongful failure to release lien). As the Tax Court supportably ruled that the Delaneys had riot overcome the presumption of correctness to which the Commissioner’s allocation is entitled, the allocation of 39% of the settlement amount to statutory prejudgment interest, substantially- based upon the aforementioned parallelism, did not constitute error.

See Robinson, 70 F.3d at 38; Estate of Todisco, 757 F.2d at 5. B. Excludability of Prejudgment Interest The Delaneys next contend that statutory prejudgment interest itself is excludable as “damages received ... on account of personal injury or sickness,” see 26 U.S.C. § 104(a)(2) (1986) (emphasis added), because the “gross income” exclusion under

section 104(a)(2) embraces all amounts recovered, by settlement or otherwise, as compensation for personal injuries, without regard to the stage in the litigation process at which settlement occurs. We address their predicate arguments in turn. 1. Tax Court Authorities The Delaneys challenge the leading precedent upon which the Tax Court relied, see Kovacs v.

Commissioner, 100 T.C. 124, 1993 WL 46512 (1993), aff'd, 25 F.3d 1048 (Table) (6th Cir.), cert. denied, — U.S.-, 115 S.Ct. 424, 130 L.Ed.2d 338 (1994), for its holding that the prejudgment interest component in a compensatory damages recovery for personal injuries is taxable. The Dela-neys maintain that Kovacs is unsound because it relied upon judicial precedents for taxing postjudgment interest as authority for taxing prejudgment interest. Consequently, they contend, Kovacs progeny such as Delaney are similarly flawed. As their argument is raised for the first time on appeal, we decline to address it.

See, e.g., Villafane-Neriz v. F.D.I.C., 75 F.3d 727, 734 (1st Cir.1996) (arguments first raised on appeal not ordinarily addressed). 2. Choice of Governing Law The Delaneys next contend that Rhode Island law controls whether any statutory prejudgment interest included in a personal injury settlement constitutes “damages” for federal income tax purposes. Since prejudgment interest is an element of damages under Rhode Island law, appellants argue, the entire $250,000 settlement must be excluded from gross income under

section 104(a)(2) as damages for personal injury. The Tenth Circuit, recently confronted with a similar problem, noted that though state law governs the nature of legal interests and rights created under state law, the “federal tax consequences pertaining to such interests and rights are solely a matter of federal law.” Brabson, 73 F.3d 1040, 1044 (Coffin, J.). Accordingly, the Brabson panel first ascertained the pertinent characteristics of statutory prejudgment interest under Colorado law, but then looked to federal law to determine its excludability. Id. at 1044.

As we agree with the thoughtful approach in Brabson, we turn first to Rhode Island law to determine the nature of the statutory prejudgment interest ministerially added by the superior court clerk to the personal injury damages award returned by the jury in this case. Unlike the Colorado statute at issue in Brabson, statutory prejudgment interest is not an element of damages in a personal injury action under Rhode Island law. Di-Meo v. Philbin, 502 A2d 825, 826 (R.I.1986) (prejudgment interest in personal injury action purely statutory and therefore not an element of damages); Castrignano v. E.R.

Squibb & Sons, Inc., 900 F.2d 455, 463 (1st Cir.1990) (prejudgment interest under Rhode Island law “is not an element of damages” in personal injury action) (citing Andrade v. State, 448 A.2d 1293, 1295 (R.I.1982)). Accordingly, in order to prevail, the Delaneys must establish that prejudgment interest is excludable under

section 104(a)(2) notwithstanding its state-law characterization. 3. Interest as “Damages On Account of Personal Injuries ” The two requirements for determining exclusions under

section 104(a)(2) were recently explained in Schleier: First, the taxpayer must demonstrate that the underlying cause of action .giving rise to the recovery is “based upon tort or tort type, rights”; and second, the taxpayer must show that the damages were received “on account of personal injuries or sickness.” Schleier, — U.S. at -, 115 S.Ct. at 2167 (emphasis added).

Although their underlying causes of action clearly satisfy the first prong, unless the Delaneys are able to make the second crucial showing — that the portion of their settlement recovery attributable to statutory prejudgment interest was “received on account of personal injuries or sickness”— their claim fails. Id. The second predicate showing necessitates what the Brabson court termed proof that, “each element of damages was linked to the injury itself.” Brabson, 73 F.3d at 1043.

The Delaneys utterly failed to preserve any claim that the prejudgment interest component in their settlement recovery was linked to their personal injuries. Id. See also Manzoli v. Commissioner, 904 F.2d 101, 105 (1st Cir.1990). As it is neither necessary nor practicable to do so in this case, see note 10 supra, we do not consider whether statutory prejudgment interest may ever be excludable from gross income under § 104(a)(2), an important question left for another day. Ill CONCLUSION For the foregoing reasons, the Tax Court judgment is affirmed and costs are awarded to appellee: So ordered. .

Under the settlement agreement, both Mr. and Mrs. Delaney released their claims against Apple Valley Condominium Association, Inc. and Condominium Management, Inc. The Delaneys reserved their right to proceed against Apple Valley Associates, which was not a parly to the settlement agreement. . After deducting $85,866 in legal fees and expenses, counsel to the Delaneys issued them a check for $164,134. . Of course, it is the nature of the settled claim itself which controls whether any of the settlement constituted compensation for a tort-type personal injury. Metzger v.

Commissioner, 88 T.C. 834, 847, 1987 WL 49302 (1987), aff'd, 845 F.2d 1013 (Table) (3d Cir.1988); Glynn v. Commissioner, 76 T.C. 116, 119, 1981 WL 11320 (1981), aff'd, 676 F.2d 682 (Table) (1st Cir.1982). Furthermore, “amounts received in compromise of a claim must be considered as having the same nature as the right compromised.” Alexander v. I.R.S., 72 F.3d 938, 942 (1st Cir.1995). . In McShane, the settlement agreement itself, as distinguished from a separate stipulation, explicitly stated: "without costs and interest." Id.

The Delaney Tax Court apparently did not consider this distinction of significance, although the Commissioner had emphasized it in his argument. Delaney, 70 T.C.M. 353. Moreover, though the taxpayers in McShane were entitled to statutory prejudgment interest, it is unclear whether their judgment included it. On the other hand, the superior court judgment appealed from in Delaney did include statutory prejudgment interest. .

Appellants cite McShane for their claim that the underlying tort judgment had not become final since it was on appeal at the time of the settlement; therefore, following McShane, the debt had not been liquidated and there was no fixed or determinable amount excludable under § 104(a)(2). Appellants miss the point of McShane, however, wherein such indeterminacy merely allowed the Tax Court to go beyond the language of the settlement agreement. McShane, 53 T.C.M. (CCH) 409 (1987). .

Not only did the Delaneys themselves rely on Kovacs below as support for their contention that prejudgment interest is not taxable, at no time did they broach their present argument that Ko-vacs and its progeny are not good law. . Even though statutory prejudgment interest is an element of compensatory damages under Colorado law, the Brabson panel determined, for purposes of 26 U.S.C. § 104(a)(2), that prejudgment interest under Colorado law is not "received on account- of personal injury.” 73 F.3d at 1044-47. . The Delaneys cite, inappositely, to Factory Mut. Ins. Co. v.

Cooper, 106 R.I. 632, 262 A.2d 370 (1970), for the proposition that prejudgment interest constitutes "damages" under Rhode Island law. In Factory Mutual, the Rhode Island Supreme Court stated that the term “damages” included statutory prejudgment interest, id., 262 A.2d at 373, while interpreting the term "damages” as used in an insurance policy. Id. at 371. See also, e.g., Lombardi v. Merchants Mut. Ins. Co., 429 A.2d 1290, 1293 (R.I.1981) (relying on Factory Mutual for proposition that prejudgment interest constitutes damages in context of insurance subrogation action). .

At this point in its analysis, the Brabson court, after consulting established canons of

interpretation, determined that prejudgment interest under Colorado law simply is not “received 'on account of personal injuries or sickness’ " notwithstanding the more hospitable state-law environment there involved (Schleier, U.S. at -, 115 S.Ct. at 2167) and is therefore taxable under § 104(a)(2). In reaching its decision, the Brab-son court looked to congressional intent and, most importantly, the “default rule” requirement that courts narrowly construe exclusions from gross income. Brabson, 73 F.3d at 1045-1046. .

The Delaneys do advert on appeal to a "time loss value of money” element in statutory prejudgment interest, and assert that it constitutes compensatory damages because it is designed to make the personal injury victim whole. Their "make whole” claim was not preserved in the Tax Court, however. See Villafane-Neriz, 75 F.3d at 734 (arguments first raised on appeal, not ordinarily addressed).

No argument was made below that the statutory prejudgment interest ministerially assessed by the clerk of court pursuant to Rhode Island law comprised both a taxable and a nontaxable component, nor did a "make whole” argument surface in any other developed manner before the Tax Court. The stun total of their efforts to surface such a claim consisted of a quotation from the district court opinion subsequently reversed in Brabson, cited in service of the argument that prejudgment interest is an element of damages under Rhode Island law.

Even more importantly, appellants established no evidentiary predicate which would have enabled the Tax Court to determine what portion of the statutory prejudgment interest ministerially added by the clerk of court constituted "make whole damages.” See United States v. Alzanki, 54 F.3d 994, 1009 (1st Cir.1995) ("Appellant’s utter failure to [raise argument below] disabled the [court below] from making a reasoned assessment ... in the first instance, and from making the predicate factual findings upon which the claims depend.”), cert. denied, -U.S. -, 116 S.Ct. 909, 133 L.Ed.2d 841 (1996).