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 excludable as "damages received on account of personal injuries" under Section 104(a)(2) of the Internal Revenue Code.

* 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. Apple 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...."1 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."2 The stipulation was silent as to whether the term "interest" meant prejudgment interest, postjudgment 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 Delaneys 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).

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: "[e]xcept 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 Delaneys 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.

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 cases 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.3 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 excludable 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), aff'g 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. 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.4 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.5 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. 120; Robinson, 102 T.C. 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 excludability 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 not 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.

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.

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, 513 U.S. 963, 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 Delaneys 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).6

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. DiMeo v. Philbin, 502 A.2d 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)).7 Accordingly, in order to prevail, the Delaneys must establish that prejudgment interest is excludable under section 104(a)(2) notwithstanding its state-law characterization.8

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 1043.9 The Delaneys utterly failed to preserve any claim that the prejudgment interest component in their settlement recovery was linked to their personal injuries.10 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.

For the foregoing reasons, the Tax Court judgment is affirmed and costs are awarded to appellee.

So ordered.