DALY v. KLING (1979)

Anthony and Mary Daly (the Dalys), erst-while purchasers in a contract for the sale of a residence owned by Frederick and Margaret Kling (the Klings), gave notice of cancellation of the escrow and demanded return of the $30,000 deposit.

When the Klings refused to release the deposit, the escrow-holder interpleaded the two parties. Both the Klings and the Dalys cross-complained for the deposit. Judgment was for the buyers—the Dalys. The Klings have appealed. We affirm.

The contract called for a purchase price of $395,000. The terms of payment were structured on an installment basis because of the Klings' desire to minimize their tax liability.

When the Dalys defaulted, the Klings resold the property to a third party for $425,000. This resale was on a cash basis and the Klings suffered a tax liability of $25,000 greater than would have been the case had the original sale been consummated.

The trial judge found that the damages suffered by the Klings were offset by the difference in the sale price and in reality the Klings suffered no damage.

The measure of damages in a case of breach of contract to purchase real property is the amount by which the contract price exceeds the value of the property. (Civ. Code, § 3307.) The seller is also entitled to recover incidental expenses incurred by reason of the buyer's default. (Abrams v. Motter, 3 Cal.App.3d 828, 83 Cal.Rptr. 855; Jensen v. Dalton, 9 Cal.App.3d 654, 88 Cal. Rptr. 426.)

The Klings argue that the price recovered in the subsequent sale is not the measure of the value of the property at the time of the Dalys' default. They thus contend that the price differential cannot be used to offset the incidental damages.

We need not discuss the Klings' contention for the reason that it is based on the mistaken assumption that the increased tax liability was compensable as damages. The trial court in its findings of fact also labored under this same assumption.

Income tax liability resulting from the frustration of the seller's expectations by the default of the buyer does not qualify as compensable damages.

It has been held that although a financial loss caused by a wrongdoer may result in a tax saving to the injured party, that amount does not mitigate or reduce the damages for which the wrongdoer is liable. (25 C.J.S. Damages § 99(3), p. 1019.) We see no reason why the converse should not also be true, i. e., although a financial gain caused by a wrongdoer may result in a tax liability to the person who sustained the gain, the amount of the tax liability does not enhance or increase the damages for which the wrongdoer is liable.

Our research has turned up no California case on the point. A New Hampshire Supreme Court case, McLaughlin v. Union-Leader Corporation, 100 N.H. 367, 127 A.2d 269, however, is squarely in point and we think persuasive. It was there stated at pages 272 and 273, that “… not every loss, which at the time the contract was made the parties knew or should have known would result from a breach, is recoverable․ Some of the personal expenses of a litigant cannot be passed on ․ We do not know of any authority … which has since held that there may be recovery on account of increased liability for income taxes arising out of a breach of contract for services. … such a liability is not a ‘loss' within the meaning of the term as used in the assessment of damages in contract action. … [¶] It may be argued that the refusal of the courts to transfer the burden of excess income taxes in breach of contract cases from the plaintiff to the defendant is unfair to the plaintiff. The answer seems to us to be that this situation results primarily from the provisions of the federal income tax statute which sometimes produce inequities. We believe the remedy should be sought at the source—in federal legislation.”

Stopford v. Boonton Molding Company, 56 N.J. 169, 265 A.2d 657, a New Jersey Supreme Court case dealing with damages in a breach of a pension contract, cited McLaughlin with approval and reached the same result.

The dearth of case law is an indication that tax liability has rarely been considered an item of compensable damages. This may be attributable to the tax consequences of such an award.

When a person pays income tax for another person, the amount paid constitutes income to the latter. (26 CFR, § 1.61-14, Income Tax Regs.) Assuming the Klings could collect, as special damages, their increased tax liability, the recovery would be taxable because, in effect, the Dalys would be paying the Klings' income taxes. Then, following the Klings' argument, these taxes in turn would constitute recoverable special damages, the result of which would be taxable-ad infinitum.

The judgment is affirmed.

COMPTON, Associate Justice.

FLEMING, Acting P. J., and BEACH, J., concur.