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term was from July 1, 1985, through June 30, 1988, and that
petitioner’s annual salary was set at $37,000. The contract also
stated that petitioner was to receive certain other benefits,
including furnished housing.
The final judgment in petitioner’s lawsuit was filed on July
20, 1989. Petitioner received damages of $185,000, which had
been reduced by order of remittitur from a jury award of
$450,000, and costs and attorney’s fees of $15,556.70.
Petitioner was also awarded interest on these amounts. On July
20, 1992, an order of execution of writ of mandamus was filed in
the district court compelling satisfaction of the “civil rights
judgment” filed 3 years earlier. This order further provided
that, if necessary, the school district was to levy additional
taxes to satisfy the judgment; the court cited case law that such
measures were appropriate where needed “to vindicate
constitutional guarantees”. In each of 1996 and 1997,
petitioners received a $30,000 payment towards the satisfaction
of this judgment. In 1996, the payment consisted of $21,489 in
interest and $8,511 in principal. In 1997, the payment consisted
of $19,966 in interest and $10,034 in principal.
Petitioners filed joint Federal income tax returns for 1996
and 1997. Petitioners reported as income on these returns the
portions of the yearly $30,000 payments representing interest
income, but they did not report the remaining portions of the
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