Friday, August 3, 2012
The taxpayer received a $100,000 wrongful termination settlement and elected not to include it in her income, relying on a section of the code that provides an exclusion from gross income for “the amount of any damages (other than punitive damages) received (whether by suit or agreement and whether as lump sums or as periodic payments) on account of personal physical injuries or physical sickness.”
The settlement didn’t specifically state it was for lost wages and was reported via a 1099 not a W-2 so the court couldn’t completely rule out the possibility that she was compensated for physical sickness arising from being terminated. The overarching rule when it comes to settlements is that gross income means all income from whatever source derived unless excluded by a specific provision of the Code. In order for damages to be excludable from gross income the taxpayer must demonstrate that:
(1) the underlying cause of action is based upon tort or tort type rights and
(2) the damages were received on account of personal injuries that are physical or a sickness that is physical.
Damages received for emotional distress are includable in gross income unless such emotional distress rises to the level of a physical sickness. Congress delineated symptoms indicative of the presence of a physical sickness in the code thereby establishing that not every physical symptom will indicate a physical sickness. Past cases provide a list of symptoms that indicate emotional distress.
Of the eight symptoms that petitioners testified to at trial, five of the symptoms were very similar to the list of emotional distress symptoms in the legislative history and not similar to the list of physical sickness symptoms provided by Congress. She also provided no evidence other than her word regarding these symptoms. The court ruled she suffered from emotional distress and not from a physical sickness.
The code does allow an exclusion from income of the amount of damages received on account of emotional distress to the extent of the amount paid for medical care, however, the taxpayer in this case did not submit into evidence and record of expenditures for medical care and therefore was not entitled to exclude any of the settlement from income.
Thursday, August 2, 2012
This case provides several examples of what not to do! The taxpayers deducted 30,000 miles (even) as a business expense on a schedule with no income or other deductions because they claimed that during their commute to their full time jobs they also looked at houses (from the outside only) that they might consider purchasing, fixing up, and reselling for a profit. They kept no mileage log or record of which houses they looked at and never actually made any appointments to see the interior of any house - much less any offers to buy houses or actual purchases of real estate.
The taxpayers were dead in the water and never should have pursued this in tax court. Commuting miles cannot be deducted even if you do something sort of like business along the way. Costs of investigating an idea to start a business/buy real estate are not deductible if you don’t wind up starting the business/acquiring the real estate. Beyond that, you must be able to prove the existence of a profit motive for any endeavor to rise to the level of a business thus enabling the deduction of related expenses.
Wednesday, August 1, 2012
A taxpayer was assessed due to having claimed $44,700 in payments made his spouse pursuant to temporary orders during the pre-divorce separation period. The orders did not specify the character of these payments as alimony or as not alimony, however, they did include wording close enough to running afoul of item B below to cause the tax court to deny alimony treatment of these payments. In my opinion, the divorce attorneys should have done a better job of making sure the payments would qualify as alimony. Depending on a person's tax rate, he or she may be better off paying more in support and obtaining a tax deduction. The recipient spouse may be at a much lower tax rate and therefore likewise better off because he/she will receive more after tax money than she would have if it were not treated as alimony.
Example: If the payee has a fed/state tax rate of 33% then a deductible $4000 payment would really cost $2680 after taxes. Assuming the recipient spouse has a fed/state tax rate of 21% this $4000 is worth $3160 after taxes. Both parties are better off with this arrangement than with a $3000 payment that is not deductible to the payee. Win win!
Unallocated family support payments are deductible as alimony or separate maintenance only if all four of the above conjunctive requirements are met
(A) such payment is received by (or on behalf of) a spouse under a divorce or separation instrument,
(B) the divorce or separation instrument does not designate such payment as a payment which is not includible in gross income of the recipient and/or not allowable as a deduction to the payee,
(C) in the case of an individual legally separated from his spouse under a decree of divorce or of separate maintenance, the payee spouse and the recipient spouse are not members of the same household at the time such payment is made, and
(D) there is no liability to make any such payment for any period after the death of the payee spouse and there is no liability to make any payment (in cash or property) as a substitute for such payments after the death of the payee spouse.