Friday, August 3, 2012
The "Don't look a gift horse in the mouth' Case
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.