Despite taxpayers’ repeated tries, the courts consistently uphold a rather clearly worded provision of the Internal Revenue Code: Only damages received on account of physical injuries are excludable from tax. The plain language would seem to clearly not incorporate damages for emotional distress, but taxpayers keep trying.
Consider the recent case of Ms. Sharp before the Tax Court — a professor who was demoted to a secretarial position, who took a leave of absence and was later reinstated only to then get into a grievance dispute with another faculty member.
The resulting stress in her work life later led her to leave the university. She developed muscle tension and migraine headaches, became afraid to go to the university, developed a fear of people, had nightmares, and ultimately became hospitalized. She was diagnosed with severe clinical depression, anxiety disorder and post-traumatic stress disorder.
Later litigation which she instigated was settled by the university, which agreed to pay her $210,000, documented by a settlement agreement which referred to the sum as for “emotional distress damages only.”
Again — seems pretty clear: emotional distress, not physical injury.
Nevertheless, Ms. Sharp didn’t report the income, and in court, advanced two arguments:
• That the amounts were received under workers’ compensation acts as compensation for personal injuries or sickness (which, if correct, would have saved the day); and
• That the amounts were received on account of physical injuries or sickness.
As for the first argument, the Court decided Ms. Sharp failed to prove that she received the amounts in exchange for settlement of a claim under her state’s workers’ compensation law, noting particularly that the matter was simply a question of fact, which must be decided by reference to the settlement agreement’s express language (which simply wasn’t there).
Likewise, she lost the second argument for the same reason — the agreement specifically stated that the university was paying for emotional distress damages only. Moral of the story — get legal and/or accounting advice before finalizing the words in documents of this nature. Words do matter.
And from our “it’s about time” department comes word, this week, from Chicago that if a city councilman has his way, bicyclists will have to start shelling out a $25 annual tax to help defray services (like maintenance of bike lanes on city streets, including snow removal) from which more and more bikers are deriving benefits. Not a popular notion — Bloomberg reports that bike-friendly bloggers have reacted with a suggestion that perhaps pedestrians should be charged a shoe tax to use sidewalks!
CONSULT YOUR TAX ADVISER - This article contains general information about various tax matters. You should consult your CPA regarding the implications to your own particular situation. Jeff Quinn can be reached at email@example.com.