26 September 2013
Research Problem Chapter 5-2
I. Facts about my client:
Client was diagnosed with multiple sclerosis when she was 27 years old.
Client was employed full-time.
Client remained full-time after her condition was discovered.
Her employer placed extreme pressure on her.
Employer’s pressure caused symptoms of multiple sclerosis to accelerate.
Client was then fired by employer.
Client sued the employer and collected damages caused by the employers’ egregious behavior.
IRS contended that the damages she suffered were from emotional distress
IRS claimed damages must be included in gross income.
Does the taxpayer (client) have a defensible basis for excluding the damages from gross income?
Denise D. Dennis v. Commissioner of Internal Revenue, Gross income generally includes all income from whatever source derived. Sec. 61(a). The definition of gross income is broad in scope, while exclusions from income are narrowly construed. Commissioner v. Schleier, 515 U.S. 323, 328 [75 AFTR 2d 95-2675] (1995). Damages (other than punitive) received on account of personal physical injuries or physical sickness may generally be excluded from gross income. Sec. 104(a)(2). For the damages to be excluded under this provision, the underlying cause of action must be based in tort or tort-type rights and the proceeds must be damages received on account of personal physical injury or sickness. Commissioner v. Schleier, supra at 337. Emotional distress is not treated as a personal physical injury or physical sickness except for damages not in excess of the amount paid for medical care attributable to emotional distress. Sec. 104(a) (flush language).
Petitioner has cited Murphy v. IRS, 460 F.3d 79 [98 AFTR 2d 2006-6088] (D.C. Cir. 2006), to argue that the proceeds of her settlement compensating her for emotional distress should be exempt from income. However, as noted above, the Murphy decision petitioner cites was later vacated by the Court of Appeals. Accordingly, we reject petitioner's argument that her income from the settlement was nontaxable.
In order for damages to be excludable from gross income under section 104(a)(2), 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. See sec. 104(a)(2); Commissioner v. Schleier, 515 U.S. at 337. The flush language of section 104(a) provides that emotional distress shall not be treated as a