The Tax Court in Brief – November 21st – November 25th, 2022
Freeman Law’s “The Tax Court in Brief” covers every substantive Tax Court opinion, providing a weekly brief of its decisions in clear, concise prose.
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Tax Litigation: The Week of November 21st, 2022, through November 25th, 2022
- Servance v. Comm’r, T.C. Summary Opinion 2022-23 | November 21, 2022 |Copeland, J.| Dkt. No. 1587-18S (Tier 1 Railroad Retirement Benefits; Claim-of-Right Doctrine; Rescission Doctrine)
Tillman-Kelly v. Comm’r, T.C. Memo. 2022-111 | November 21, 2022 | Urda, J. | Dkt. No. 6127-20
Short Summary: Chicago State University (“CSU”) hired Mr. Bryant Tillman-Kelly in 2009 as a project director of a grant CSU had received. Mr. Tillman-Kelly reported to the U.S. Department of Education and CSU’s Ethics Office that certain grant funds were misappropriated. In June 2010, CSU terminated Mr. Tillman-Kelly’s employme
Mr. Tillman-Kelly filed suit against CSU, its board of trustees, and Dr. Justin Akujieze (his direct supervisor) (together, the “Defendants”) in Illinois state court. Mr. Tillman-Kelly alleged that he subjected to, among other things, humiliation and harsher discipline compared to other employees. He further sought damages related to emotional distress, humiliation, and lost income and benefits; he did not, however, allege or seek damages related to any physical injuries. In 2017, Mr. Tillman-Kelly and the Defendants settled the state court case. Per the settlement agreement, the Defendants paid Mr. Tillman-Kelly $230,671.00 related to “alleged non-wage injuries, as non-economic emotional distress damages.”
Bryant and Melanie Tillman-Kelly (“Petitioners”) did not report the settlement payment on their 2017 Form 1040; however, CSU reported the settlement payment to the Internal Revenue Service (“IRS”) on Form 1099-MISC. The IRS later issued a Notice of Deficiency to the Petitioners, determining a deficiency of $67,322.00 and an accuracy-related penalty of $13,423.00. The Petitioners petitioned the Tax Court and submitted the case for decision without trial under Rule 122.
Key Issues: Whether the settlement proceeds received during tax year 2017 should be excluded from Petitioners’ gross income under Section 104(a)(2).
Primary Holdings: The settlement proceeds received during tax year 2017 should be included in Petitioners’ gross income, as they do not qualify for the exclusion under Section 104(a)(2).
Key Points of Law:
- The Commissioner’s determinations in a notice of deficiency are generally presumed correct, and the taxpayer bears the burden of proving those determinations erroneous. See Rule 142(a)(1); Welch v. Helvering, 290 U.S. 111, 115 (1933); Merkel v. Comm’r, 192 F.3d 844, 852 (9th Cir. 1999), aff’g 109 T.C. 463 (1997).
- Gross income includes all income from whatever source derived, and exclusions from gross income must be narrowly construed. SeeR.C. § 61(a); see also Comm’r v. Glenshaw Glass Co., 348 U.S. 426, 429 (1955); Helvering v. Clifford, 309 U.S. 331, 334 (1940); Comm’r v. Schleier, 515 U.S. 323, 328 (1995).
- Gross income excludes 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. See R.C. § 104(a)(2). Further, emotional distress is not considered a physical injury or physical sickness unless it is attributable to a physical injury or physical sickness. See Treas. Reg. § 1.104-1(c)(1).
- When a taxpayer receives damages pursuant to a settlement agreement, the nature of the claim that was the actual basis for the settlement controls whether the damages are excludable under Section 104(a)(2). See United States v. Burke, 504 U.S. 229, 237 (1992); see also Bagley v. Comm’r, 105 T.C. 396, 406 (1995).
Insight: Tillman-Kelly addresses an issue taxpayers continue to wrestle with—the taxability of settlement payments related to emotional distress. As discussed in previous Tax Court cases—see, e.g., Domeny v. Comm’r, 99 T.C.M. (CCH) 1047 (2010); Parkinson, 99 T.C.M. (CCH) 1583 (2010)—settlement agreements need to clearly identify the intent of the parties and what the settlement payment is related to. Otherwise, the IRS will presume (as it did here) that the payment should be includable in the taxpayer’s gross income and not excluded under Section 104(a)(2). Taxpayers should be mindful of the tax consequences related to any settlement agreements they intend to sign.