A very interesting full decision of the Tax Court was released today in Perez v. Commissioner. The issue was whether a woman who had eggs retrieved from her body after undergoing fertility treatments in exchange for compensation could exclude the compensation because of the pain and suffering she went through in the procedure.
Today’s decision was written by Judge Mark Holmes, so it’s very readable for the layman. The petitioner, Nichelle Perez, agreed to undergo treatments so eggs could be taken from her body; in return she received compensation of $10,000. She did this twice in 2009; the egg donation agency issued her a 1099-MISC for $20,000. She didn’t include it as income because under Section 104(a)(2) income from damages from personal injuries and pain and suffering can be excluded from taxation. This is noted in Regulation Sec 1.104-1(c)(1):
Section 104(a)(2) excludes from gross income 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 Court had to decide whether excluding her compensation qualified as damages per this regulation. The regulation notes that damages are required; this causes the Court to look at a Chevron test. Unlike Loving v IRS where the first step of the Chevron test failed, here the Court looked at the second step. I’m going to extensively quote Judge Holmes’ opinion here as there’s no need for paraphrasing:
On this step, we find a regulation invalid only if it is “‘arbitrary or capricious in substance or manifestly contrary to the statute.’” Perez argues that the definition of “damages” in the regulation is invalid because it requires prosecution (or threat of prosecution) of a legal suit as a prerequisite for a payment’s exclusion from income…[citations and footnotes omitted]
Perez very clearly has a legally recognized interest against bodily invasion. But we must hold that when she forgoes that interest–and consents to such intimate invasion for payment–any amount she receives must be included in her taxable income. Had the Donor Source or the clinic exceeded the scope of Perez’s consent, Perez may have had a claim for damages. But the injury here, as painful as it was to Perez, was exactly within the scope of the medical procedures to which she contractually consented. Twice. Her physical pain was a byproduct of performing a service contract, and we find that the payments were made not to compensate her for some unwanted invasion against her bodily integrity but to compensate her for services rendered…
This small change just helped tax regulation keep up with a bit of a shift in American law toward administrative or statutory remedies and away from common-law tort for some kinds of personal injuries. It is not at all arbitrary, capricious, or manifestly contrary to the Code. But it also doesn’t help Perez. We completely believe Perez’s utterly sincere and credible testimony that the series of medical procedures that culminated in the retrieval of her eggs was painful and dangerous to her present and future health. But what matters is that she voluntarily signed a contract to be paid to endure them. This means that the money she received was not “damages”.
We conclude by noting that the result we reach today by taking a close look at the language and history of section 104 is also a reasonable one. We see no limit on the mischief that ruling in Perez’s favor might cause: A professional boxer could argue that some part of the payments he received for his latest fight is excludable because they are payments for his bruises, cuts, and nosebleeds. A hockey player could argue that a portion of his million-dollar salary is allocable to the chipped teeth he invariably suffers during his career. And the same would go for the brain injuries suffered by football players and the less-noticed bodily damage daily endured by working men and women on farms and ranches, in mines, or on fishing boats. We don’t doubt that some portion of the compensation paid all these people reflects the risk that they will feel pain and suffering, but it’s a risk of pain and suffering that they agree to before they begin their work. And that makes it taxable compensation and not excludable damages.
It would be nice if tax professionals could claim part of the fees were damages from the myriad of paper cuts we get each year. Or if I could claim damages for my chipped and fake teeth (yes, I played hockey). That said, Judge Holmes’ decision, as harsh as it may be for Ms. Perez, does seem absolutely right to me. Under the US Tax Code, any accession to income is taxable (unless Congress has exempted it). Ms. Perez willingly signed a contract prior to her procedures for compensation.
Lew Tashioff has more on this. There’s also an interesting discussion on this case from last March at the Faculty Lounge.