In Uncategorized on 10/28/2013 at 18:24

It’s easy to second-guess. That activity is on the Top Ten Indoor Sports List. And we’ve all messed up, sometimes really big. So I’m not naming names when it comes to the attorney who gets this footnote in Kathleen S. Simpson and George T. Simpson, 140 T. C. 10, filed 10/28/13: “We do not express any opinion as to whether Mr. X’s assessment was supported by the facts and the law underlying Ms. Simpson’s FEHA claims.” 2013 T. C. 10, at p. 8, footnote 3. (Name omitted). FEHA is California’s Fair Employment and Housing Act. And the Judge here is Judge Laro.

This case is noteworthy in that it applies the revised Section 104(a)(2) physical injury exclusion from income to a settlement otherwise than one arising from a tort or tort-like claim. Here, the claim is in the nature of a Workers’ Comp award, although it fails characterization as a Workers’ Comp for want of statutory compliance.

But in any event, whatever was settled (and it’s by no means clear what the payor thought they were settling, and that’s the test), it wasn’t the classic slip-and-fall or pedestrian-knock-down. Lost wages were in the mix, as were emotional harm, counsel fees and court costs (the latter two items being deductible but not excludable).

The problem is that Kathleen testified she had real physical problems arising directly from work. She had become a turnaround specialist for Sears, who sent her to manage a problem store that was three hours from her home, where the whole staff had been fired and replacements had less than a year of experience. She was working 60-hour weeks and lifting merchandise, to help out. She hurt her shoulder, she says, but the best the medical evidence she could produce claimed clinical depression, irritable bowel syndrome, and fibromyalgia.

Though she complained and asked for a transfer, Sears did nothing except fire her.

Catherine sues, but Sears gets summary judgment on two causes of action (neither of which mentions direct physical injuries), and based on the surviving third cause of action, her attorney, Mr X, negotiates a settlement based on Sears’ failure to give Kathleen a Workers’ Comp claim form when they can her. Though the settlement might qualify for treatment as a Workers’ Comp claim, Mr X doesn’t file or get it signed-off by the CA Workers’ Comp Board, so it fails the Section 104(a)(1) test. “Ms. Simpson never filed a workers’ compensation claim, and Sears and Ms. Simpson never submitted the settlement agreement to the California Workers’ Compensation Appeals Board (WCAB) for the approval required under Cal. Lab. Code sec. 5001 (West 2011). Mr. X was not aware of the approval requirement.” 2013 T. C. 10, at p. 10 (Name omitted).

Mr X, while stating he is not a tax attorney, does tell Kathleen “(D)ue to the nature of the claim that was settled, although I am not Ms. Simpson’s tax adviser, I understand that the settlement proceeds should not be considered taxable.” 2013 T. C. 10, at p. 11.

So Kathleen didn’t, but IRS said she should have, and gave her a SNOD for the whole $250K settlement (actually $262,500, but the $12,500 for lost wages she did report).

Kathleen and Mr X both credibly testify they meant to settle something to do with physical injury Kathleen sustained on the job. But noncompliance with the filing and sign-off requirement means that the settlement wasn’t a Workers’ Comp settlement. You have to fulfill the requirements, as I said in an eponymous blogpost, and Section 104(a)(1) requires statutory compliance.

But the 2012 amendment to Reg. 1.104-c comes to the rescue. As long as the injury is physical, it need not be based on tort or-tort-like conduct, or be statutorily-based.

Catherine gets her physical injury exclusion, based on 10% of her net award. The Court can’t do better than that “‘(B)ecause the record before us is not susceptible of any precisely accurate determination’ of the extent to which the settlement was attributable to Ms. Simpson’s personal physical injuries and sickness, we use our best judgment and find that 10% of the settlement payment of $98,000 was made on account of those physical injuries and physical sickness (other than emotional distress).” 2012 T. C. 10, at p. 27.

So Kathleen can exclude $9800, owes tax on the remaining $88,200, but can deduct the $152,000 in legal fees and court costs she paid to get it. IRS concedes the Section 62(a)(20) discrimination legal fees deduction, quibbles about the court costs, but Kathleen’s and Mr X’s candid testimony carry the day.

I won’t comment here on the proportion of fees and expenses to Catherine’s ultimate recovery.

Take away for PI lawyers– Please please please read and re-read Section 104 and the regulations. When you draft your settlement stip, beware of the Scylla of ambiguity and the Charybdis of unsupportable precision found in Healthpoint Ltd. (see my blogpost “An Unsettling Settlement,” 10/3/11). And don’t give tax advice, unless, of course, you’re competent to do so.

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