This part of the famous could’a would’a should’a trio doesn’t help Debra Jean Blum, 2021 T. C. Memo. 18, filed 2/18/21. Deb sued her lawyers, claiming they blew her med mal case against a WA hospital, which put her in a defective wheelchair. The lawyers settled, and Deb got $125K, but the settlement agreement expressly disclaimed compensating any physical injury and said that the claim was for legal malpractice only.

Deb doesn’t report the $125K, and IRS lets her off the chops, but wants the tax. Deb claims it’s physical per Section 104, but the plain language of the settlement agreement blows that away. And Deb’s claim that it was physical because, had her lawyers not blown her case, she would have been compensated by the hospital for her admittedly physical injuries, does not impress Judge Patrick J (“Scholar Pat”) Urda.

“The purported loss that she claims was the amount that she might have received from winning her personal injury lawsuit, which strikes us as a highly speculative proposition. Moreover, Ms. Blum fails to convince us that the settlement payment was meant to replace this purported loss, rather than for any of the other reasons that might have prompted her former attorneys to settle.” 2021 T. C. Memo. 18, at p. 12.

Deb’s new lawyers try the “recovery of capital” argument. They base this on a case, cited in the Memo., which held that what a taxpayer recovered from the preparer, on account of the tax they had to pay based on the preparer’s erroneous advice, wasn’t income. But in that case the recovery was matched, as to nature of claim and as to dollars, by what the taxpayer was actually out of pocket.

Here, we won’t ever know what a jury would’ve awarded Deb, if anything. And the settlement agreement expressly stated it was to settle the legal malpractice claim; having seen such settlement agreements, I doubt there was any admission of fault.