Case Study Review Using Source Tax Documents

Dr. Tooth, a dentist from Small Town, USA, has been awarded $3,600,000 from a jury verdict due to a former patient spreading a cruel rumor about him, after having a billing disagreement. The rumor destroyed the dentist’s patient base, which caused him financial strain. After the rumor was spread and financial strain set it, the doctor’s health began to suffer. Dr. Tooth then sued the patient for defamation and intentional infliction of emotional distress. Dr. Tooth has requested that the appropriate tax treatment for his award be determined.

As the tax advisor it is one’s responsibility to find the best answer for the client’s specific situation. The taxpayer’s desired result is to always find out how much of the award is taxable and at what rate. This way the taxpayer can pay the least amount of tax allowed by law. There is also no changing the situation as the award has already been determined, so there is no need to begin tax planning.

The questions to ask when beginning research are: What court awards are taxable? At what percent are they taxable? Are attorney and court costs deductible? These questions remain the same before and after receiving the breakdown of the award. An additional question to ask after finding out that the doctor paid attorney fees is if the fee was taken from his award, or if it was to be paid regardless of the verdict.

Communication with the doctor would need to be continued on a regular basis, in order to inquire about any questions that may arise. After first speaking with Dr. Tooth, the most important information to begin research would be to find out how the award was broken down. Another question needing to be asked is if any fees were paid that may be deductible. Source documents would also need to be requested, such as court documents stating the fees and breakdown of the award.

Dr. Tooth gave several facts, some relevant and others irrelevant. The facts given in the case that were irrelevant was any fact that did not give relevant information for finding the appropriate tax treatment of the award; such facts are the doctor’s age, the patient’s wealth. The reason the patient spread the rumor is also irrelevant, this fact is relevant to the jury, but not to the tax treatment of the award. Many relevant facts were also given, such as the fact that the doctor received a jury award for damages of defamation and intention infliction of emotional distress.

According to IRC 61 the lawsuit award could possibly included in gross include due to it being monies received. The code section that answers the question of what part of the award is taxable is pertains to Compensation for injuries or sickness is IRC 104(a)(2). This code section describes an exclusion from gross income for damages received due to a personal injury or sickness. Publication 502 also describes how some of the award would be handled due to a portion ($20,000) being deemed for future medical expenses.

The study of IRC 104(a)(2) does help refine the initial question of what portions of the jury award are taxable. The awards of punitive damages are taxable under Ð'§104(a)(2), although the award for pain and suffering under Ð'§104(a)(2) are not taxable. The award of $200,000 for compensation for emotional distress is taxable under 104(a)(2), in flush paragraph under section 104(a)(5) it states “For purposes of paragraph (2) , emotional distress shall not be treated as a physical injury or physical sickness.” Additional proof of this was found in Rev Rul 2007-14, 2007-12 IRB 747. “Citing the rationale in Hawkins, (footnote 4.1) the Tax Court held that emotional distress damages for injury to human capital were damages received on account of personal nonphysical injuries or nonphysical sickness and not excludable from gross income.” The award of $1,000,000 for lost wages is taxable as compensation under Ð'§61. The reimbursement for medical expenses are not taxable but amount must be deducted from future medical expenses claimed on schedule A, but according to publication 502 if the reimbursed amount exceeds actual medical expenses the difference is taxable. This is also true for the $20,000 awarded for future medical expenses, but this amount must also be deducted from future medical expenses claimed on schedule A.

Reg Ð'§1.104-1, Compensation for injuries or sickness, under section (c), “Damages received on account of personal injuries or sickness”, more defines Ð'§104(a)(2). Section 104(a)(2), “excludes from gross income the amount of any damages received (whether by suit or agreement) on account of personal injuries or sickness.”

According to Reg Ð'§ 1.6045-5, Information reporting on payments to attorneys, an additional, information return must be filed. The regulation states that “every payor engaged in a trade or business who, in the course of that trade or business, makes payments aggregating $600 or more during a calendar year to an attorney in correction with legal services… must file an information return for such payments.” According to this