McGowen v. Comm'r
2011 T.C. Memo. 186
Tax Ct.2011Background
- Petitioners McGowen filed a joint 2006 federal income tax return asserting underreporting related to a 2005-2006 settlement with PacifiCare.
- PacifiCare settled claims for $125,000, allocating $39,750 to attorney fees, $42,625 (lost income) to McGowen, and $42,625 (emotional distress).
- Emotional distress damages were not linked to a physical injury on the settlement terms.
- McGowens received Form W-2 for the lost income payment and Form 1099-MISC for the emotional distress payment; the latter was not reported on the 2006 return.
- The IRS issued a deficiency notice alleging underreported income of $12,618 and a $2,467 accuracy-related penalty under section 6662(a).
- The Tax Court held decision will be entered for respondent after considering the section 104(a)(2) exclusion and the section 6662(a) penalty.
Issues
| Issue | Plaintiff's Argument | Defendant's Argument | Held |
|---|---|---|---|
| Taxability of emotional distress settlement payment | McGowen argues emotional distress payment is excludable under 104(a)(2). | Respondent contends emotional distress damages are not physical injury or physical sickness and thus not excludable. | Emotional distress payment not excludable under 104(a)(2). |
| Accuracy-related penalty under section 6662(a) | McGowen reasonably believed part of the settlement was non-taxable and acted in good faith. | Penalty feasible unless reasonable cause and good faith shown; burden on taxpayer to prove reasonable care. | McGowen not liable for the section 6662(a) penalty. |
Key Cases Cited
- United States v. Burke, 504 U.S. 229 (1992) (fundamental tort-based exclusion for damages under 104(a)(2) hinges on nature of underlying claim)
- Commissioner v. Schleier, 515 U.S. 323 (1995) (broad interpretation of gross income exclusions; narrowly construe §61(a))
- Seay v. Commissioner, 58 T.C. 32 (1972) (settlement damages analyzed by the underlying claim to determine 104(a)(2) excludability)