In Crane v. Commissioner, T.C. Memo 2011-256 (2011), a taxpayer (Crane) worked as a leased employee for a healthcare company (Oakwood). During her tenure at Oakwood, Crane’s direct supervisor was a man named Mr. Plue (Plue).
Now apparently, Plue had never taken the time to learn the three cardinal rules to avoiding a sexual harassment lawsuit:
1. Be handsome
2. Be attractive
3. Don’t be unattractive.
As a result, one of Crane’s coworkers accused Plue of harassment and general scumbaggery, a claim Crane supported upon the resulting internal investigation.
Shortly thereafter, the leasing arrangement between Crane’s employer and Oakwood was terminated, leaving Crane out of a job. In turn, Crane applied for another opening at Oakwood, but was turned down despite having the proper qualifications.
In response to this string of events, Crane sued Oakwood. In her claim, Crane asserted:
…that by aiding Slaven in pursuing her claim [of sexual harassment] and acting as a witness for Slaven, Oakwood retaliated against her [Ms. Crane]causing her both economic and non-economic damages.
The retaliatory adverse actions claimed by Crane include:
1. Oakwood demoting her from physician liaison to laboratory sales representative;
2. Oakwood declining to renew its contract with PCS; and
3. Oakwood failing to offer her a physician liaison job at Annapolis Hospital.
Crane’s suit went to an arbitrator, who found that while Crane did not suffer any economic damages due to her termination, she had suffered other damages worth $75,000:
Notwithstanding my prior findings, I do find that Crane suffered non-economic damages as the result of Plue’s direct actions and Oakwood’s failure to do more to control Plue’s actions during the time the investigation into Slaven’s sexual harassment complaint was pending. I find that Plue purposely acted in a way to intimidate Crane’s testimony in that investigation. I also find that given little or no communication by Oakwood during the time the investigation was pending to Crane as to how she was, if at all, being protected from Plue’s intimidation, Oakwood acquiesced in Plue’s actions. This is especially true since some of Plue’s acts of intimidation were directly contrary to instructions he was given by his superior.
In compensation for these non-economic damages, I award Crane the sum of $75,000 which includes any and all types of damages she may be entitled to claim including any attorney’s fee award.
On her 2007 tax return, Crane failed to include the final arbitration award in her gross income.
As we previously discussed here, Section 104(a)(2) provides that gross income does not include 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. Section 104(a)(2) further provides that emotional distress shall not be treated as a physical injury or physical sickness, except to the extent that damages attributable to the emotional distress were used to pay for medical care, as described in section 213(d)(1)(A) or (B).
The IRS assessed Crane with additional tax and an underpayment penalty related to her 2007 tax return, including in income the arbitration award. The IRS argued that the award was not excludable from Crane’s gross income under section 104(a)(2) because that award was not received on account of personal physical injuries or physical sickness of Crane.
In her defense, Crane came up with a compelling argument as to why the arbitration award was made on account of physical injuries or sickness, and thus was excludable from gross income. Crane contended that under Michigan law, the arbitrator was not permitted in this case to award compensation for emotional distress, and thus the amount awarded must have been for physical harm:
Under Michigan law, a plaintiff can only recover for emotional distress proximately caused by a defendant’s negligent conduct if there is a definite and objective injury. The emotional distress must manifest itself in the form of definite and objective physical injury.
As a result, when the facts and circumstances are taken into consideration, because of the way Michigan law prohibits the recovery for purely emotional distress damages in a negligence claim, and because Deborah Crane suffered from a physical sickness or illness because of her treatment in the workplace, this Court should find that the arbitration award was made to compensate Deborah Crane for physical harm or illness suffered as the natural result of the negligent conduct of Oakland [sic] Healthcare, Inc.
Tax Court Opinion
The Tax Court was not convinced, holding against Crane and including the arbitration award in income. In reaching its decision, the court went to the language of Crane’s original claim(copied above), which was devoid of evidence establishing Crane’s contention that she “suffered from a physical sickness or illness because of her treatment in the workplace”.
The record was also devoid of evidence establishing that Crane’s claim against Oakwood was for, or that the arbitrator’s award in his final arbitration decision was made on account of, personal physical injuries or physical sickness of Crane.
What Can We Learn?
The courts have proven time and time again that in order for a settlement or judgment to be excluded from income under Section 104, a taxpayer must be able to prove an identifiably physical harm has been suffered. While that line has become blurred due to the physical side effects and symptoms of emotional distress, in Crane’s case, she never had a leg to stand on as her original claim never asserted any physical injury or sickness had resulted from the actions of her employer.