Double Taxation: A Take On All Things Taxes

Julie Blackwood, who had long suffered from depression, was unceremoniously canned from her job;  the details of the sacking are unimportant.

After her termination, Blackwood’s depression relapsed, causing her to suffer symptoms such as insomnia, sleeping too much, migraines, nausea, vomiting, weight gain, acne, and pain in her back, shoulder and neck. Blackwood sued her former employer, and was eventually awarded a $100,000 settlement. She was issued a Form 1099-MISC, but on the advice of counsel excluded the $100,000 from her tax return as a nontaxable payment pursuant to I.R.C. § 104.

As we’ve discussed previously, I.R.C. § 104 provides an exclusion from gross income for “the amount of any 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”. The flush language of I.R.C. § 104(a) provides that emotional distress shall not be treated as a physical injury or physical sickness.

Blackwood argued that the exacerbation of her depression symptoms as a result of her termination was a physical injury or physical sickness under I.R.C. § 104(a)(2). The IRS viewed it differently; arguing that the depression symptoms Blackwood  suffered were properly classified as emotional distress under the flush language of I.R.C. § 104(a).

The Tax Court ultimately sided with the IRS, agreeing that while Blackwood’s depression manifested itself in physical symptom, the root cause of the litigation against her former employer was not personal injury or physical harm, but rather emotional distress. A review of the congressional reports led the court to its decision:  

The legislative history of section 104(a) states it “is intended that the term emotional distress includes symptoms (e.g., insomnia, headaches, stomach disorders) which may result from such emotional distress.” Congress’ listing of physical symptoms of emotional distress is evidence of Congress’ intent to establish that not every physical symptom will qualify as a physical injury or physical sickness under section 104(a)(2). Therefore, the fact that a taxpayer suffers physical symptoms from emotional distress does not automatically qualify the taxpayer for an exclusion from gross income under section 104(a)(2). …Petitioners did not provide evidence that petitioner’s physical symptoms of depression were severe enough to rise to the level of a physical injury or physical sickness.

While the decision may seem unsympathetic, it should come as no surprise, as the courts have been fairly consistent in holding that physical symptoms caused by emotional distress do not rise to the level of “personal injury or physical harm” under I.R.C. § 104. I’ve always been curious, however, how the courts would rule should the line between emotional distress and physical injury become blurred even further:

Consider the following example: A professional dancer is constantly belittled by her producer to lose weight, and develops an eating disorder. She sues, and recovers a large settlement. Is the eating disorder a physical injury, or is it an emotional one? Is the eating disorder the initial injury, or is it the manifestation of a deeper emotional harm, similar to Blackwood’s physical symptoms caused by her depression?

Blackwood v. Commissioner, TC Memo 2012-190.