Thursday, July 24, 2014

Damages For Distress from Harassment Taxable

Originally Published on forbes.com on August 9th,2011
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When the Tax Court is right, it is right, but we don’t have to like it.  That’s the way I feel about the case of Julie M. McGowen, anyway.  Ms. McGowen had a rather difficult supervisor:
In 2004 Julie Marie McGowen worked as a financial analyst forPacifiCare Health Systems, Inc., and PacifiCare of California (collectively, PacifiCare). From August to December 2004 Mrs. McGowen was harassed at work by Kevin Bulrice. Mr. Bulrice created an intimidating, hostile, and offensive work environment and, on one occasion, threw a binder at Mrs. McGowen. Mrs. McGowen reported these incidents to her superiors, but her superiors did not take action to prevent Mr. Bulrice from continuing to harass Mrs. McGowen. Mrs. McGowen’s work conditions became intolerable and she began to develop symptoms of emotional distress (e.g., shaking, sweating, anxiety, sleeplessness, panic attacks, depression, etc.). On December 19, 2004, Mrs. McGowen elected to take a medical leave of absence due to stress.
The company was not real sympathetic, apparently:
During her leave of absence Mrs. McGowen remained in contact with PacifiCare and periodically updated PacifiCare on the status of her health. On March 23, 2005, Mrs. McGowen requested an extended leave of absence and informed PacifiCare that she would be undergoing counseling for her stress-related problems. On April 19, 2005, PacifiCare notified Mrs. McGowen that her employment had been terminated effective April 15, 2005.
That was probably not the company’s most inspired personnel decision that year:
On September 26, 2005, Mrs. McGowen filed a complaint against PacifiCare and several PacifiCare employees with the Superior Court of the State of California, County of Orange (complaint). In the complaint Mrs. McGowen alleged sexual harassment, failure to prevent sexual harassment, disability discrimination, failure to prevent discrimination, intentional infliction of emotional distress, and other causes of action. Mrs. McGowen also described how she was mistreated and requested “compensatory damages for emotional distress and other economic and non-economic losses”. 

Mrs. McGowan was awarded $125,000.  After the lawyers took their share she was left with a bit over $85,000.  Half of that was for lost wages which was reported to her on W-2.  The other half was for for “physical injury caused by emotional distress”.  My mother, who though entirely of Irish descent, was Italian by association, (I am so thankful that she learned how to cook from her Italian friends rather than her Irish mother-in-law) would call that “agita“.    “Tsoris“  is another good term for it.  (You don’t grow up in public accounting in Worcester, Mass without picking up a little Yiddish even if you are a Holy Cross graduate.)  I don’t know why there isn’t a really good English word for it.  I’m pretty sure the Irish Catholic attitude is to “offer it up” (for the souls in purgatory) rather than to experience it, which is why I need to reach out to other cultures for a good word.  Regardless of whether she thought of it as agita or tsoris or chose to offer it up, Mrs. McGowan didn’t think she should be taxed on the money that she got paid for having suffered it, even though there was a 1099-MISC issued.
The problem with her tax position is that Mr. Bulrice just didn’t throw the binder harder enough or perhaps it was poorly aimed.  In order for damages to be excluded there has to be a physical injury.  Physical symptoms that manifest from non-physical injuries are excluded from the definition. 
There is no evidence that the binder physically injured Mrs. McGowen or that Mrs. McGowen suffered other than the symptoms of emotional distress. Moreover, pursuant to the settlement agreement, Mrs. McGowen received damages on account of her emotional distress and not as a result of “a physical injury or physical sickness” as defined in section 104(a).
I was pleased that the Tax Court cut Mrs. McGowan a break on the penalties:
Mrs. McGowen, who lacked knowledge and experience in tax law, reasonably believed that a portion of her settlement payment was not taxable and in good faith did not report that portion of the settlement payment on her 2006 return.
I do think it is a bit odd that her attorney didn’t tell her.  I realize that her attorney was probably not a tax attorney, but lawyers who negotiate settlements should be sensitive to tax outcomes.