Emotional Distress or Physical Sickness Resulting in Emotional Distress

In Tishkoff v. Commissioner, T.C. Summary Opinion 2016-65, the court considered whether a lawsuit settlement payment was subject to income tax. The question was whether the payment to the taxpayer was for her for emotional distress or for personal physical sickness that resulted in emotional distress. One is taxable, the other is not.

  • The taxpayer worked for Wells Fargo as the administrative assistant to the “market president.”
  • Her employment was terminated in 2009.
  • She filed a complaint with the U.S. Department of Labor alleging that Wells Fargo violated whistleblower protection provisions of the Sarbanes-Oxley Act of 2002. She then filed a complaint against Wells Fargo in the Superior Court of California, County of San Francisco, alleging four causes of action: (1) wrongful termination for whistleblowing; (2) hostile work environment harassment; (3) intentional infliction of emotional distress; and (4) whistleblower retaliation.
  • Her complaint also alleged that she “suffered severe emotional distress and physical injuries and has necessarily expended sums in the treatment of such injuries” and that the emotional distress included anxiety, depression, trouble focusing, and weight gain and that petitioner had to seek therapy and take medication for treatment of this emotional distress.
  • Wells Fargo settled the lawsuit by paying the taxpayer $200,000.
  • The taxpayer executed a settlement agreement in which Wells Fargo denied all of her claims.
  • The settlement agreement described the $200,000 as payment for “alleged emotional distress.”
  • Wells Fargo issued a Form 1099-MISC to the taxpayer to report the $200,000 payment.
  • The taxpayer did not file a tax return to report the payment to the IRS, which resulted in the tax court case.

In the tax court case, the taxpayer argued that the $200,000 payment was excludable from income under Section 104(a)(2).

Settlement payments are subject to tax absent a provision that makes them excludable from income. Section 104 excludes from income damages received for personal physical injuries or physical sickness. Damages for emotional distress attributable to a physical injury or physical sickness qualify as damages excludable from income under Section 104. Stress-induced sickness does not qualify; the personal physical injury or personal physical sickness must instead be the cause of the stress.

In Tishkoff, the settlement agreement did not indicate whether the payment was for emotional distress or physical injury resulting from emotional distress. So the court considered other evidence, including the taxpayer’s testimony.

The taxpayer described her physical sickness and emotional distress as follows:

… because of the alleged abusive treatment by her employer, on one occasion she fell and twisted her ankle and on another occasion she cut her thumb while slicing a bagel. [She asserted] … that both injuries required doctor’s visits and that the cut on her thumb required stitches and left a scar. [She also asserted] … that the emotional distress caused her to gain about 75 pounds, have a fast heartbeat and panic attacks, and have high blood pressure. [She} … asserts she also had to visit a doctor for these medical problems [that] … she did not have a prior medical history of these ailments. {She] … also asserted in her [tax court] petition that the emotional distress caused her to have severe headaches, throw up, and suffer pain and nausea and that she attempted suicide and “has the scars to prove it.

In evaluating these facts, the court noted that:

… it appears more likely that, to the extent petitioner suffered personal physical injury or personal physical sickness, that injury or sickness was the result of her emotional distress, than that the emotional distress was caused by her physical injuries and physical sickness.

As such, the court concluded that the taxpayer’s physical sickness was due to emotional distress, not physical sickness, and the payment was not excludable from income for income tax purposes.


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