Lawsuit Proceeds Were Taxable

Theresa Devine worked as a National Guard civilian aircraft technician at Andrews Air Force Base from 2008-2010.  Beginning in 2008 she became the target of sexual harassment and gender discrimination by senior noncommissioned officers (NCOs).  This continued until she resigned in February 2010 at which time she continued to serve in a military position with her unit.

In late 2008 she informed her supervisors she was pregnant.  In alleged contravention to the National Guard rules, she was ordered to continue working in an area where she would be exposed to toxic chemicals.  When she developed a rash she was ordered to stock parts on shelves.  Several months later she consulted informally with a National Guard human resources officer.  She reported she had experienced several incidents of sexual harassment, inappropriate behavior, and retaliatory action by senior NCOs in her unit.

When her supervisors learned what she had done, they chastised her for “breaking the chain of command and going outside to report the incident.”  During a meeting in April 2010 she described the misconduct she had experienced.  She informed the equal employment opportunity (EEO) officers that the bases for her complaint were sexual harassment and gender discrimination.  She did not allege that she suffered physical injury for which the National Guard might be liable.

On a National Guard complaint form she said a ranking NCO (NCO-1) denied her a promotion because she was pregnant, made romantic advances to her even though he knew she was married, and informed other unit members that he desired to have sexual relations with her.  Mrs. Devine did not allege that she suffered any physical injury.

Her second complaint form claimed a second NCO (NCO-2) had stated he did not want women working in his unit, referred to her in a derogatory fashion as a “good little mechanic”, and insisted she could not receive a promotion because she was pregnant.  Again Mrs. Devine did not allege that she suffered any physical injury.

The National Guard agreed with her complaints and reprimanded the NCOs, ordered her unit supervisors to receive EEO training, and directed that Mrs. Devine be considered for a promotion in the normal course.

A few months later Mrs. Devine filed an EEO complaint against the National Guard.  This complaint state she was still suffering ongoing reprisals and sexual harassment.  Again she did not mention she suffered from any physical injury.  In April 2011 she amended her complaint form alleging another NCO (NCO-3) “came up behind me and violently threw himself into me giving me a hug ***.  It was forceful enough that it actually hurt.  We currently do not have a friendly relationship and I find this behavior to be inappropriate and disturbing.”  Again she did not allege this caused her physical harm, it was an example of unwanted touching and indicative of the hostile environment in which she worked.

In June 2012 a settlement was reached and Mrs. Devine received $220,252.  Nothing in the settlement agreement mentioned any physical injury.  When questioned about not reporting this income, Mr. & Mrs. Devine argued that the settlement was related to physical injury because touching was physical and therefore the settlement should be nontaxable under IRC Section 104.  IRC Section 104 states lawsuit settlements are nontaxable if they are for physical injury or physical illness.  The law specifically says “emotional distress” is not a physical injury or physical illness for this purpose.

Tax Court agreed with the IRS position that this settlement was not received in connection with a physical illness or injury.  Nothing was mentioned about either of these during any of the complaints or discussions, therefore the entire settlement was taxable.  The settlement agreement stated the settlement proceeds would be subject to Federal and State income taxes.  A Form 1099-MISC was also issued.  Tax Court also upheld the accuracy related penalty.

Although the main issue in this case is the lawsuit settlement, it is notable that Mr. & Mrs. Devine also failed to report taxable interest income of $14, wages of $207, a state tax refund of $207, and a retirement plan distribution of $5,192.  These amounts are minor in comparison to the big issue, but their inclusion shows nothing is too small for IRS to know about.

Michael L. Devine, Jr, & Theresa M. Devine, TC Memo 2017-111.  This case can be found by going to www.ustaxcourt.gov, clicking on Opinion Search, and entering DEVINE in the “Case Name Keyword” box.


This text has been shared with you courtesy of:  David & Mary Mellem, EAs & Ashwaubenon Tax Professionals, 920-496-1065 (920-496-9111).