What Are Medical Damages?

A court of appeals case in March serves as a reminder about the definition of medical damages. The case was not a 1099 case, but it’s informative for those of us in the field.

The case involved two people with the last name of Roman, who had been married but divorced in 2004. Mr. Roman had various health problems, and Mrs. Roman moved in with him as his caregiver.

In 2010, they moved into an apartment complex. Shortly after they moved in, they started making various complaints to the apartment’s owners. According to the Tax Court, those complaints included “expressing concerns about noise and harassment and submitting requests for accommodations in connection with Mr. Roman's disabilities. Various legal actions ensued.”

The company that owned the apartments, called “Jefferson Hollywood at LP,” was looking to sell the apartment complex. They found a buyer, but the buyer insisted that the Romans would need to leave the complex or else they would reduce their offer by $1 million. Jefferson then offered a settlement agreement to the Romans — $700,000 to vacate the premises.

The couple did leave. Mrs. Roman received $700,000, and Jefferson sent her a 1099-MISC, reporting that amount.

This all happened in 2013, and she didn’t report this amount as income on her tax return. Mr. Roman didn’t file a tax return at all for 2013.

The IRS said this was a taxable settlement, and furthermore, it should be split between Mr. and Mrs. Roman 50/50.

Medical Damages

We often use the term "medical damages," but the true terminology is amounts received "on account of personal physical injuries or physical sickness." This is section 104(a)(2).

At issue in this case is whether the settlement constituted this type of payment. The IRS and the courts agreed that the settlement was not on account of physical injuries or physical sickness. The settlement agreement stipulated that it was payment to vacate the apartment. While there’s no doubt that Mr. Roman did have health problems, the settlement wasn’t in relation to his health problems. The tax court used the term “nexus.”

(T)hey have not shown the nexus between such ailments and the $700,000 payment. Virtually all of Mr. Roman's ailments were unrelated to living at the Apartments. And to the extent the Romans argue that Mr. Roman's ailments were exacerbated by any noise from the building or stressors caused by living at the building, the Romans have not demonstrated that any claim for physical injuries against Jefferson or Greystar was considered when the Settlement Agreement was executed. Although Ms. Roman testified that she began experiencing panic attacks, depression, anxiety, and migraines on account of noise from a neighboring apartment, her claims appear to have been more in the nature of emotional distress, which are explicitly excluded from section 104(a)(2). See I.R.C. §104(a). Finally, although Ms. Roman testified that she injured herself while moving out of the Apartment, she made no claim that the injury resulted from any actions or inactions on the part of Jefferson or Greystar. Therefore, the Romans' recitation of their various ailments does nothing to support the argument that the $700,000 was compensation for personal physical injuries or physical sickness.

One key is that the settlement agreement didn’t explicitly say the settlement was for medical damages. With no specific language, the court said it needed to look at the intent. The court said the settlement was mainly so Jefferson could get the couple out of the apartment so it could complete the sale. Therefore, the court determined that it was not a settlement for medical damages.

Assignment of Income

Another portion of this case involved whether both taxpayers had income from the settlement, or only one of them. The court report says Mrs. Roman received the entire proceeds, and she got the 1099. The IRS said the couple should have split the settlement 50/50. The Tax Court sided with the IRS.

The court said the settlement wouldn’t have existed without both people leaving the apartment. Therefore, they each owned the settlement equally. This raises the issue of beneficial ownership of income.

While Mr. Roman didn’t get any money, and in fact told the court that he didn’t want any money, he still had an economic interest in the settlement. Thus, the court said, half of the settlement belonged to him.

The Tax Court decided the case in 2023, and an appeals court upheld the Tax Court’s ruling earlier this year.

Conclusion

For those of us in the 1099 world, this case doesn’t break any new ground, but it does give some reminders:

1. Watch the wording of settlement agreements. As a payer of a settlement, always assume it’s taxable unless the agreement specifically says the settlement is for a reason that’s not taxable, such as medical damages.

2. Ownership of income isn’t always determined by who actually gets the money. It’s determined by who controls the payment. This is one of those “do the best you can” sorts of things, as sometimes you might not know all the details.