Opinion ID: 791827
Heading Depth: 2
Heading Rank: 2

Heading: Personal Physical Injury or Physical Sickness

Text: 15 Even if the 1996 amendment to I.R.C. § 104(a)(2) applies to the $2 million damages settlement, Lindsey argues he is entitled to exclude the settlement proceeds, because he received the payment as damages for physical sickness. Before a recovery may be excluded under I.R.C. § 104(a)(2), a taxpayer must establish two independent criteria: (1) prosecution or settlement of an underlying claim based on tort or tort-type rights, and (2) receipt of damages on account of personal [physical] injuries or [physical] sickness. Schleier, 515 U.S. at 337, 115 S.Ct. 2159. 16 Because some of the claims specified in the Termination Agreement were based in tort, Lindsey arguably satisfies the first prong. However, a taxpayer can satisfy the second criterion only by establishing a direct causal link between the damages and the personal injuries or physical sickness sustained. See Banaitis v. Commissioner, 340 F.3d 1074, 1080 (9th Cir.2003), abrogated on other grounds by Commissioner v. Banks, ___ U.S. ___, 125 S.Ct. 826, 829, 160 L.Ed.2d 859 (2005); Fabry v. Commissioner, 223 F.3d 1261, 1270 (11th Cir.2000). This direct causal link inquiry, in turn, requires us to perform a fact-specific analysis of the damages award. Lindsey's physician, Dr. William Taylor, testified that, during the energy acquisition and settlement negotiations from 1995 to 1997, Lindsey suffered from hypertension and stress-related symptoms, including periodic impotency, insomnia, fatigue, occasional indigestion, and urinary incontinence. We agree with the Tax Court that these health symptoms relate to emotional distress, and not to physical sickness. Importantly, NGC, the payor of the settlement award, was never made aware Lindsey was suffering any physical sickness, thereby belying the existence of a direct causal link between any physical sickness suffered by Lindsey and damages paid out to him. 17 Lindsey opted to take an all-or-nothing approach, claiming the entire $2 million is physical sickness settlement damages and is excludable as taxable income. The Termination Agreement identifies Lindsey's nonphysical tort claims for damage to his emotions, reputation and character, which damages are no longer excludable as gross income following the enactment of the 1996 amendment. The Termination Agreement also identifies Lindsey's damage claims for interference with contract, which clearly constitute economic damages. The same Termination Agreement provision further requires Lindsey to provide consulting services to NGC, which implies the parties may have intended some portion of the $2 million payment to be compensation for future consulting services. 18 Lindsey fails to establish the second criterion, because he has not identified what percentage of the settlement damages is allocable to physical injury or physical sickness, and the record lacks any evidentiary basis for concluding a specific portion of the $2 million settlement payment is allocable to Lindsey's physical injury or physical sickness. Therefore, the tax court properly denied the exclusion. Bagley v. Commissioner, 121 F.3d 393, 395, 397 (8th Cir.1997) (When assessing the tax implications of a settlement agreement, courts should neither engage in speculation nor blind themselves to a settlement's realities.).