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Pfizer Settlement Payment Was Not Excludible from Income as Payment for Physical Injury

(Parker Tax Publishing December 2017)

A district court held that a payment received by a taxpayer under a settlement with his former employer was not excludible from gross income as damages for physical injuries under because the underlying claim was not a tort and was not for a physical injury. The district court also found that FICA tax was properly withheld because the payment fell under the broad definition of remuneration for employment. Bell v. U.S., 2017 PTC 533 (D. Conn. 2017).

Michael Bell began working in Pfizer's information technology department in 2002. Bell was declared legally blind in his left eye in 1995 and began losing vision in his right eye in 1998 or 1999. By the time he began working for Pfizer, his vision problems were so severe that he struggled to read handwriting or distinguish details of photographs. He stopped driving and was declared legally blind in 2005. Bell's doctors did not conclusively diagnose a reason for his blindness.

Bell claimed that, when he was hired, he was told that Pfizer would pay to move him from New Jersey to Connecticut. Bell said that he bought a house in Connecticut based on that representation but, after he moved, he was told that most of the money he received would have to be repaid. Bell said he would not have bought the house without the promise and payment of a large sum of money and that the experience caused him much stress. Bell also claimed that he was taunted and harassed at work on account of his disability.

Bell and Pfizer began settlement negotiations after Bell asked for compensation due to his physical injuries. Bell and Pfizer negotiated a settlement agreement under which Pfizer agreed to pay Bell $190,000 in 2007 and $990,000 in 2008. Pfizer treated both payments as taxable wage income. It withheld state and local income taxes as well as the Federal Insurance Contributions Act (FICA) tax.

According to the IRS, the payments to Bell were taxable as wages subject to withholding and represented amounts before withholding. Although the agreements with Pfizer did not specify the grounds for the payments, they did state that Bell had been paid in full any and all monies owed to him in connection with his employment with Pfizer and in connection with his termination from active service. The IRS assessed tax deficiencies which Bell paid. Bell then filed a refund claim which the IRS denied.

Bell sued the IRS in a district court, claiming that the payments were made on account of lost wages and personal injury. Specifically, he said that the 2007 payment was for lost wages and that the 2008 payment was not for any wage or benefit, and therefore was paid for claims for personal injury. Bell argued that the settlement agreement represented payment for a physical injury and therefore should have been excluded from his income. The IRS moved for summary judgment, arguing that Pfizer appropriately withheld taxes from the settlement payment because the payment was taxable wages.

Under Code Sec. 104(a)(2), gross income generally does not include the amount of damages for personal physical injuries or physical sickness. To claim the exception, a taxpayer must show that (1) the underlying cause of action was based on a tort type right and that (2) the damages were received for personal injuries or physical sickness. Bell argued that the settlement payment was excludable because, had he not settled with Pfizer, he would have brought claims of intentional and negligent infliction of emotional distress, both of which are tort claims. With respect to the second element, Bell claimed that he sought recovery not for emotional distress but rather relief from the physical injuries resulting from emotional distress.

The district court granted the IRS's motion for summary judgment. First, the court found that the underlying cause of action was not a tort type right. Because the agreement did not state that it was for a particular type of damages, the court looked to Pfizer's intention in making the payment and found that Pfizer was released from any liability related to Bell's employment and his termination. The court also noted a statement by Pfizer's general counsel that the agreement with Bell was related to his demand for compensation on account of various claims arising from his employment, including a claim of disability discrimination. The district court cited two Second Circuit decisions where similar settlement agreements were determined to be in the nature of severance pay or extra compensation, and not in settlement of a possible tort claim. Bell's testimony that the underlying causes of action was intentional and negligent infliction of emotional distress conflicted with the plain language of the release agreement, the court found.

The district court also held that the damages Bell received were not on account of personal injuries or physical illness. Code Sec. 104(a)(2), the court noted, was amended by Congress to add the word "physical" to the phrase "personal injuries or sickness," thereby expressly excluding damages for emotional distress. Thus, regardless of whether the underlying claims were torts, Bell's claims for recovery under emotional distress theories were foreclosed by Congress. The court concluded that the payment under the settlement agreement could not be excluded from Bell's gross income for that reason.

The district court also found that FICA taxes were properly withheld. It concluded that the settlement agreement was remuneration for Bell's employment with Pfizer because it was intrinsically related to his work there. All of his claims derived from his relationships with his employer and coworkers, and the settlement made clear that it represented payment in connection with his employment with Pfizer and his termination from active service. The court reasoned that, whether the agreement was called a settlement or a severance agreement, it was a contract that would have been entered into only with employees. The payment from the contract was therefore wages under the broad FICA definition of the term.

For a discussion of the taxability of damages received from a settlement agreement, see Parker Tax ¶74,130.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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