Court Rules Depression is a Taxable Damage

In Blackwood v. Commissioner, T.C. Memo. 2012-190, No. 23530-10, the Tax Court sided with the IRS in finding that the symptoms of depression do not qualify as a tax exempt physical injury.

Julie Blackwood (“Blackwood”) worked for Siemens as a trainer assigned to Siemens' client, the Charleston Area Medical Center (“hospital”). Her job duties included training hospital personnel in the use of a Siemens-developed computer program for the collection of patient information at the time of the patient's admission to the hospital.  

Following the admission of her son to the hospital in December 2007, Blackwood observed the hospital nurse taking her son's medical history without using the Siemens data entry program. Following the release of her son from the hospital, Blackwood used her Siemens access to view her son's electronically stored medical records. Upon review Blackwood learned that the hospital nurse had input information regarding questions she failed to ask her son during the admissions process. Blackwood reported her observation of the hospital nurse's use of the Siemens system to her superiors at work and requested guidance as to how to report the hospital nurse's actions. Upon returning to work on January 3, 2008 after vacation Blackwood was informed that her employment had been terminated by Siemens because she had accessed her son's hospital medical records without permission and in violation of the Health Insurance Portability and Accountability Act. 

Before January 3, 2008, Blackwood suffered from depression. As a result of her termination, her depression relapsed, causing her to suffer symptoms such as insomnia, sleeping too much, migraines, nausea, vomiting, weight gain, acne, and pain in her back, shoulder and neck.

On August 21, 2008, Blackwood signed a confidential settlement agreement in which Siemens agreed to pay her $100,000 for alleged damages for illness and medical expenses allegedly exacerbated by, and allegedly otherwise attributable to Blackwood’s alleged wrongful discharge. The settlement agreement stated that Blackwood was responsible for all applicable taxes, if any, as a result of the receipt of the settlement and was issued a Form 1099-MISC reporting the $100,000 Siemens paid to her in 2008. On the advice of counsel, Blackwood did not report or disclose the $100,000 as income on her Federal income tax return for 2008. On July 26, 2010, the IRS issued Blackwood a notice of deficiency for 2008; and Blackwood subsequently filed a petition disputing the deficiency. 

In order for damages to be excludable from gross income under Section 104(a)(2), a taxpayer must demonstrate that the damages were received on account of personal injuries that are physical or a sickness that is physical. The court focused on whether Blackwood’s depression symptoms qualified as a physical injury or physical sickness under Section 104(a)(2).

Blackwood provided medical documentation that she suffered from increased levels of anxiety and depressive symptoms that seemed directly related to the termination from her job, and that she was receiving psychiatric services and medications from a psychiatrist. There was no documentation that Blackwood suffered from any physical injuries or specific physical symptoms of depression. At trial Blackwood testified that she suffered from insomnia, sleeping too much, migraines, nausea, vomiting, weight gain, acne, and pain in her back, shoulder, and neck as a result of her depression.  

The flush language of Section 104(a) provides: "For purposes of paragraph (2), emotional distress shall not be treated as a physical injury or physical sickness." The legislative history of Section 104(a) states it "is intended that the term emotional distress includes symptoms (e.g., insomnia, headaches, stomach disorders) which may result from such emotional distress." H.R. Conf. Rept. No. 104-737, at 301 n.56 (1996), 1996-3 C.B. 741, 1041. The legislative history of Section 104 specifically contemplates that emotional distress may manifest itself in physical symptoms by explicitly listing physical symptoms as symptoms that may result from emotional distress. Congress' listing of physical symptoms of emotional distress is evidence of Congress' intent to establish that not every physical symptom will qualify as a physical injury or physical sickness under Section 104(a)(2). Therefore, the fact that a taxpayer suffers physical symptoms from emotional distress does not automatically qualify the taxpayer for an exclusion from gross income under Section 104(a)(2).  

Blackwood relied on the recent case of Domeny v. Commissioner, T.C. Memo. 2010-9, 2010 Tax Ct. Memo LEXIS 9.  In Domeny, the taxpayer suffered from multiple sclerosis. Due to a hostile and stressful work environment, Domeny's MS symptoms began to worsen and her primary care physician determined the taxpayer was too ill, because of her MS symptoms, to return to work. After giving the physician's instructions to her supervisor, Domeny was terminated from her job. After her termination, Domeny’s MS symptoms began spiking. The Tax Court found the worsening of her MS due to be excludable under Section 104(a)(2). 

The court distinguished Blackwood’s case from Domeny, finding Blackwood’s symptoms did not show the level of physical injury or physical sickness in Domeny and that she did  not provide evidence that her physical symptoms of depression were severe enough to rise to the level of a physical injury or physical sickness. Therefore, the court concluded that Blackwood’s depression and corresponding physical symptoms did not qualify as physical injuries or physical sickness under Section 104(a)(2) and that the $100,000 settlement payment from Siemens was taxable. 

Section 6662(a) imposes a 20% accuracy-related penalty on any portion of an underpayment attributable to a substantial understatement of income tax.  Blackwood testified that she was advised by her counsel that the settlement payment was not taxable. Her counsel was both a certified public accountant and lawyer. The court concluded that Blackwood acted with reasonable cause and in good faith as to excluding the settlement payment from gross income and was therefore not liable for the accuracy-related penalty under Section 6662(a). 

Author’s Note:  We see yet another emotional distress case deemed taxable by the IRS and upheld by the Tax Court.  The novel aspects of this one include a misreading of the Domeny case by Blackwood’s counsel (Domeny already had a physical sickness that was worsened by her employer), as well as the fact a lawyer who was also a CPA would counsel their client that an emotional distress injury was tax free.  This has been the law since 1996 and nothing in the Domeny decision would change that.

For help with any employment, D&O, E&O or taxable/punitive case, please contact:

John McCulloch, JD, FLMI, CSSC
Vice President, EPS Settlements Group
1300 W. Belmont Avenue, Suite 306
Chicago, IL 60657
630-864-8420 cell
773-880-1478 office

Email me - jmcculloch@structures.com
Company Profile - http://www.epssg.com/Professionals.aspx?professionalID=212
LinkedIn - http://www.linkedin.com/pub/john-mcculloch/2/b50/46

UBS client from Miami Beach, Florida sentenced to prison

    Akerman Senterfitt  July 30 2012

   

A former UBS, AG ("UBS") client from Miami Beach, Florida was sentenced to four months in federal prison for willfully failing to file a Form TD F 90-22.1, Report of Foreign Bank and Financial Accounts ("FBAR"), for the UBS account the man held with as much as $4,000,0000 in it. This information was released by the U.S. Attorney for the Southern District of Florida on July 25, 2012.

The former UBS client paid a civil penalty of $2,000,000 related to the $4,000,000 high account balance stemming from tax year 2006. Additionally, the former UBS client was sentenced to four months in federal prison, three years of supervised release, 250 hours of community service and a $20,000 criminal fine.

The UBS account related to two offshore corporations owned by the man, one in the Virgin Islands and one in the Republic of Panama. These corporations opened accounts at UBS. The man was not named as the direct owner but instead he was deemed only the "beneficial owner." The accounts with UBS were opened from tax years 2005 through 2007.

It is stated that the man was aware of the obligation on the FBAR to report as he had previously filed FBARs for other offshore corporations. An FBAR is required to be file by both U.S. citizens and residents who have a financial interest in or signatory authority over a non-U.S. financial account with a value of more than $10,000 at any point during the tax year. The $10,000 amount is an aggregation of all non-U.S. financial accounts and not just an analysis on an account by account basis. See our Practice Update.

The information on the former UBS client was turned over after UBS agreed in February, 2009 to pay $780,000,000 under a deferred prosecution agreement to settle the claim that UBS conspired to defraud the U.S. by impeding the Internal Revenue Service ("IRS"). UBS also agreed to turn over information to the U.S. Department of Justice on 300 account holders. See our Practice Update.

A US citizen or resident that held an account with UBS or any other institution that has not filed the necessary FBARs for the last eight tax years, should immediately reach out to legal counsel to discuss any potential issues they may have and their alternatives.

Chief Counsel's advisory 201212008 holds green card holders working for foreign government in the United States were not exempt from U.S. tax

Jerald Davis August, Fox Rothchild LLP, Italy, USA

In CCA 20122008, the Chief Counsel’s Office ruled that compensation earned by green card workers while working for the Italian government in the United States is not exempt from the federal income tax pursuant to an 1878 U.S.-Italy consular convention on the basis that greencard holders can not be consular offices, nor under the 1984 U.S.-Italy income tax convention if Italy has the primary right to tax the worker, since the U.S. provides for foreign tax credits. Finally, § 893(a) does not exempt the compensation of green card holders who are working for the Italian government in the United States and have not signed the USCIS Form I-508 waiver, unless such green card holders establish, under the facts and circumstances, that the enumerated conditions of § 893(a) are met.

The CCA is noteworthy in its announcing that it will invoke the savings clause under bilateral tax treaties to tax foreign workers who are not consular officials or who meet the requirements of §893. Individuals who are citizens or residents of the U.S. and tax residents of another country working for their home government need to be aware of the Chief Counsel’s office position on this subject.

Background Facts.

Certain individuals, who were tax residents of both Italy and the U.S. under each respective country's domestic law, worked in the U.S. for the Italian government. The individuals were U.S. green card holders. The Service was asked to rule on the taxability of their income under three different authorities—a consular convention dating back to 1878, an income tax treaty currently in effect with Italy, and §893 of the Internal Revenue Code.

Section 893(a) exempts from federal income tax the compensation of employees of foreign governments received for official services if certain enumerated conditions are met. However, the exemption is not applicable to green card holder foreign government employees who have signed the waiver (USCIS Form I-508) provided under §247(b) of the Immigration and Nationality Act (8 U.S.C. § 1257(b)). A green card holder employee is no longer entitled to the tax exemption conferred by § 893(a) from the date of signing the USCIS Form I-508 waiver. See Treas. Reg. § 1.893-1(a)(5).

CCA Analysis

On the first issue, the U.S.-Italy Convention Concerning the Rights, Privileges, and Immunities of Consular Officers, May 8, 1878 ("U.S.-Italy Consular Convention"), which remains in force today, provides tax exemptions for "consular officers" who are "citizens of the state by which they were appointed." Under a State Department note issued in 1986, the State Department stated that "[i]n order to be eligible for recognition as a career consular officer, an individual must ... be the holder of an A-1 non-immigrant visa." A green card is not an A-1 non-immigrant visa. Therefore, the IRS held that the U.S.-Italy Consular Convention did not apply to exempt the income of the green card holder from U.S. tax.

On the next argument, that made under the 1984 U.S.-Italy Income Tax Treaty, which applied to the years at issue, Article 19(1)(a) of the U.S.-Italy Income Tax Treaty provides in general that remuneration paid by Italy to an individual in respect of services rendered to Italy is taxable only in Italy. Article 19(1)(b)(ii) provides, however, that such remuneration is taxable only in the U.S. if the services are rendered in the U.S. and the individual is a resident of the U.S. who did not become a resident of the U.S. solely for the purpose of rendering the services. The Service did not resolve which clause governed.

The CCA concludes that if only Article 19(1)(a) applied, then under the "saving clause" in Article 1, the embassy remuneration also would likely be taxable in the U.S. Under the saving clause, the U.S. is permitted to tax its residents as if there were no Treaty. The Service noted that Article 1(3)(b) lists Article 19 as an exception to the saving clause, but this exception is available only to individuals who are neither U.S. citizens nor green card holders. Thus, according to the IRS, even if Article 19(1)(a) applied (and not Article 19(1)(b)(ii)), the U.S. also can tax the green card holders' embassy remuneration.

The Service did note that double taxation would be alleviated by Article 23(2) of the U.S. Italy Tax Treaty, which provides that the U.S. will provide a credit against U.S. tax based on the amount of tax paid to Italy on the embassy remuneration and subject to the limitations of U.S. law.

Finally, the IRS also concluded that §893 did not apply. Section 893 exempts from federal income tax the compensation of employees of foreign governments received for official services if certain enumerated conditions are met. According to the Service, the exemption is not applicable to green card holder foreign government employees who have signed the waiver (USCIS Form I-508) provided under §247(b) of the Immigration and Nationality Act (8 U.S.C. section 1257(b)).

IRS proposes regulations on substantial risk of forfeiture

• Bryan Cave LLP
• Richard L. Arenburg and Christopher J. Rylands
• USA
• June 11 2012
• 
  

Author page » Author page »

The IRS has released proposed regulations under Section 83 of the Internal Revenue Code to refine the concept of what constitutes a substantial risk of forfeiture for the purpose of narrowing the scope of the concept.
The proposed regulations are in response to case law, tracing back as far as 1986, which the IRS claims has created confusion over the appropriate elements of what may constitute a substantial risk of forfeiture.
In the proposed regulations, the IRS clarifies that a substantial risk of forfeiture may be established only through (1) a service condition or (2) a condition related to the purpose of the transfer, such as a performance condition relating to the services provided by a service provider. In addition, the proposed regulations further clarify that in determining whether a substantial forfeiture exists based on a condition is related to the purpose of the transfer, both the likelihood that the forfeiture event will occur and the likelihood that the forfeiture will be enforced must be considered.
The IRS emphasizes in the proposed regulations that transfer restrictions do not create a substantial risk of forfeiture, such as lock-up agreements or restrictions related to insider trading. However, the IRS acknowledges that the statutory exception related to potential short-swing profits liability under Section 16(b) of the Securities Exchange Act does delay taxation under Section 83.
The IRS appears to be laying the groundwork for the anticipated issuance of new regulations under Section 457 of the Internal Revenue Code, which incorporates the same concept of a substantial risk of forfeiture. While we are not aware of any statements by IRS officials to that effect, it is one possible explanation why the IRS did not address an issue from 1986 until now.
The proposed regulations, if finalized, will apply to transfers of property occurring on and after January 1, 2013 

California court rejects higher tax on 'alcopops'

By Dan Walters
dwalters@sacbee.com

Published: Thursday, May. 3, 2012 - 12:00 am | Page 4A

Last Modified: Thursday, May. 3, 2012 - 8:25 am

The California Board of Equalization overstepped five years ago when it voted to tax flavored malt beverages, known popularly as "alcopops," as hard liquor instead of beer, a state appellate court has ruled.

The Sacramento-based 3rd District Court of Appeal, in a decision released Monday, described the bottled drinks, such as Mike's Hard Lemonade and Smirnoff Ice, as "hybrids" of beer and distilled spirits but based its decision on a state agency's classification of them as beer.

The difference in taxation is immense. California taxes beer at 20 cents a gallon but hard liquor at $3.30 per gallon.

If California taxpayers paid up, state's deficit would disappear

If California taxpayers paid up, state's deficit would disappear

By Kevin Yamamura
kyamamura@sacbee.com

 

Published: Saturday, Apr. 7, 2012 - 12:00 am | Page 1A 

Last Modified: Sunday, Apr. 8, 2012 - 12:46 pm

As Californians put the finishing touches on their income tax returns, tax collectors say the state's $9.2 billion deficit would drop to zero if all taxpayers submitted what they owe.

That means every resident claiming the market value of tattered jackets donated to charity. Every business reporting every dollar of income they receive even when paid in cash. Every service worker reporting every tip. And every resident paying use tax on Internet purchases.

But full compliance does not occur. 

In a new estimate, the Franchise Tax Board says that $10 billion in state income taxes go unpaid each year, often when workers receive payments under the table, businesses skirt reporting requirements or people take deductions for which they do not qualify. The state Board of Equalization says an additional $2.3 billion in sales and use taxes go unpaid.

"It's our way of investing in society for the various benefits we receive," said Jerome Horton, who helps oversee the state's two major tax agencies as chairman of the Board of Equalization and board member at the Franchise Tax Board. "When we find folks aren't, it places an unfair burden on everyone else playing by the rules."

Dennis J. Ventry, a tax law professor at the UC Davis School of Law, said that as much as tax agencies like to call the system voluntary because people file their own returns, he doesn't consider it so.

According to a 2005 Legislative Analyst's Office report, taxpayers report about 99 percent of their wage income as employers withhold taxes and document income on W-2 forms. But when people self-report their income streams, compliance dips below 70 percent.

"If you ask me what keeps people in compliance, it is the withholding regime and the reporting regime," Ventry said.

The state's $10 billion income tax gap and $2.3 billion sales and use tax gap total 13 percent of the state's 2010-11 general fund budget, the year for which they were estimated.

The Franchise Tax Board, which oversees income tax collection, does not have precise statistics on the state gap. The board points to a recent Internal Revenue Service study upon which the state's findings are based.

The federal study of the 2006 tax year found the IRS received 83.1 percent of taxes through voluntary compliance and 85.5 percent after accounting for people who paid late or after being audited.

The bulk of the $450 billion federal tax gap came from underreporting, a broad category that ranges from hiding income to abusing deductions to not paying self-employment tax. The rest of the gap: people who didn't file at all or paid less than they owed.

Estimates of the tax gap come largely from studying audit data on compliance and applying statistical techniques to determine how much businesses and individuals fail to pay their full share.

Horton believes the gap is significantly larger, because the estimates do not consider income from illegal activities such as selling drugs or counterfeit goods.

To Ventry's point, the analyst's report suggests that the less "visible" a payment is, the less people comply.

"This is clearly the case in cash transactions, as well as in other areas where there is a lack of adequate independent reporting requirements," the report notes. "For example, when businesses do not accurately report payments to subcontractors, tax agencies have no way in which to verify the income."

The state tax board routinely reports on cases in which Californians are caught cheating on their taxes. In 2008, a couple who ran two El Dorado County painting companies failed to report more than $547,000 in taxable income. The couple faced jail time, community service and probation in addition to having to pay back taxes and penalties.

A Brentwood couple who owned seven sandwich shops and a newspaper distribution business last year pleaded no contest to tax evasion. They did not file tax returns for four years and hid more than $800,000 in income, partly by opening a bank account with false Social Security numbers.

The tax board has the advantage of piggybacking on IRS efforts to find income tax cheats. But the state is also trying to conduct more of its own data-sifting to detect where California taxpayers are not reporting income.

One instance is a pilot program started in 2008 that flags people who register vehicles worth at least $25,000 with the Department of Motor Vehicles but fail to pay income taxes. The DMV forwards car registration data to the board, which then cross-checks the list against its own records.

Some of those flagged never filed tax returns, while others owe back taxes. Since 2008, the state has collected nearly $37.9 million through the enforcement program.

"It's an indicator that someone is in the state and may have the means through some other sources to pay their tax debt," said FTB spokeswoman Denise Azimi.

Horton is pushing Senate Bill 1185 with Sen. Curren Price, D-Los Angeles, to create a "Centralized Intelligence Partnership" that would coordinate data across state agencies to flag tax evaders and people selling illegal goods and services. It would incorporate data from agencies ranging from the DMV to the Department of Consumer Affairs.

To increase tax compliance and reduce deficits, lawmakers have offered proposals in the past that would have required businesses to withhold taxes on payments to independent contractors. None passed.

In 2009, former Gov. Arnold Schwarzenegger vetoed a budget plan that would have raised an estimated $300 million annually. Business groups said it would have been too burdensome.

"Businesses would have had to spend time, labor and a lot of money to implement withholding systems and comply with some very complex tax laws," said David Kline of the California Taxpayers Association. "Other companies operating out of the state would not have faced the same costs, so it would have been one more example of making it difficult to do business for a California company."

For years, Democrats have tried to force Amazon and other online retailers to collect sales tax from California shoppers. A Board of Equalization report last year showed that only 0.42 percent of taxpayers paid use tax on their personal income tax forms, though others may have paid elsewhere.

In a deal last year with Amazon, lawmakers agreed to delay a new law requiring online sales tax collection until September 2012. Amazon is expected to collect sales tax on California purchases at that time, and the company is believed to be working on a 1,500-employee distribution center in western Stanislaus County.

"Last chance" estate planning may end soon

• Jeffer Mangels Butler & Mitchell LLP
• Scott A. Harshman
• USA
• February 13 2012
• 

This article was first published in the Orange County Business Journal, February 13, 2012   
Much has been written about the perfect storm of estate planning: the coincidence of low values, low interest rates, valuation discounts and the $5 million ($10 million for a married couple) gift and estate tax exemption. Unfortunately, the $5 million gift and estate tax exemption ends (reverting to $1 million) after December 31, 2012. Values of certain assets are increasing. However, most importantly, valuation discounts may be severely restricted at any time by IRS regulations. Thus, the best opportunities may close well before December 31, 2012. Don't wait for this "last chance" at once-in-a-generation estate planning.

Over the last three years of economic crisis and unfunded legislative spending, extraordinary deficits have been created and will continue for years to come. Congress and the Administration continue to examine all available means for raising new tax revenue, including additional gift and estate tax revenue. The Administration's revenue raising proposals for the last three budgets, include: (1) disregarding valuation discounts applicable to certain restrictions on transfer of interests in family-controlled entities; and (2) limiting grantor retained annuity trusts to a minimum 10-year term. In addition, the IRS has for several years maintained that it has the authority to restrict or eliminate valuation discounts by regulation. Several political and legal factors suggest that such regulations could be issued at any time, effective on the date of publication, without an opportunity for notice and comment. President Obama has promulgated the "We Can't Wait" doctrine to justify extensive regulatory actions and bypass Congress. If there is political concern regarding the potential outcome of the 2012 elections, there is strong incentive to implement more "can't wait" regulations, including eliminating family valuation discounts.

Many traditional planning techniques employ valuation discounts to enhance the transfer of wealth to heirs with little or no gift or estate tax consequences. For example, a Grantor Retained Annuity Trust ("GRAT") allows a person to transfer assets to a trust in exchange for payment from the trust of a yearly amount that includes an interest factor set by the IRS, which is 1.4% for February 2012. Valuation discounts effectively lower the required annual payment, thus increasing the amount that passes to the beneficiaries when the GRAT ends. This has been a favorite wealth transfer technique of the rich and famous, including the Gates, Buffet and Walton families, and numerous Google millionaires.

Elimination of family valuation discounts would impact many other conventional planning techniques. One is a sale to an intentionally defective grantor trust ("sale to a DGT"). A sale to a DGT has several advantages over a GRAT. Another technique that would be impacted is a transfer to a charitable lead annuity trust ("CLAT"). The CLAT is a Trust to which the grantor transfers assets and the Trust pays a yearly amount to a charity for a period of years, after which any remaining trust assets pass to the grantor's children or other beneficiaries. The annuity payment is a fixed percentage of the initial value of the assets transferred to the CLAT, including valuation discounts. The value of the gift to the remainder beneficiaries is measured by the initial discounted value of assets, value of the annuity payments, and term. There are many nuances applicable in considering these and other planning techniques that should be reviewed with a qualified estate planning professional.

Finally, the grand revenue raiser - rates and exemptions. No one would have predicted that 2010 would be the year with no estate tax or that the gift and estate tax exemptions would increase to $5 million with a maximum estate and gift tax rate of 35% in 2011 and 2012. Now, the specter of huge 2013 estate and gift tax increases looms. This window of opportunity, combined with the possible loss of valuation discounts, should create some urgency for those desiring to transfer wealth to children and grandchildren. Advisors and clients should act now.