Tax law often involves line drawing. Doyle v. Commissioner, T.C. Memo. 2019-8 (Feb. 6, 2019) (Judge Holmes) teaches two line-drawing lessons, one about the §104(a)(2) exclusion for payments received on account of physical injury and the other about “above-the-line” vs. “below-the-line” deductions.
Mr. Doyle was a whistle-blower who sued his former employer after it fired him. The parties settled the case without trial. The former employer agreed to pay Mr. Doyle a total of $350,000 for lost wages and another $250,000 for emotional distress. The payments were each split evenly between 2010 and 2011. For each year the employer sent Mr. Doyle a W-2 for $175,000 and a 1099-MISC for $125,000. In addition, Mr. Doyle paid some amount in attorneys fees.
The issue litigated in Tax Court was about the $125,000 emotional distress payments in each year. It appears Mr. Doyle’s tax return preparer, one Herbert Hunter, took what can only be described as a bizarre reporting position. No. Wait. It can also be described more kindly as “weird.” That’s how Judge Holmes puts it. A Judge with a less generous disposition might use the word “fraudulent.”
You be the judge. To deal with the $125,000 payments for emotional distress, Mr. Hunter created a fake Schedule C, with a “999999” NAICS code (“unclassified establishment”). On the 2010 Schedule C he reported the $125,000 payment, and then zeroed it out by two offsetting deductions: one for $23,584 for “legal and professional services,” and one for $101,416 for “personal injury.” Mr. Hunter prepared the 2011 in much the same way, only then the deduction for legal fees was $33,000. ”Weird”? “Bizarre”? “Fraudulent”? Take your pick.
By the time Mr. Doyle got to Tax Court, he at least had an attorney who understood the difference between an exclusion and a deduction. One issue was whether the emotional distress payments were excludable under §104(a)(2). The resolution of that issue is one of the line-drawing lessons today.
But there was a second issue in the case, one that teaches a second line-drawing lesson. Mr. Doyle’s attorney, one Steven G. Early, seems to have totally missed the second issue, involving the proper place to deduct attorneys fees. Judge Holmes missed that as well. Sadly, I must confess I also missed it. But Professor Gregg Polsky caught it (and I thank him for bringing it to my attention). So I will pass that lesson on to you. Keep reading.
February 25, 2019 in Bryan Camp, New Cases, Scholarship, Tax, Tax Practice And Procedure | Permalink
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