It would seem that a tax burden would be the insult added to the injury.
But what is “personal physical injury?” Like many phrases found in tax law, the meaning can be counterintuitive to the average taxpayer.
A California woman in her 20s read about the opportunity to receive payment for providing unfertilized eggs to infertile couples. She applied at the company, and first completed a battery of physical and psychological tests.
If matched with a couple, and if all tasks were successfully completed, it was possible to receive $10,000 of compensation for providing the eggs. This was the maximum allowed by the American Society for Reproductive Medicine.
The woman successfully completed two rounds of egg retrieval. She received a Form 1099 reporting $20,000 of compensation for her efforts.
Tax people find cases such as this one interesting because they can imagine many alternatives for proper tax reporting. Some might argue no income, others compensation income, still others capital gain income.
The Tax Court quickly disposed of the capital gain option. To have a capital gain, one must sell a capital asset. Past case law suggested that a sale of plasma might be a sale of a capital asset. So, why not the eggs?
The most significant impediment was the contract the woman signed with the donor company. It made clear that eggs were not being sold.
The payments were said to be for “pain, suffering, time, inconvenience, and efforts.” The facts as described by the court supported the existence of all of these items.
The woman had to self-inject three drugs in her belly. The drugs burned throughout the procedure. Her belly bruised. She had to search for non-bruised parts of her belly for future injections.
Eggs were recovered through surgery that required anesthesia. She was able to produce 15-20 eggs due to the medication she was provided. Her body was bloated.
Bruising and bloating, coupled with burning pain, seemed to be from a personal physical injury. She excluded the payments from income.
A sticky problem with her exclusion argument was a regulation that said the personal injury compensation must arise in a tort or tort-like action. Her tax counsel argued this regulation was no longer relevant because of changes made to the statute after it was enacted.
The Tax Court did not agree that the regulation was no longer valid. It also said that her payment was not received for an injury, but for consenting to an “invasion” of her body.
The court said that her physical injury, while quite real and significant, was a known consequence of the procedures that she agreed to endure.
Physical injuries are known to result from many activities for which payment is received. The Tax Court specifically mentioned a few examples to help illustrate why payments fail to qualify for the exclusion apart from a tort claim.
Boxers willingly agree to subject themselves to cuts, bruises, pain and other effects of the “sweet science.” A dentist seems to be a hockey player’s best friend.
So, pain, suffering and bruising are known outcomes of some activities that we choose to pursue. Requiring a tort action brings some order to the tax exclusion.
The contract between the woman and the company allowed the Tax Court to dodge the issue of a sale of a capital asset. I suspect that issue will return to the court in a different fact pattern.
The court’s decision did not require a determination of applicability of the self-employment tax. The years at issue pre-dated the 20% deduction for qualified business income.
Whether retirement contributions could be made from the income was not addressed. A tax preparer would raise these issues when preparing an egg provider’s return. I’ve even left some out.
I am quite confident that an egg donor could not be viewed as making a gift to the recipient. The loss of the eggs would not reduce the donor’s gross estate. The other issues raised above are not as clear.
Arnold Schwarzenegger campaigned for governor of California with an awkwardly phrased statement of the various activities taxed by the state. Who knew he missed one?
James R. Hamill is the Director of Tax Practice at Reynolds, Hix & Co. in Albuquerque. He can be reached at firstname.lastname@example.org.