IRS is Hard Boiled on Poached "Eggs Fu Young"

by John Darer CLU ChFC CSSC RSP CLTC

If you thinking about raiding your ovaries to donate eggs to help produce offspring for someone else in exchange for monetary compensation , don't count on your compensation being tax-free.

Compensation for pain and suffering resulting from the  consensual performance of a service contract is not “damages” under I.R.C. section 104(a)(2) and must be included in gross income 

See NICHELLE G. PEREZ, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent  United States Tax Court Docket 9103-12  January 22, 2015.  Download Perez v Commissioner

Nichelle Perez received $20,000 under 2009 contracts that she signed with a clinic before she underwent a prolonged series of painful injections and operations to retrieve her unfertilized eggs for transfer to infertile couples. The contracts said that she was being paid in compensation for her “in consideration for all of her pain, suffering, time, inconvenience, and efforts.”  The Code says that  damages for pain and suffering are not taxable.

Perez argued that they were in exchange for the pain, suffering, and physical injuries she endured as part of the egg-retrieval process; the Commissioner, on the other hand, argues Perez was simply compensated for services rendered.  The Tax Court found in favor of the IRS.

IRC 104(a)(2) is a fundamental Code section for structured settlements.  The  Tax Court's reasoning here underscores why you just can't "shoehorn" everything into a prayer of a tax-free outcome in order to structure,  if it doesn't qualify.

Section 104(a)(2) excludes from gross income the amount of any damages (other than punitive damages) received (whether by suit or agreement and whether as lump sums or as periodic payments) on account of personal physical injuries or physical sickness.

Damages are defined as “an amount received (other than workers’ compensation) through prosecution of a legal suit or action, or through a settlement agreement entered into in lieu of prosecution.” Sec. 1.104-1(c)(1), Income Tax Regs.

The Tax Court cited a series of long standing cases in reasoning  "moneys paid to any taxpayer as compensation for an advance waiver of possible future damages for personal injuries, would constitute taxable income".

Perez voluntarily contracted to do the procedure twice and the Court found that "her physical pain was a byproduct of performing a service contract, and we find that the payments were made not to compensate her for some unwanted invasion against her bodily integrity but to compensate her for services rendered".