We can do some amazing things given the state of our science and technology. These advances lead to some interesting tax questions.
The IRS recently addressed such a question in PLR 201950004. It considers whether damages paid by a fertility clinic for failing to perform a genetic test are excluded from the recipient’s income as a physical injury when the recipient ended up having a genetic condition.
Put another way, can a settlement payment for being born with a genetic condition be excluded from income for tax purposes?
Facts & Procedural History
The taxpayer hired a fertility clinic to help her conceive. The clinic performed an embryo transfer via in vitro fertilization. It used an anonymous donor egg. But it failed to do genetic testing for the egg.
The clinic did not inform the taxpayer that the donor egg and/or donor
carried, or was at risk for carrying, the gene that causes a genetic condition. The child ended up having the genetic condition, which caused the child to suffer from multiple physical, cognitive, and behavioral disabilities.
The taxpayer filed suit against the clinic and eventually settled the lawsuit. The taxpayer received a settlement award for physical damages and emotional anguish. The taxpayer submitted a letter ruling request to the IRS to confirm that the settlement award was not taxable income to her.
Personal Physical Injuries or Physical Sickness
Section 104 excludes amounts received for personal physical injuries or physical sickness. It goes on to say that amounts for emotional distress due to the injuries or sickness is excluded.
Whether a damage award is for physical injury or sickness has been heavily litigated. We have covered several of these cases (emotional distress for employment action, disability payments for military service, and discrimination where no economic harm).
The question is often what the taxpayer is being paid for. One is to look to the original lawsuit complaint and other documents to see what the dispute was about. If it was for a physical injury and not just emotional distress, it is likely excluded from tax. If it is for emotional distress, it is likely taxable.
But what about damages associated with being born with a genetic condition? Are these amounts for physical injuries?
Being Born Can be a Physical Injury
There can be no doubt that having a genetic condition is a physical sickness.
But is the lawsuit settlement described in this ruling compensation for a physical injury? Is there a difference between damages for a physical injury and for the failure to warn? If it is the failure to warn, is this an injury or failure that is within the gambit of Section 104? It isn’t clear how a court would rule on this question.
But for this taxpayer, they don’t have to worry about what a court would say. The IRS concluded that the settlement was for a physical injury and is excluded from income under Section 104.
This helps clarify the IRS’s position on the issue. Taxpayers who receive compensation for birth defects should consult with their tax attorney to determine whether their income is taxable.