Dr. Tooth is a 40-year old dentist in Small Town, USA. He graduated from dental

Question

Dr. Tooth is a 40-year old dentist in Small Town, USA. He graduated from dental school seven years ago and built a thriving practice. In 2001, however, Dr. Tooth had an ugly billing disagreement with a patient. The patient, a wealthy and well-known member of the community, in retribution, maliciously spread a rumor that Dr. Tooth was a carrier of a serious infectious disease. This rumor destroyed Dr. Tooth's patient base, as most of his patients quickly switched dentists.

As a result of the stress of losing his business, the cruel gossip that resulted from the rumor, and the financial strain caused by this situation, Dr. Tooth began to suffer from severe migraine headaches, loss of appetite, and significant facial twitches. Dr. Tooth sued the patient for defamation and intentional infliction of emotional distress. He won a jury verdict and in 2003 he recovered $3,600,000 in damages from the patient.

•$1,000,000 lost wages. This was calculated on the basis that, in addition to the one year of wages lost since the date of the defamation, he has lost the ability to earn future wages in Small Town.
•$50,000 reimbursement for medical expenses incurred in seeing a neurologist, internist, and psychologist.
•$20,000 for future anticipated medical expenses.
•$30,000 reimbursement for attorney's fees that had already been paid.
•$2,000,000 in punitive damages. The jury determined that the action of the patient was so malicious and heinous that he should be monetarily punished for his actions.
•$300,000 for pain and suffering.
•$200,000 to compensate Dr. Tooth for the emotional distress he suffered.
Through your interview with the client, you discover that, out of the award, $350,000 was paid directly to his attorney.

2.Prepare a 2- to 3-page memo using the IRAC (Issue, Ruling, Analysis, and Conclusion) tax memo format.

Explanation / Answer

According to the IRS the general rule is that any reimbursements for physical injuries or sickness are non-taxable unless the plaintiff has deducted the medical expenses on Schedule A that he is being reimbursed for on his tax return. So the reimbursement for medical expenses is not taxable. The reimbursement for attorneys fees is taxable but the $30,000 in fees can be deducted as an itemized miscellaneous deduction on Schedule A. Any lawyer fees deducted directly from the award money before the plaintiff receives payment are deductible as well since they would be included in income, but out of pocket expenses incurred by the client are not deductible. The wage's lost reimbursement, pain and suffering payment, emotional distress payment, and punitive damages are all taxable income that would need to be reported. AMT allows for a medical expense deduction for all medical expenses exceeding 10% OF AGI rather than 7.5% as stated on Schedule A. Miscellaneous itemized dedductions are not deductible for AMT purposes. Here is my source below from the IRS website. Physical injuries or physical sickness settlements are generally non-taxable. • If you receive a settlement for physical injuries or physical sickness and did not take an itemized deduction for medical expenses related to this injury in prior years, the full amount is non-taxable and generally does not need to be reported on your income tax return. BUT • If you receive a settlement for physical injuries or physical sickness and did deduct medical expenses related to the injury, the tax benefit amount is taxable and should be reported as “Other Income” on line 21 of Form 1040. Interest, punitive damages, emotional distress or mental anguish, and employment discrimination or injury to reputation settlements are generally taxable. • Interest: Amounts on any settlement are generally taxable as “Interest Income” and should be reported on line 8a of Form 1040. • Punitive Damages: Amounts are taxable and should be reported as “Other Income” on line 21 of Form 1040. It does not matter if punitive damages are related to a physical injury or physical sickness. • Emotional distress or mental anguish: Amounts are taxable to the extent that they exceed medical costs, not previously deducted, for treatment of emotional distress or mental anguish. A statement showing the entire settlement amount less related medical costs should be attached to the return. The net taxable amount should be reported as “Other Income” on line 21 of Form 1040. Damages you receive for emotional distress or mental anguish directly due to a physical injury or sickness are treated as received for the physical injury or sickness. Because these payments qualify as medical, do not include them in your income. • Lost wages, lost profits, unlawful discrimination, or injury to reputation: Amounts are taxable and should be reported as “Other Income” on line 21 of Form 1040.

Related Questions

Navigate

• Browse (All)
• Browse D
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.