## Facts

- Julie Leigh Domeny, a California taxpayer, was diagnosed with multiple sclerosis (MS) in 1996 and later worked as a fundraiser for Pacific Autism Center for Education (PACE).
- After a new executive director became her supervisor, Domeny’s work environment became stressful; she reported misconduct involving embezzlement and experienced increased tension at work.
- During the workplace conflict, Domeny’s MS symptoms intensified.
- On March 7, 2005, Domeny left work due to worsening MS symptoms; on March 8, 2005, her physician concluded she was too ill to work because of MS symptoms and advised she not work until after March 21, 2005.
- After Domeny faxed this medical instruction to PACE, she was informed her employment would be terminated effective March 15, 2005; her MS symptoms spiked after the termination notice.
- Domeny and PACE settled potential employment-related claims; the settlement included (1) a payment treated as wage compensation and (2) a separate payment of $16,933 that the agreement did not expressly characterize or allocate.
- PACE treated the $16,933 as nonemployee compensation, did not withhold income tax, and did not include it on Domeny’s Form W-2.
- The IRS issued a notice of deficiency for 2005 and asserted an accuracy-related penalty under I.R.C. § 6662(a); the parties resolved all issues except whether the $16,933 was excludable from gross income, and the IRS conceded the penalty.

## Issues

1. Whether the $16,933 settlement payment was excludable from gross income under I.R.C. § 104(a)(2) as damages received on account of personal physical injuries or physical sickness.

## Decision

- The Tax Court held the $16,933 payment was excludable from gross income under I.R.C. § 104(a)(2).
- The court found Domeny proved her work environment and termination exacerbated her MS and produced acute physical sickness.
- Because the settlement agreement did not allocate the payment, the court evaluated the surrounding facts and evidence to determine the payment’s character.
- The accuracy-related penalty under I.R.C. § 6662(a) did not apply (conceded by the Commissioner).

## Legal Principles

- Damages are excludable under I.R.C. § 104(a)(2) only if received “on account of personal physical injuries or physical sickness.”
- After the 1996 amendments, emotional distress is not treated as a physical injury or physical sickness for § 104(a)(2) purposes, even if accompanied by physical symptoms associated with distress.
- When a settlement agreement is silent or ambiguous as to the nature of a payment, the court determines the payment’s character by examining the intent of the payor and payee as shown by the agreement’s context, the claims asserted or reasonably at issue, the parties’ conduct, and the evidentiary record.
- Objective medical evidence and physician testimony can support a finding that damages were paid on account of a medically diagnosable physical sickness and its exacerbation, rather than on account of emotional distress alone.

## Conclusion

The Tax Court excluded a $16,933 settlement payment from gross income under I.R.C. § 104(a)(2) after finding, based on medical and contextual evidence, that the payment was made on account of the taxpayer’s acute physical sickness from an MS exacerbation triggered by workplace conditions and termination.


Domeny v. Commissioner, T.C. Memo. 2010-9 (2010)