## Facts

- Kelly B. Niles suffered a childhood head injury followed by negligent medical care, resulting in permanent brain damage, quadriplegia, and total dependency.
- A state-court personal-injury action produced a single lump-sum jury award of $4,025,000.
- In defending the verdict as reasonable on appeal, Niles offered a detailed hypothetical itemization attributing $1,588,176 of the award to future medical expenses; the judgment was affirmed.
- Niles excluded the entire award from gross income under I.R.C. § 104(a)(2).
- For later years, including 1975, Niles incurred and deducted substantial medical-care expenses under I.R.C. § 213.
- The IRS assessed deficiencies and, for 1975, disallowed the medical-expense deduction by allocating part of the lump-sum tort award to future medical expenses and treating later medical costs as already “compensated for.”
- The government conceded its allocation theory lacked supporting regulations, rulings, or precedent and departed from a longstanding administrative practice against allocating components within lump-sum personal-injury awards.

## Issues

1. Whether I.R.C. § 213(a)’s denial of deductions for expenses “compensated for by insurance or otherwise” authorizes the IRS to allocate part of an excludable lump-sum personal-injury award to future medical expenses.
2. Whether such an allocation can be used to disallow medical-expense deductions until the allocated amount is exhausted, even though the award was received as an undifferentiated lump sum.

## Decision

- The Ninth Circuit affirmed summary judgment for Niles in his tax-refund suit.
- The court held the IRS lacked authority to allocate a portion of a lump-sum personal-injury award to future medical expenses to disallow § 213 deductions.
- The court rejected reliance on Niles’s litigation-based itemizations as a basis to recharacterize the tax treatment of the lump-sum award.
- The court gave little weight to the IRS’s ad hoc litigating position, emphasizing the absence of supporting authority and the agency’s long-standing contrary practice.

## Legal Principles

- A lump-sum personal-injury recovery excluded under I.R.C. § 104(a)(2) is not subject to post hoc IRS allocation into components (such as future medical expenses) for purposes of denying deductions under I.R.C. § 213(a).
- The phrase “compensated for by insurance or otherwise” in § 213(a) targets specific reimbursement of medical expenses, not general tort recoveries that are not legally earmarked for particular medical bills.
- Consistent, long-established administrative practice can be persuasive in construing tax statutes, while abrupt departures unsupported by regulations or precedent receive little deference.
- Detailed projections of future medical costs used to support a tort verdict do not convert an undifferentiated lump-sum award into a designated fund that offsets later medical-expense deductions.

## Conclusion

The Ninth Circuit held that § 213(a) does not permit the IRS to treat a portion of an excludable lump-sum personal-injury award as prepayment of future medical costs, and the taxpayer could claim medical-expense deductions for later care notwithstanding earlier tort compensation.


Niles v. United States, 710 F.2d 1391 (9th Cir. 1983)