Payment for suicide allegedly caused by job stress is excludible.

The Tax Court recently allowed a payment by a company to the widow of one of its former employees who had committed suicide allegedly because of job stress to be excluded from income. In Paton, TC Memo 1992-627, the court ruled that even though the settlement documents for the payment did not mention any wrongful death or other tort-type claim, the company's intent was to settle a wrongful death claim.

Sec. 104(a)(2) excludes "the amount of any damages received ... on account of personal injury." Regs. Sec. 1.104-1(c) specifies that the injury must be based on a tort-type claim. Previous Tax Court rulings have based the exclusion on the "nature of the underlying claim rather than the validity of the claim." These rulings have determined that, when the settlement documents do not specify the reason for the payment, the nature of the underlying claim is based on the payor's intent in making the payment.

Dr. Paton, a veterinarian, had been employed as the manager of the animal health division of a drug company. When the company made budget cuts, he was forced to fire several employees, including some with whom he had worked for many years. These staff reductions in turn made it difficult for Dr. Paton's division to maintain production quality. The company blamed Dr. Paton when a defective batch of animal vaccines was distributed to the public. He committed suicide in June 1982, and the company paid his salary for the rest of the year.

His widow believed that the company was responsible for his suicide. Her attorney advised her that there might be a wrongful death claim of uncertain strength against the company. The attorney then wrote a letter to the company requesting a payment to Mrs. Paton. The letter alleged that the job pressures caused Dr. Paton's death and implicitly threatened litigation.

The president of the company, in a written reply, offered to pay $50,000 "out of concern for Mrs. Paton's well-being--and not because of any legal obligation." The president then requested that she sign a general release "to avoid any misunderstanding." The release did not specify the reason for payment. No taxes were withheld on the payment, which was reported to the IRS as nonemployee compensation on Form 1099-MISC.

Mrs. Paton first argued that the payment was a gift. The court rejected this contention; it found that the company did not make the payment out of disinterested generosity, which is required for a gift.

Alternatively, she claimed that the payment qualified for the Sec. 104(a)(2) exclusion. Clearly, wrongful death is a tort. The issue was whether the company made the payment to avoid a wrongful death lawsuit, with the burden of proof on the taxpayer. The IRS argued that she did not meet this burden: (1) the release was for "all claims" rather than a specific "tort-type claim"; (2) the president's letter stated that the payment was made only "out of concern" for Mrs. Paton and therefore the company reported it to the Service as taxable nonemployee compensation; and (3) neither Mrs. Paton nor her attorney asserted any tort-type claims to the company.

The court rejected these arguments and found that the company's sole reason for making the payment was to avoid the wrongful death lawsuit. The court pointed out that the company only made the payment after receiving the letter from Mrs. Paton's attorney threatening litigation. Even though this threat was only implicit, the company's request for a general release revealed its true motive. In addition, the company had no remaining obligations to Dr. Paton's estate. Finally, Mrs. Paton had never worked for the company, nor did she have any other claim against it. Therefore, the court ruled that the payment was excludible under Sec. 104(a)(2).

In this time of widespread job cutbacks and other cost reductions by employers, many employees are under great job stress. Both employees who are worried that they will be terminated and those who face greater productivity pressures due to staff reductions are susceptible. While severance pay, incentive payments for early retirement and payments based on contractual claims are taxable, under Paton any payments received for disability and other injuries, as well as for death, due to job stress may be excludible.

CPAs should advise clients who have received payments for job stress claims that they may be excludible. CPAs having clients who make payments to employees to satisfy job-related stress claims should advise them to negotiate smaller payments since they may be excludible. Also, to save potential litigation-related costs, the real reason for any payment should be stated and acknowledged. As the Tax Court showed in Paton, it will determine the real reasons for a payment when the facts do not follow the payor's stated reasons.

From Peter C. Barton, MBA, J.D., CPA, Associate Professor of Accounting, and Clayton R. Sager, Ph.D., Assistant Professor of Accounting, University of Wisconsin-Whitewater, Whitewater, Wisc.