Compensation for Undergoing Procedures to Donate Eggs to Infertile Couples Not Excludable Under §104(a)(2)

In the case of Perez v. Commissioner, 144 TC No. 4, the Tax Court took care immediately upon starting the opinion section by explaining what it wasn’t deciding, a somewhat unusual step.  But, then again, this was a somewhat unusual case.

The issue in this case was whether Nichelle Perez had taxable income for payment she received for undergoing procedures to donate her eggs to infertile couples. 

The Court explained what wasn’t at issue:

We acknowledge that this case has received some publicity in tax and nontax publications, which is why it is important to state clearly what it does not concern. It does not require us to decide whether human eggs are capital assets. It does not require us to figure out how to allocate basis in the human body, or the holding period for human-body parts, or the character of the gain from the sale of those parts.

In reality, neither the IRS nor Ms. Perez were asserting any of those items were at issue. 

Rather, both parties agreed that the payments she received were income to her.  However, Nichelle pointed out that her agreement to undergo these procedures specifically stated that she received payment in “consideration for all of her pain, suffering, time, inconvenience, and efforts” during the period of the procedures.

Nichelle was paid not on the number of eggs retrieved, but rather based on her continued cooperation in following the instructions and undergoing the rather painful procedures involved in the egg donation process.  Nichelle testified that the process was extremely painful, involving, among other things, self-administering hormonal injections using a one-inch needle.  The injections went into her stomach, causing bruising and, as she testified, burning during the entire time she injected it.

When the time came to harvest the eggs, Ms. Perez had to undergo a surgical procedure under anesthesia.

Despite the overall amount of pain and suffering she endured, Ms. Perez agreed to second round of the procedures.  In each case she received $10,000.

Ms. Perez received a Form 1099-MISC for $20,000 at the end of the year.  She argued that such amounts were payments for pain and suffering, excludable under IRC §104(a)(2).

That portion of the tax law reads:

§ 104 Compensation for injuries or sickness.

(a) In general.

Except in the case of amounts attributable to (and not in excess of) deductions allowed under section 213 (relating to medical, etc., expenses) for any prior taxable year, gross income does not include—


(2) Treatises the amount of any damages (other than punitive damages) received (whether by suit or agreement and whether as lump sums or as periodic payments) on account of personal physical injuries or physical sickness;

She noted the agreement stated that she was being compensated for pain and suffering.  Thus, she argued, the payments would be excluded from income.

The IRS’s regulations interpreting IRC §104(a)(2) define damages as an amount received through prosecution of a legal suit or action, or through a settlement agreement entered into in lieu of prosecution.  Noting that this would seem to present a problem for a contract that she voluntarily entered into in which she agreed to undergo procedures she was aware would involve pain and suffering, Ms. Perez argued that the IRS overstepped its authority in interpreting the Code when it limited the definition to legal actions.

A significant part of her argument was to point to the fact that in 1996 Congress changed IRC §104(a)(2) to remove the requirement that the damages be incurred in a tort-like action.  However, the Tax Court concluded that this did not mean that all legal actions had to be banished from the regulations—rather, that the change was meant to enable taxpayers who recovered under no-fault statutes to exclude the damages received.  That did not render the IRS requirement for legal action to be an impermissible interpretation of the law.

The Court noted:

Perez very clearly has a legally recognized interest against bodily invasion. But we must hold that when she forgoes that interest—and consents to such intimate invasion for payment—any amount she receives must be included in her taxable income. Had the Donor Source or the clinic exceeded the scope of Perez’s consent, Perez may have had a claim for damages. But the injury here, as painful as it was to Perez, was exactly within the scope of the medical procedures to which she contractually consented. Twice. Her physical pain was a byproduct of performing a service contract, and we find that the payments were made not to compensate her for some unwanted invasion against her bodily integrity but to compensate her for services rendered.

The Court also noted concerns that taking Ms. Perez’s view of the law could lead to “mischief” and offered up some explanation:

A professional boxer could argue that some part of the payments he received for his latest fight is excludable because they are payments for his bruises, cuts, and nosebleeds. A hockey player could argue that a portion of his million-dollar salary is allocable to the chipped teeth he invariably suffers during his career. And the same would go for the brain injuries suffered by football players and the less-noticed bodily damage daily endured by working men and women on farms and ranches, in mines, or on fishing boats. We don’t doubt that some portion of the compensation paid all these people reflects the risk that they will feel pain and suffering, but it’s a risk of pain and suffering that they agree to before they begin their work. And that makes it taxable compensation and not excludable damages.

Looking beyond the facts directly involved in this case, advisers should note that the real issue the Court appears to have is the fact that the taxpayer entered into a contract where the receipt of compensation was tied to actions that were reasonably expected to lead to a certain amount of pain and suffering. 

Given the commentary on the “mischief” a decision in favor of the taxpayer would have lead to, the Court clearly wants to draw a “bright line” denying the use of the exclusion for physical injuries to those situations where a taxpayer voluntarily enters into an arrangement where the taxpayer will be specifically compensated if the taxpayer undertakes actions that the taxpayer understood likely would lead to such pain and suffering.

Effectively, the taxpayers in both this case and the hypothetical situations described by the Court in its “mischief” paragraph specifically and consciously waived any claims for the specific injuries incurred.  And, in the Court’s view, that’s taxable compensation—the §104(a)(2) exclusion is rather limited to amounts paid when individuals suffer such injuries in other circumstances and seeks redress after the fact.