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Stadnyk v. Commissioner - 367 F. App'x 586 (6th Cir. 2010)


Under the 1996 Amendment, I.R.C. § 104(a)(2) expressly limits the type of damages excludable from income to personal physical injuries or physical sickness and expressly states that emotional distress does not constitute a physical injury or sickness. Pub. L. No. 104-188, § 1605(a), 110 Stat. 1755, 1838. 


Petitioners Daniel J. Stadnyk and Brenda J. Stadnyk purchased a used 1990 Geo Storm from Nicholasville Road Auto Sales, Inc. ("Nicholasville Auto") for $ 3,430. Brenda Stadnyk tendered two checks to Nicholasville Auto as partial payment from a checking account with Bank One ("Bank One"). After the couple drove approximately seven miles from the dealership, the car broke down and they spent $ 479.78 to repair the car. They attempted to call Nicholasville Auto about the car, but their calls were ignored, placed on hold for long periods of time, and not returned. Because of their dissatisfaction with the car, Mrs. Stadnyk contacted Bank One to place a stop payment order on their check for $ 1,100. Bank One's record of the stop payment order indicated "dissatisfied purchase" as the reason for the stop payment. However, Bank One incorrectly stamped the check "NSF" for insufficient funds and returned it to Nicholasville Auto. Nicholasville Auto filed a criminal complaint against Mrs. Stadnyk for issuing and passing a worthless check in the amount of $ 1,100. Because of this Mrs. Stadnyk was arrested and indicted for "theft by deception over $ 300" based on the returned check marked for insufficient funds. These charges, however, were later dropped. Nevertheless, Mrs. Stadnyk filed a complaint against Nicholasville Auto for malicious prosecution, abuse of process, false imprisonment, defamation, and outrageous conduct. The complaint also alleged a cliam against Bank One for breach of fiduciary duty of care by improperly and negligently marking her check "NSF" for insufficient funds. Mrs. Stadnyk entered into a mediation agreement with Bank One, under which Bank One agreed to pay Mrs. Stadnyk $ 49,000 to settle her claims and provide her with a letter of apology. Mrs. Stadnyk's attorney, the attorney for Bank One, and the mediator all advised her that the settlement proceeds would not be subject to income tax. Based on this advice, the Stadnyks did not report the $ 49,000 settlement. Respondent Commissioner of Internal Revenue ("Commissioner"), however, issued a notice of deficiency to the Stadnyks, after determining that they were liable for a tax deficiency of $ 13,119.00 and an accuracy-related penalty of $ 2,624.00 under the Internal Revenue Code. The Stadnyks filed a petition for redetermination of a deficiency in the United States Tax Court; the tax court ruled in favor of the Commissioner with respect to the deficiency and in favor of Stadnyks with respect to the penalty. The Stadnyks filed a timely notice of appeal in federal appellate court.


Was the settlement subject to federal income tax?




The appellate court affirmed the judgment of the tax court. The court held that the fact that the award was compensatory did not make it nontaxable. It explained that if personal injury awards were not income, there would be no need for I.R.C. § 104(a)(2)'s exclusion, which exempted damages received on account of personal physical injuries or physical sickness. Mrs. Stadnyk's award did not fit within the § 104(a)(2) exclusion. Although the settlement was based on tort or tort type rights, she suffered no physical injury. Her claims were for emotional injuries and thus were not excludable. The mere fact that false imprisonment involved a physical act did not mean that the victim was physically injured; Mrs. Stadnyk testified that she suffered no physical injuries as a result of her physical restraint. Given the conclusion that a personal injury award was income, the Stadnyks' related constitutional argument was also rejected.


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