October 20, 2008
The
Cost of
Confidentiality
Patricia S. Duffy, or
Kevin L. Connors
610.524.2100
or visit www.duffyconnors.com
Generic boilerplate settlement releases that contain terms of confidentiality will implicate tax consequences, as illustrated by Amos v. Commissioner of Internal Revenue. Generally, the proceeds of a settlement agreement for a personal injury case have been excludable from the Plaintiff’s calculation of gross income.
An anomaly to that rule arose in a personal injury settlement between Dennis Rodman and Eugene Amos, a television cameraman that Rodman had kicked in the groin, during an NBA basketball game on January 15, 1997. Rodman received an 11-game suspension for kicking Amos, and was also required to undergo, perhaps belatedly, psychiatric counseling.
Amos, the television cameraman, brought a personal injury lawsuit against Rodman, with that lawsuit settling for $200,000. The release perfecting the settlement agreement between the parties included a confidentiality clause that read as follows:
“It is further understood and agreed, as part of the consideration for this Agreement Release, the terms of this Agreement and Release shall forever be kept confidential and not released to any news media personnel or representatives thereof or to any other person …”
The IRS concluded that Amos had not been entitled to exclude the settlement proceeds from his gross income.
When Amos filed his tax returns in 1997, Amos did not include the $200,000 in settlement proceeds as part of his gross income. His tax return was audited by the Internal Revenue Service, with the IRS concluding that Amos had not been entitled to exclude the settlement proceeds from his gross income.
The US Tax Court ruled that only $120,000 of the $200,000 proceeds were excludable under Section 104(a)(2), which excludes:
“The amount of any damages (other than punitive damages) received (whether by suit or agreement and whether it's lump sums or as periodic payments on account of personal physical injuries or physical sickness.”
The Tax Court analyzed the settlement proceeds received by Amos, and determined that there must be two independent requirements that every taxpayer must meet before a recovery can be excluded under Section 104(a)(2).
The taxpayer must determine that the recovery is based on a tortious right.
First, the taxpayer must determine that the underlying cause of action giving rise to the recovery is a recovery based on a tortious right, and secondly, the taxpayer must show that the damages were received on account of personal injuries or sickness.
Analyzing the Amos settlement proceeds, the Tax Court determined that the character of the settlement payment had hinged on the dominant reason that the payor, or releasor, was making the settlement payment. Consequently, the Tax Court was forced to determine why Rodman had agreed to pay $200,000 to Amos to settle the personal injury claim.
With Amos never having introduced any evidence regarding the extent of his physical injuries, the IRS commissioner argued that the entire settlement amount, except for $1.00, should have been included in Amos’ gross income, with the IRS arguing that Rodman had paid the settlement funds, not as compensation for physical injuries, but to keep the claim and settlement confidential.
The Tax Court focused on the nature and character of the claim being settled, not necessarily on its validity.
The Tax Court rejected the IRS’ argument, as to the de minimus nature of Amos’ injury, and focused instead on the nature and character of the claim being settled, not necessarily on its validity, to determine what portion of the settlement proceeds was truly excludable from gross income calculations.
Concluding that Rodman actually had two reasons for settling the claim, one being compensation for physical injuries, and, secondly, to buy confidentiality, including non-disclosure of the settlement, not to prosecute Rodman criminally, and not to publicize the Rodman incident, the Tax Court ultimately determined that Rodman was paying $120,000 for settlement of the physical injury claim, and was paying $80,000 for settlement of the non-physical characteristics of the claim, to include those elements relating to confidentiality.
No specific reasoning was given by the Tax Court, to explain how the Tax Court arrived at its breakdown of the settlement proceeds, between physical and non-physical characteristics.
Amos illustrates, however, the potential tax implications of settlement agreements that contain confidentiality clauses that do not specifically indicate what portion or amount of the settlement proceeds are being designated as consideration for confidentiality as a condition for settlement. If a specific dollar figure is referenced in the settlement agreement as being dedicated to the negotiation of the confidentiality clause, that portion of the settlement proceeds is reportable as gross income to the recipient of the settlement proceeds.
The inclusion of a generic blanket confidentiality clause might carry with it tax implications.
This simply illustrates that the inclusion of a generic blanket confidentiality clause in a settlement agreement might carry with it tax implications, absent the settlement agreement specifying the amount of settlement proceeds being designated as consideration for the agreed-upon confidentiality.
Questions concerning this issue or its impact, or any other issues with regard to casualty litigation, can be directed to our attorneys.