Linda Sharp, a former university professor of choral music, received a settlement from the University of Northern Iowa for “emotional distress damages only,” according to the settlement agreement, in the amount of $210,000. She claimed that she had been treated badly by her superiors and, based on the several newspaper accounts in Cedar Rapids, Iowa (where the story got a lot of press coverage), I can see why she complained. She had severe clinical depression and a host of other psychiatric diagnoses.
She excluded the first $70,000 payment, which was received in 2010, from gross income on her 2010 return. She attached to a her return a note (not the prescribed form) that she was doing so. She relied on the advice of her attorney. The IRS disagreed with her exclusion.
Professor Sharp lost the case. Basically, in a recent memorandum decision, Tax Court Judge Kroupa said that the plain language of the settlement agreement kept the payment from being excludable under IRC Section 104(a)(1) and (2), which allows exclusion from gross income for (1) amounts received under workmen’s compensation insurance for personal injuries or sickness and (2) damage amounts received on account of physical injuries or physical sickness.
Then, Judge Kroupa upheld the IRS’s imposition of a 20% accuracy penalty for substantial understatement of tax. One of the ways to avoid the penalty is for the taxpayer to have relied the advice of a competent tax professional. Possibly because of a procedural matter, there was not much proof offered into evidence that the attorney who advised her was knowledgeable about taxes. (Yet, it appears from footnote 4 in the opinion that this same attorney was representing her in this Tax Court case!)
Judge Kroupa lowered the boom on Professor Sharp: “It is difficult to imagine how petitioner, a professional, accomplished woman, could reasonably rely on an attorney whose tax advice was so contrary to such an established body of law. In any case the record fails to reflect that petitioner reasonably believed her attorney to be a competent tax adviser with sufficient expertise to justify reliance.”
Judge Kroupa, I respectfully dissent. She’s a music educator! I know a bunch of professional, accomplished, very bright music professors. I doubt seriously if any of one of them has a sufficient grasp of the tax code to overrule the attorney who is representing her or him before the Tax Court. It’s like I told someone today: as smart as he/she is, I wouldn’t want a brain surgeon doing my taxes.