Do you remember Dennis Rodman?
He is more recently associated with traveling to North Korea and functioning as an off-the-record ambassador with Kim Jong-un, the dictator of that country. In the 1990s he was better known for playing with Michael Jordan and Scottie Pippen on the Chicago Bulls.
Early in 1997 the Bulls were playing the Minnesota Timberwolves. Rodman went after a loose ball, falling into a group of photographers on the sidelines. Rodman twisted his ankle. While getting back on his feet he kicked one of the photographers in the groin.
The photographer’s name was Eugene Amos. He went to a hospital, where he had difficulty walking and was in noticeable pain. The doctors offered pain medication but he refused, explaining that he was already taking medications for a preexisting back injury. Some dispute arose, and Amos left the hospital without being discharged.
He hired an attorney immediately upon leaving.
The next day Amos went to another hospital. He complained about his groin, but the doctors did not notice anything other than the expected swelling. They were concerned about his back, though, and took a round of X-rays.
Before the lawsuit was filed, Rodman paid him $200,000 to go away.
Oh, and Amos had to sign a confidentiality provision to not discuss the matter. Standard stuff, but given that we are talking about it the agreement did not hold up as expected.
There is a Code section that addresses physical injuries:
§ 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-
(1) amounts received under workmen's compensation acts as compensation for personal injuries or sickness;
(2) 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;
Relying upon Section 104(a)(2), Amos excluded the $200,000 from his 1997 tax return.
Wouldn’t you know the IRS pulled his return for audit?
And they disagreed with his exclusion of the $200,000 from taxable income. Why? As far as they were concerned, Rodman paid Amos all but $1 of the $200,000 to keep his mouth shut. The IRS was, however, willing to exclude the $1 from income.
Amos disagreed. He took one in the orchestra, after all.
Off to Tax Court they went.
The IRS argued that Amos had not proven his physical injuries, and that Mr. Rodman himself was skeptical that Amos sustained any injuries to speak of. The IRS further argued that Amos was required to pay $200,000 in damages to Rodman should he violate the confidentiality agreement, clearly indicating that Rodman did not intend to pay anything for alleged physical injuries.
The Court immediately dismissed the first argument, noting that if an action has its origin in a physical injury, then damages therefrom are treated as payments received on account of the injury.
The Court decided that the “dominant” reason for the settlement was to compensate Amos for his claimed injuries. However, the settlement also indicated that Rodman was paying some portion for Amos not to:
(1) Defame Rodman
(2) Disclose either the existence or amount of the settlement
(3) Publicize facts relating to the incident, and
(4) Assist in criminal prosecution against Rodman
Problem is, the agreement did not separate how much was paid for what.
The Court did what it had done many times before: it came up with a number.
The Court decided that $120,000 was payable for physical injuries and $80,000 was paid for confidentiality terms. Therefore $120,000 could be excluded under Section 104(a)(2). The $80,000 could not.
The Amos decision changed how personal injury attorneys draft documents. It is now expected that the injured party will not want to sign any confidentiality agreement. If there is one, anticipate the injured party to stipulate a nominal amount to the agreement and to request indemnification for any resulting taxes, penalties, interest, attorney fees and court costs.
And that is how Dennis Rodman contributed to the tax literature.
About the author
Steven D. Hamilton is a career CPA, with extensive experience involving all aspects of tax practice, including sophisticated income tax planning and handling of tax controversy matters for closely-held businesses and high-income individuals.