Group Project Cover Page

The team member who physically submits the projects to the professor must print and sign his/her name in the space
below.

Print Name Signature

_______________________ ________________________

In order to receive credit, each team members who contributed to the assignment must print and sign his/her name in
the space below. By signing this cover page, each individual is declaring that this assignment was: prepared by the
contributions of the member of the team; without the assistance from any individual not part of your team except for
the class instructor; without the use of any part of the textbook’s solutions manual; or without the use of any other
method deemed as a violation of the university’s academic dishonesty policy. No credit will be given for the assignment
if there is any indication that your declaration is untrue.

Print Name Signature

_______________________ ________________________

_______________________ ________________________

_______________________ ________________________

_______________________ ________________________

_______________________ ________________________

_______________________ ________________________
FACTS:
Marco suffered physical injuries as a result of an automobile accident, in which he incurred $100,000 in
medical expenses. The party at fault had no insurance or assets. Marco attempted to collect upon his insurance
policy, which included uninsured motorist protection. However, the insurance company claimed that a
provision in his policy made him ineligible for coverage. In an attempt to recover his medical expenses, Marco
joined other policy holders in a class-action lawsuit for breach of contract. Marco was awarded $100,000 in the
settlement.

ISSUE:
Is the $100,000 Marco received in connection with the settlement of the class action lawsuit taxable as gross
income?

Is the settlement considered punitive damages or physical injury damages?

CONCLUSION:
Marco should exclude the settlement amount from gross income. Marco was only compensated for medical
expenses incurred as a result of personal injury, through accident insurance.
ANALYSIS:
Deborah L Watts v Commissioner, T.C. Memo. 2009-103, 6056-06, held that the plaintiff should not include in
gross income amounts awarded for personal injuries through a breach of contract lawsuit. Marco’s only legal
recourse was to join a class action lawsuit. Marco would not have been eligible to join the class action lawsuit
unless he suffered physical injuries.
Section 104(a)(2) provides that damages received on account of physical injuries (whether by suit or
agreement), which have not been included in any other prior year deductions, are excludable from gross
income.
Commissioner v. Schleier, (94-500), 515 U.S. 323 (1995), presents the Commissioner's regulation interpretation
of section 104(a)(2). The case sites section 1.104-1(c) of the Treasury Regulations, 26 CFR § 1.104-1(c)
(1994). The interpretation provides a two-pronged test to determine excludable amounts under section 104(a)
(2). For damages to be excludable under provision, the underlying cause of action must (1) be based in tort or
tort-type rights or through a settlement agreement entered into in lieu of such prosecution, and (2) the proceeds
must be damages received on account of personal physical injury or physical sickness. Marco’s settlement was
entered into, in lieu of tort-type rights. Suing for breach of contract was Marco’s only avenue of recourse to
obtain reimbursement for his medical expenses. Additionally, the amount received was on account of personal
physical injury. Thus, Marco meets both prongs of the test.

Section 104(a)(3) provides that amounts received for medical expenses through accident insurance for personal
injury, which have not been included in any prior year deductions, are excludible from gross income. Marco’s
eligibility to join the class action lawsuit was dependent upon Marco’s uncompensated personal injuries. Thus,
Marco received restitution through accident insurance and for personal injury, as specified within the meaning
of section 104(a)(3). Moreover, the amount awarded did not exceed actual medical expenses incurred, and the
amount did not include accrued interest. Under these circumstances, Marco should not include the $100,000
settlement payment as gross income because he was compensated only for medical expenses incurred as a result
of personal injury.
Dear Marco Taxpayer:
This letter is in response to your request to review your taxable revenue in regards to your class-action
settlement award per the facts you gave us. Conclusion is based on facts obtained thus far from you, the
taxpayer, and may change with any additional facts provided.
The award amount did not exceed your medical expenses. The award was owed to you by the insurance
company and was only attainable by you through the breach of contract suit. Therefore the moneys awarded are
for physical injury “through” accident insurance.
Your award is considered physical injury reimbursement through accident insurance. As a result it is not
included in your gross income and nontaxable.
Please contact us with any further questions or concerns regarding our conclusion.
Sincerely,

Christina Bentivegna, Tania Nazari, Yun Ju Chen, Cindy Dean