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$700,000 Settlement Payment from Apartment Complex Was Not Excludable from Income

(Parker Tax Publishing December 2023)

The Tax Court held that two taxpayers, a formerly married couple who lived together in an apartment, could not exclude from gross income a $700,000 settlement payment received by one of the taxpayers from the owner of the apartment building as a payment made on account of personal physical injuries or sickness under Code Sec. 104(a)(2) because the payment was intended to compensate the taxpayers primarily for moving out of the apartment building. The court also found that the payment had to be allocated 50/50 to each taxpayer, even though the full amount was paid to only one of the taxpayers, because if either taxpayer had failed to move out of the apartment, the payment would not have been made. Roman v. Comm'r, T.C. Memo. 2023-142.


Gabriel and Luminita Roman were married until 2004. Gabriel Roman is an individual deemed by the Social Security Administration to be permanently disabled and has been diagnosed with various conditions, including, among others, major depression, paranoia, and prostate cancer. Gabriel also underwent spine surgery in July 2010. He receives benefits under Medi-Cal, the State of California's Medicaid program.

After their marriage ended, the Romans continued living together, with Luminita serving as Gabriel's live-in care provider under California's In-Home Supportive Services program. Luminita received compensation from the State of California's Department of Social Services for providing care to Gabriel. Gabriel also received government low-income housing assistance.

The Jefferson at Hollywood Apartments (Apartments) is an apartment complex in Los Angeles, California. Gabriel executed a lease agreement to move into the Apartments in October 2010. He also executed a Caregiver Addendum and Affidavit along with the lease, which allowed Luminita to reside in the apartment with him as his "live-in caregiver." The Romans moved into the Apartments after Gabriel signed the lease. At that time, the Apartments was owned by Jefferson at Hollywood, LP (Jefferson), and managed by Greystar Real Estate Partners, LLC (Greystar).

Shortly after moving to the Apartments, the Romans began making various complaints to Jefferson and Greystar about the property, including expressing concerns about noise and harassment and submitting requests for accommodations in connection with Gabriel's disabilities. Various legal actions ensued. Gabriel filed a federal lawsuit against Jefferson and Greystar for discrimination and harassment. Luminita sued Jefferson and Greystar alleging intercepted communications, negligence, and violations of a common law right to privacy. The other actions brought by the Romans against Jefferson and Greystar included claims for unlawful detainer and a fair housing complaint.

In 2013, with the Romans' various legal actions pending, Jefferson decided to sell the Apartments to BRE Properties (BRE). At the time, BRE was engaged in litigation with the Romans, in which the Romans alleged that BRE discriminated against them on account of Gabriel's disabilities when they attempted to rent a unit at one of BRE's other properties in 2009. BRE discovered that the Romans lived in the Apartments before closing on the purchase of the Apartments. BRE insisted that Jefferson either reduce the price or ensure that, before the sale, the Romans vacate the property and release any claims against the property. BRE said it would reduce its offer by $1 million if the Romans remained at the Apartments. Eventually, in July 2013, Jefferson and BRE executed a Purchase and Sale Agreement to memorialize the sale of Apartments to BRE. The agreement required Jefferson to confirm that the Romans were no longer tenants and had vacated the property, and that Jefferson had settled the litigation with them.

In September 2013, Jefferson offered the Romans $700,000 in exchange for their vacating the Apartments and executing a mutual release of any pending and future legal claims. Marc Renard, who negotiated the settlement with Luminita on behalf of Jefferson, gave the Romans 15 minutes to accept the offer and told Luminita that for every 15 minutes in which they did not accept (after the initial 15 minutes), the offer would go down by $50,000. Luminita then conveyed the offer to Gabriel and told him she would leave him if he did not agree. Within the first 15 minutes set by Renard, the Romans accepted the offer. The agreement was reduced to writing in the form of a Settlement and Mutual Release Agreement (settlement agreement).

Pursuant to the settlement agreement, the Romans moved out of the Apartments in September 2013 and caused their various ongoing actions against Jefferson and Greystar to be dismissed. Luminita received a $700,000 payment from Jefferson later in 2013. Gabriel was not directly paid any portion of the settlement proceeds, nor did he receive directly any proceeds as a result of his legal claims against Jefferson and Greystar.

On her 2013 tax return, Luminita reported total income of $15,530. Although she received a Form 1099-MISC from Jefferson, she did not report any portion of the settlement proceeds in her return. Gabriel did not file a timely return for 2013. In 2015, he filed a return for 2013 on which he did not report any income or claim any loss, deduction, credit, or other tax items. The IRS issued notices of deficiency, and the Romans took their case to the Tax Court.

Code Sec. 104(a)(2) excludes from gross income "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." Emotional distress is not treated as a physical injury or physical sickness for purposes of Code Sec. 104(a)(2).

In Rivera v. Baker West, Inc, 430 F.3d 1253 (9th Cir. 2005), the Ninth Circuit held that for settlement proceeds to fall within the Code Sec. 104(a)(2) exclusion, there must be a direct causal link between the proceeds and the personal injuries sustained. The nature of the claim that was the basis for the settlement controls whether the damages are excludable under Code Sec. 104(a)(2). When a claim is resolved by settlement, the relevant question for determining the tax treatment of a settlement award is: in lieu of what were the damages awarded. To determine the basis of a settlement, courts look first to the terms of the settlement agreement to determine whether any of the proceeds were paid on account of personal physical injury or physical sickness. If the agreement lacks express language specifying the purpose of the compensation, the court will consider the facts and circumstances surrounding the settlement to determine the intent of the payor. The Tax Court has repeatedly held (for example, in Doyle v. Comm'r, T.C. Memo. 2019-8) that all settlement proceeds are included in gross income where there is a general release but no allocation of settlement proceeds among various claims.


The Tax Court held that Luminita and Gabriel each earned $350,000 of gross income for 2013 in connection with the settlement agreement. The court further held that Gabriel was liable for an accuracy-related penalty under Code Sec. 6662 and Luminita was liable for the addition to tax under Code Sec. 6651(a)(1).

The court found nothing to suggest that Jefferson and Greystar were on notice of any material liability for personal physical injuries or sickness of the Romans (within the meaning of Code Sec. 104(a)(2)). The actions filed by the Romans involved numerous complaints against Jefferson and Greystar including, among others, discrimination, harassment, privacy violations, noise, retaliation, and other fair housing violations. Yet the court saw no complaint in which the Romans sought damages for personal physical injuries or sickness. To the extent any maladies were alleged in a complaint, they appeared to the court to be more in the nature of emotional distress. The court noted that Code Sec. 104(a) explicitly says that amounts related to emotional distress do not fall within the exclusion to gross income under Code Sec. 104(a)(2).

The court further found that the general waiver clause contained in the settlement agreement did not settle any claims for personal physical injuries or physical sickness that they Romans may have had against Jefferson and Greystar. The Romans failed, in the court's view, to show a nexus between the various ailments they suffered from and the $700,000 payment. The court noted that virtually all of Gabriel's ailments were unrelated to living at the Apartments. To the extent the Romans argued that Gabriel's ailments were exacerbated by any noise from the building or stressors caused by living at the building, the court found that the Romans failed to demonstrate that any claim for physical injuries against Jefferson or Greystar was considered when the settlement agreement was executed. In addition, the court found that, although Luminita claimed she had panic attacks, depression, anxiety and migraines on account of noise from a neighboring apartment, her claims appeared to have been more in the nature of emotional distress.

On the issue of the allocation of the $700,000 payment, the court agreed with the IRS that Luminita and Gabriel each received half of the payment. The court explained that under the precedent of the Tax Court and Ninth Circuit, determining the true earner of income is a question of who controls the earning of the income rather than the question of who ultimately receives it. The court cited the Supreme Court's opinion in Comm'r v. Banks, 543 U.S. 426 (2005) for the rule that a taxpayer cannot exclude an economic gain from gross income by assigning the gain in advance to another party. The court determined that a 50/50 allocation was required because the $700,000 was paid primarily in exchange for the Romans' vacating the Apartments. The court reasoned that, if either had failed to move out, the amount would not have been paid. The court further found that to the extent any portion of the payment was for the Romans' release of their current and future claims against Jefferson and Greystar, this too supported a 50/50 allocation since both had pending claims against Jefferson and Greystar. Moreover, both Luminita and Gabriel had rights under the lease that could give rise to future claims.

However, the court disagreed with the IRS's contention that Gabriel paid his share to Luminita as compensation for services. The court said that although Luminita was Gabriel's caregiver when she received the payment, the State of California paid her separately for providing care. Additionally, the court found that by residing with Gabriel as his caregiver. Luminita appeared to have shared, at least indirectly, in some his government housing benefits. The court also saw no evidence that Gabriel owed Luminita any additional backpay or wages on account of her caregiving. In the court's view, to the extent any portion of Gabriel's share was truly transferred to Luminita for her exclusive use (as opposed to, for example, being paid to her with the understanding that the amount ultimately would be used for Gabriel's benefit as well), it appeared to have been in the nature of a gift.

For a discussion of the exclusion for damages received on account of physical injuries, see Parker Tax ¶75,910.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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