January 15, 2004
Some in church suits may face tax bill
By Ralph Ranalli, Globe Correspondent, 9/21/2003
For years, legal uncertainty has dogged the plaintiffs suing the Archdiocese of Boston for the sexual abuse they suffered at the hands of clergy. Would their claims against the church be limited by a law capping awards against charitable institutions? Would appellate courts dismiss their claims as too old? Would the church settle the cases?
Now lawyers are warning that Internal Revenue Service rules and a 7-year-old change in the federal tax code mean continued uncertainty, as victims try to determine whether they will be taxed on their share of the recent $85 million tentative settlement reached with the archdiocese.
Because the harm suffered by most of the more than 560 abuse victims covered by the proposed settlement is emotional and mental distress caused by a physical sexual assault, it falls into a hazy area of federal tax law, between what is considered a physical injury and what is viewed as purely emotional distress.
"There is little case law in this area. . . . It's kind of a dangerous topic," said Michael B. Bogdanow, cochairman of the Boston Bar Association's litigation section and author of the widely used legal text "Massachusetts Tort Damages," which includes a chapter on the taxability of damage awards. "Unfortunately, it's one of those gray areas where, the closer you get to the midpoint of the gray zone, the grayer it gets."
The financial implications of the debate are potentially significant.
Under the terms of the settlement, any victim whose claim included any component of physical touching -- from a single fondling to multiple rapes -- will receive a settlement award of between $80,000 and $300,000, determined by a team of arbitrators selected by the two sides.
A client receiving a $200,000 award, for example, would take home roughly $130,000 after the standard attorney's fees and expenses are taken out.
If that award is deemed taxable, anywhere from $23,000 to $35,000 would go to the federal government, depending on the victim's tax bracket, reducing the award to as little as $95,000, lawyers said.
Sidney Gorovitz, a Waltham lawyer who represents several people with claims against the archdiocese, said that most of the plaintiffs' lawyers have been telling their clients the same thing: Get all the advice you can from a certified public accountant or a tax attorney and hope for the best.
"We are hopeful that our settlement awards will be a nontaxable venture, but the truth is we just don't know," Gorovitz said. "If they are [taxable], it would be victimizing them yet another time, which would be horrible. But hey, the IRS is the IRS."
"If it is emotional [damage] but based on the physical, then I believe it would be nontaxable," said Barry P. Wilensky, a Boston lawyer who chairs the Massachusetts Bar Association's Tax Section. "And at the end of the day, is the IRS going to go after these people who have already suffered so much? "
Peggy Riley, New England regional spokeswoman for the IRS, said the agency would judge the taxability of each award on a case-by-case basis. "It will depend on the individual facts and circumstances of each case," she said.
Prior to seven years ago, civil damage awards and settlements to plaintiffs in tort cases had been defined as nontaxable income by the government, according to legal specialists and Massachusetts Lawyers Weekly, which first raised the issue earlier this week.
But the law was changed in 1996 by members of Congress who were upset that some plaintiffs, particularly in employment-related cases, were being awarded large, tax-free judgments for purely emotional injuries, Bogdanow said. That year, Congress drew a distinction in the law that taxed emotional distress judgments while keeping compensation for physical injuries tax-free.
The IRS, however, has never spelled out exactly what constitutes physical injury versus emotional injury, legal specialists said.
Some lawyers have interpreted the law to mean that payment of any claim that contains a component of physical touching -- such as a sexual assault followed by a claim of mental harm -- could be interpreted as an award for physical damages.
Others believe that, under the new law, only people who suffer physical harm that can be diagnosed medically, such as a broken leg suffered in a slip-and-fall case, can escape being taxed.
That sets up a possible scenario in which a plaintiff who was raped by a priest five times at age 16 and was subsequently diagnosed with post-traumatic stress disorder by a psychiatrist could end up having to pay taxes on his settlement. Another plaintiff raped the same number of times at the same age by the same priest but diagnosed with stress-related ulcers by an internist, would not have to pay taxes on his award, lawyers said.
"What about people who break into sweats, or whose hearts start to race, or suffer from insomnia or vivid nightmares?" asked lawyer Carmen L. Durso, who represents 42 people with claims against the archdiocese. "Are those physical? It's crazy. It was a misguided effort by Republicans in Congress to punish people who were being successful in court."