Taxing Lessons Case Summaries

Case — Taxability of Medical Study Payments

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TL Case Summ


Are payments received from a medical study taxable?


Taxpayer Says: The payments were compensation received on account of physical illness or physical sickness, and are excludable from gross income.

Internal Revenue Service Says: The exclusion does not apply, and the payments are taxable income.


From Internal Revenue Code Section 61(a): Gross income includes all income from whatever source derived unless otherwise excluded by the Internal Revenue Code.

From Internal Revenue Code Section 104: COMPENSATION FOR INJURIES OR SICKNESS. (a) In General.–Except in the case of amounts attributable to (relating to medical, etc., expenses) for any prior taxable year, gross income does not include– * * * * * * * (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;

From Commissioner v. Schleier, 515 U.S. at 336-337: In interpreting section 104(a)(2), the Supreme Court has held that damages are excludable from gross income where a taxpayer proves (1) the underlying cause of action giving rise to the recovery is based on tort or tort type rights, and (2) the damages were received on account of personal injuries or sickness.


In the tax code, gross income is an inclusive term, and you can generally only exclude compensation or other income from your tax return if the income in question is specifically mentioned in Sections 101-140 of the code. Those sections include death benefits, gifts and inheritances, and compensation for injuries or sickness.

In this case, the taxpayer had suffered from gout for years. He entered into a contract with a biopharmaceutical company to participate in a gout research study. For his participation, he received $5,550 from the company, which was reported to him and the IRS on Form 1099-MISC, Miscellaneous Income.

The taxpayer did not report the income on his original tax return. He argues the payment is not taxable income because it was received in connection with his sickness, and it is therefore excludable under the exception to the general rule.

On audit, and after requesting and not receiving a copy of the contract, the IRS said the income was taxable.


Make your selection, then see “The Court’s Decision” below for a full explanation

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Sorry, wrong answer :(
Right answer!
For the IRS. The taxpayer has been suffering from gout since roughly 1983, and he did not allege that he suffered from physical injury or sickness on account of the gout study. He did not prove a direct causal link between the payment he received and the gout that he has suffered from since 1983. Taxpayer entered into a written contract to participate in the gout study in 2008. He testified that he has the contract, but he failed to produce it at trial. Without the contract, we cannot determine that the payment was compensation for anything except participation in the study.