Christopher R. Hoyt (Missouri-Kansas City) has graciously allowed me to share his views on the recent case of Ward v. American Family Life Assurance Co., No. 2:05-cv-02120 (D.C. S.C. 5/16/06), originally shared on the TaxProf Discussion Group:

An interesting court case involving a lawsuit filed by a victim against an insurance company who paid the victim a settlement. The payments were disability benefits under an accidental death and dismemberment policy. The settlement agreement stated: "all sums paid in accordance with the agreement are for compensation for physical injuries and damages and/or emotional injuries and damages and are intended to compensate the Plaintiff solely for his losses suffered in connection with those injuries and damages."

This particular lawsuit was triggered when the insurance company told the IRS on a Form 1099-MISC that the damages were taxable but the victim insisted that they were tax-exempt. The tax code provides an exclusion for damages received for "physical injuries and sickness" (I.R.C. Sec. 104). The lawsuit was to compel the insurance company to retract the Form 1099-MISC. The court granted summary judgment in favor of the defendant insurance company on the theory that the IRS can determine the taxable nature of the payment through communication with the taxpayer-victim.

An interesting observation by the court: "Nor did the agreement expressly forbid the filing of the Form 1099-MISC." Could this be construed to permit the filing of a 1099-MISC to be part of the terms of a settlement agreement? That probably should not be the case when damages are clearly taxable, such as an age-discrimination employment claim. Another concern is when the filing of a Form 1099-MISC can be used as a way to intentionally harass a person in situations when a payment is excludible.