What Does Dennis Rodman Have To Do With Your Settlement Agreements?

By Matthew Garretson and Sylvius Von Saucken

In the recent case Amos v. Commissioner of Internal Revenue, the United States Tax Court stated that "if a settlement agreement lacks express language stating what the amount paid pursuant to that agreement was to settle, the intent of the payor is critical to that determination." 2003 WL 22839795 (U.S. Tax Ct, 2003). As most personal injury attorneys understand, the correct "intent" is very important to memorialize in your settlement documents because IRC §104(a)(2) provides that "gross income does not include the amount of any damages (other than punitive damages) received (whether by suit or agreement and whether as lump sum or as periodic payments) on account of personal physical injuries or physical sickness."

The Supreme Court of the United States summarized the requirements of §104(a)(2) as follows:

First, the taxpayer must demonstrate that the underlying cause of action giving rise to the recovery is "based upon tort or tort type rights"; and second, the taxpayer must show that the damages were received "on account of personal injuries or sickness.¹"

In Amos, the Court found that the dominant reason that the Defendant, Dennis Rodman, paid plaintiff the settlement amount at issue was to compensate petitioner for his alleged physical injuries arising from an incident involving the two individuals (Dennis Rodman allegedly lost his cool and had an altercation with Amos while Amos was photographing a Bulls basketball game). However, the Court also found that the settlement was in consideration for several other requirements (mainly a confidentiality agreement). Since the settlement agreement identified those "other requirements" as consideration for the settlement proceeds, the Court determined that the parties did not intend all of the settlement proceeds to be allocated to the component for payment on account of personal physical injuries. As a result, the Court allocated 80% of the settlement as monies paid for physical injuries suffered by the Plaintiff and the other 20% as monies paid in consideration for the other requirements stipulated in the Settlement Agreement. The Court's allocation resulted in 20% of the settlement proceeds being (for non-physical injuries) included in Plaintiff's gross income and not exempt from IRC § 61 (the general taxing statute).

In order for you to best advise your client on how to avoid such a problem, The Garretson Law Firm and The Settlement Services Group propose that you use one of two methods in drafting the Confidentiality Section of your Settlement Agreement.

Method One: The parties should make reciprocal promises as part of the consideration and allocate $1 (i.e. the proverbial peppercorn from contracts class in law school) as the other part of the good and valuable consideration. This way, there is no mistaking the parties' intent that a de minimus amount of the settlement is to be paid in exchange for the Releasor's promise to hold all aspects of the settlement confidential to the extent permitted by law. If this method is utilized your client should include the $1 peppercorn on his or her individual income tax return. Doing so provides yet another argument against the IRS re-allocating the settlement proceeds to reduce the excluded portion.

Method Two: Include language indicating that the parties are making reciprocal promises regarding confidentiality. This way, there is no mistaking that the only consideration being given by the defendants for your client's promise to keep the settlement confidential is the defendant's reciprocal promise. The following is an example of such language:

"In exchange for Releasor's foregoing agreement, Releasees and their attorneys agree that, except as otherwise required by specific court order, statute or other binding requirement of law, they will keep confidential any and all information obtained in this litigation, including all investigations, mediations and settlement negotiations relating to Releasor and his claim. While Releasees and Releasor represent that this agreement would not have been consummated absent the foregoing confidentiality covenants, Releasees and Releasor acknowledge that no portion of the settlement amount represents consideration for the mutual promise to maintain strict confidentiality of all the terms of this agreement. Rather, the Releasees and Releasor expressly have agreed that each other's reciprocal confidentiality covenant is the sole consideration given in exchange for that of the other."

Taken literally, the Amos case sends a clear message that if you draft your settlement agreements to include bargained for promises, unless you state specifically what consideration was given in exchange for those promises, you are taking the risk of letting the Courts later decide what the parties meant when drafting the language. Doing so may subject your client to having his or her settlement reallocated and having a portion of the settlement no longer benefiting from the favorable tax treatment of §104(a)(2). Such a reallocation would reduce the net recovery amount that was originally thought to be have been agreed to by your client.

_{1 Commissioner v. Schleier, 515 US 323, 336-337 (1995)}