Payments to Egg Donor Not Excludable From Income

By James A. Beavers, J.D., LL.M., CPA, CGMA

Gross Income

The Tax Court ruled that a woman who received payments for undergoing the procedures necessary to donate her eggs could not exclude the payments from gross income as damages for personal injuries or physical sickness under Sec. 104(a)(2).

Background

Nichelle Perez is a 29-year-old single woman from Orange County, Calif. When she was in her early 20s, she learned about egg donation. In the egg donation process, a woman goes through a regimen of hormone injections to stimulate egg production and, at the appropriate time, the eggs are retrieved through a surgical procedure and provided to an infertile woman who wishes to conceive a child. In almost all cases of egg donation, the donor is compensated for going through the egg-donation process. After searching the internet, Perez found Donor Source International LLC, an egg-donation agency in Orange County that matches egg donors with women and couples struggling to conceive on their own.

The Donor Source, a for-profit California company that has been in business since 2003, is one of approximately 30 donor agencies in California. The donor submits an application to the company and, if selected, is invited for a consultation to review the details of the donation program. Potential donors are also subjected to a series of psychological and physical evaluations, including blood tests, pap smears, breast exams, and pregnancy tests. Once approved by The Donor Source, the potential donor creates an online profile that includes a picture, a description of her family history, and other personal details for prospective parents to view. The Donor Source offers donors a fixed fee for going through the egg-donation process and also promises reimbursement for expenses in traveling to and from medical appointments.

Once a prospective set of parents picks a donor to provide the egg donation, the donor signs two contracts, one with The Donor Source and one with the anonymous intended parents. These contracts let The Donor Source, with the approval of the intended parents, terminate the relationship with the donor up until the time the donor begins receiving egg-stimulation hormone injections.

Perez signed one contract with The Donor Source in February 2009. It stated:

Donor Fee: Donor and Intended Parents will agree upon a Donor Fee for Donor's time, effort, inconvenience, pain, and suffering in donating her eggs. This fee is for Donor's good faith and full compliance with the donor egg procedure, not in exchange for or purchase of eggs and the quantity or quality of eggs retrieved will not affect the Donor Fee.

Thus, if Perez kept her side of the deal, but produced unusable eggs or no eggs at all, she would still be paid the contract price. The contract plainly provided that it was not for the sale of body parts, i.e., it was not a payment for Perez's eggs.

The contract also allocated foreseeable risk. It stated that the donor assumes "all medical risks and agree[s] to hold The Donor Source harmless from any and all liability for any and all physical or medical harm to herself . . ." The contract between Perez and the intended parents was in all ways consistent with the contract with The Donor Source. Under the contract, The Donor Source agreed to pay Perez $10,000 for completing the egg-donation process.

During the egg-donation process, Perez was required to travel to a fertility clinic and submit to a series of intrusive physical exams. In addition, she was required to administer to herself one to three painful hormonal injections in her stomach over a three-week period and to receive a final trigger shot with a two-inch needle in her hip at a clinic. These shots caused Perez significant physical pain and extreme abdominal bloating. After all of this, on the retrieval date, she was put under anesthesia, and a doctor, using an ultrasound needle, penetrated her ovaries to harvest her eggs. Her first egg-donation process was successful, yielding 15 to 20 eggs, and The Donor Source paid her the agreed-upon $10,000 fee. After it was over, Perez felt cramped and bloated; she had mood swings, headaches, nausea, and fatigue.

Despite the extreme physical discomfort during the donation process, Perez elected to go through it again later that year. She signed contracts with the new prospective parents and The Donor Source on Aug. 31, 2009, and, after completing the second egg-donation process, she received another check for $10,000.

The Donor Source sent Perez a Form 1099 for 2009 for $20,000. After consulting other egg donors online, Perez concluded that the money The Donor Source had paid her for the egg donations was not taxable under Sec. 104(a)(2) because it compensated her only for her pain and suffering. The IRS did not agree and sent her a notice of deficiency. Perez challenged the IRS's determination in Tax Court.

The Tax Court's Decision

The Tax Court held that Perez must include in income the amounts paid to her for undergoing the egg-donation process. The court found that compensation for pain and suffering from the consensual performance of a service contract is not damages for purposes of Sec. 104(a)(2) and thus cannot be excluded from gross income.

The court first determined that the contracts were for services and not for the sale of property. Perez's contracts with The Donor Source specified that the compensation she received was in exchange for her "good faith and compliance with the donor egg procedure." Unlike the taxpayers in two cases cited by the court involving sales of blood plasma, who were paid by the quantity and the quality of plasma produced, Perez's compensation depended on neither the quantity nor the quality of the eggs retrieved, but solely on how far into the egg-donation process she went. Thus, the court found that The Donor Source compensated Perez for services rendered and not for the sale of property.

The real question, the court found, was whether the exception in Sec. 104(a)(2) applied to the payments so that Perez was not required to include the payments in income under the general rule of Sec. 61. Under Sec. 104(a)(2), a taxpayer's gross income does not include:

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.

Regs. Sec. 1.104-1(c), before it was revised in 2012, provided that

The term "damages received (whether by suit or agreement)" means an amount received (other than workmen's compensation) through prosecution of a legal suit or action based upon tort or tort type rights, or through a settlement agreement entered into in lieu of such prosecution.

Perez argued that the definition of "damages" in the regulation is invalid because it requires prosecution (or threat of prosecution) of a legal suit as a prerequisite for a payment's exclusion from income. Instead, she contended that "damages" in Sec. 104(a)(2) should be interpreted broadly to mean compensation in money received for a loss regardless of any legal suit or action.

The Tax Court rejected this argument because it mischaracterized what The Donor Source paid Perez for. Perez essentially argued that she received the payments as a result of a settlement of her claims for physical injury and pain and suffering against The Donor Source. The court, however, determined that the payments were compensation for an advance waiver of the personal injuries she might incur in the ­egg-donation process. Citing its own precedent in Starrels, 35 T.C. 646 (1961), aff'd, 304 F.2d 574 (9th Cir. 1962), and Roosevelt, 43 T.C. 77 (1964), the court found that a payment for such an advance waiver was includible in income. As the court stated:

Perez very clearly has a legally recognized interest against bodily invasion. But we must hold that when she forgoes that interest—and consents to such intimate invasion for payment—any amount she receives must be included in her taxable income. Had the Donor Source or the clinic exceeded the scope of Perez's consent, Perez may have had a claim for damages. But the injury here, as painful as it was to Perez, was exactly within the scope of the medical procedures to which she contractually consented. Twice. Her physical pain was a byproduct of performing a service contract, and we find that the payments were made not to compensate her for some unwanted invasion against her bodily integrity but to compensate her for services rendered.

In 2012, the IRS revised Regs. Sec. 1.104-1(c) to remove the requirement that the damages be linked to a suit based on a "tort or tort type right." The court explained that the IRS made this change after Sec. 104 was amended in 1996 to allow the exclusion for damages awarded under a no-fault statute, consistent with the changing nature of the types of suits in which individuals were being awarded damages for physical injuries. Consequently, the elimination of this requirement did not affect Perez, because she was not being denied the exclusion because of the type of suit that gave rise to the payments she received. Rather she was being denied the exclusion because the payments were compensation for an advance waiver of personal injuries, not damages for injuries she had previously suffered.

Reflections

The Tax Court stated in closing that "[w]e see no limit on the mischief that ruling in Perez's favor might cause." According to the court, ruling in her favor would make it possible for taxpayers of all sorts to claim that part of their compensation for services was excludable as damages under Sec. 104(a)(2) if they suffered some sort of physical injury or pain or suffering resulting from their work. The Tax Court gave as one example a professional boxer who, under Perez's theory, could argue that some part of the prize he received for a fight was excludable from income because it was payment for the bruises, cuts, and nosebleeds he received in performing his services under a contract.

Perez, 144 T.C. No. 4 (2015)

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