I previously introduced Lisa Milot (Georgia) as one of our guest tax experts for today’s mini-symposium on Perez v. Commissioner. Lisa specializes in federal transfer taxation, estate planning, and property law. Prior to joining the Georgia Law faculty in 2007, she practiced for five years with the tax law firm Ivins, Phillips & Barker in Washington, D.C., where she was a special partner in the tax and estate planning group. Prior to that, she was an associate in the business group at the firm Cooley LLP in Reston, Va. Lisa’s post is below.
Hi Kim (and Loungers more generally) –
I think Perez is a really interesting case, both for the window into practices within the egg donor community and because this is an issue that affects thousands of generally lower income taxpayers annually, yet there’s no good or recent authority on how to handle it. As I’ve previously discussed, the court cases and IRS rulings that exist are contradictory and incomplete. And what we see in the Perez testimony is that IRS practice adds an additional set of contradictions by closing audits without adjustment based on taxpayers’ arguments that the proceeds are actually nontaxable as damages received for physical injury. [Ed. Note: See here for a more detailed discussion of prior IRS practice]
As an initial matter, I don’t see the taxpayer in Perez winning on the argument that § 104(a)(2) excludes the payments from taxable income—the associated 2009 version of Regulation § 1.104-1(c) ties qualification for this exclusion to a legal claim based on a “tort or tort-like injury”, so amounts received under a bargained for contract, even if for “time, effort, inconvenience, pain, and suffering” don’t qualify. Even under the 2012 amendment to the Reg as retroactively applied, the voluntary nature of the relationship with the clinic means the proceeds should not be “damages” within the meaning of the statute. While logic isn’t a great tax argument, my analogy to professional athletes’ income makes clear, I think, why the taxpayer’s argument can’t be right.
However, after dispensing with the § 104(a)(2) argument largely based on the Reg and associated caselaw, the IRS simply states that the proceeds are taxable income, which begs the question “what sort of income?”. The Tax Court has specifically asked for amicus briefs to address this point, and I find this the most potentially interesting legal point of the case.
[Thanks to Andrew Hayashi pointing out the need for clarification with respect to the amendment of Treas. Reg. § 1.104-1(c).]
I previously argued that the proceeds from isolated sales should be short-term capital gains. First, while not true historically, our rights to our body materials (once separated from our bodies) in certain contexts now involve enough strands to be treated as property for tax law purposes, even if not officially “property” for state law purposes. Moreover, eggs generally are capital assets since that’s the default classification of property under the Code and, as sold on a one-time basis at least, they do not fit any of the specific exceptions to this treatment. Finally, the gain is short-term, I believe, because until the eggs are extracted from the woman’s body, they are more like an expectancy—potential property—but not property itself until they have an independent existence. Thus a sale immediately upon retrieval produces short-term capital gain, taxable at the taxpayer’s ordinary income tax rates.
Here, the situation is more complicated because of the taxpayer’s repeated sales (4 or 5 times over a 2 or 3 year period), potentially making the eggs property sold in the ordinary course of the taxpayer’s trade or business—one of the exceptions to capital asset treatment. If this is the case, then her proceeds are still taxable at her ordinary income tax rate as the sale of a non-capital asset, but she also owes self-employment tax. This would more than double Ms. Perez’s tax rate on this sale over the one-time context. Based on some preliminary research, I’m leaning towards this as the appropriate tax treatment given the facts of this particular case, but I’m interested to read the income tax folks’ analysis of this point.
There are a few additional issues here, but I’ll just give my very brief thoughts to try keep this to a more blog-appropriate length:
- Whether the clinic’s classification of the proceeds as a payment for services means that’s the proper tax treatment (I don’t think so; categories assigned by taxpayers are not controlling for tax purposes; instead, it is the substance of the transaction that matters);
- Whether illegality of an activity under state law (here selling the eggs themselves) affects the tax treatment (it doesn’t, and, anyway, my admittedly superficial understanding of CA state law is that it is illegal to sell eggs for research purposes but not for fertility purposes);
- Whether the IRS’s past practice of not pursuing taxes once women claim the proceeds are nontaxable under § 104(a)(2) prevents the IRS from claiming otherwise now (it doesn’t; I suspect past practice was simply an administrative convenience—that the cost of collection wasn’t worth the tax due on one-time sales, and the chance of actual collection was low given economic status of many of the women involved); and
- Whether the amount paid to the women upon completion of some of the process but prior to actual egg harvesting (here, $1500) is services income (I think it is) and, if so, whether the women are independent contractors (and thus responsible for their self-employment taxes) or employees (so that the clinics should be paying half of the payroll taxes and withholding the other half as well as paying for workmen’s comp insurance and other state employment requirements; because of the control the clinics exercise over the women’s schedules, I think this is the better categorization).
Thanks for hosting, Kim and The Faculty Lounge! I look forward to reading others’ thoughts and can be reached directly at email@example.com but will also check back here throughout the day to see how things develop. – Lisa