Tax Court rules sexual harassment settlement is taxable income
Fortune-Paladino v. Commissioner, T.C. Memo. 2025-101, No. 4975-23., 2025 BL 353634, 2025 Tax CT Memo Lexis 106, Court Opinion
On October 2, 2025, the U.S. Tax Court held in Fortune-Paladino v. Commissioner that Cerissa Rene Fortune-Paladino's $135,000 settlement from her former employer was taxable income.
The court found that the payment compensated her for emotional distress and humiliation rather than physical injuries, meaning it was not excludable under Internal Revenue Code §104(a)(2).
Why It Matters
The ruling reinforces that settlements for emotional distress in employment discrimination and harassment cases are taxable unless the payment is specifically for physical injury or sickness.
Key Facts
Petitioner: Cerissa Rene Fortune-Paladino
Respondent: Commissioner of Internal Revenue
Court: U.S. Tax Court (Judge Marvel)
Employment: Drug and alcohol counselor at Davis Archway Centers for Addiction Treatment, Inc.
Events:
Alleged repeated sexual harassment by her supervisor
Terminated after returning from medical leave following car accident injuries
Filed a federal lawsuit in 2018 alleging sex discrimination and retaliation under federal and Pennsylvania law
Settlement:
In January 2019, Davis Archway agreed to pay $135,000 to resolve the lawsuit
$54,000 paid to attorneys; $81,000 retained by petitioner
Tax Year at Issue: 2019
IRS Determination: Settlement proceeds were taxable income; deficiency of $28,354 and accuracy-related penalty of $5,671 under §6662
Petitioner’s Position: Claimed the settlement was excludable under §104(a)(2) as compensation for personal injuries
Timeline
Feb–Jul 2014: Employment at Davis Archway; alleged harassment occurred
June–July 2014: Medical leave and termination
August 27, 2018: Federal lawsuit filed
Jan 2019: Settlement agreement executed
2019: Petitioner filed a return omitting settlement income
December 5, 2022: IRS issued Notice of Deficiency
March 6, 2023: Petition filed with Tax Court
June 9, 2025: Trial held
October 2, 2025: Decision filed under Rule 155
Court Findings
The Commissioner met the evidentiary burden linking the taxpayer to unreported income.
The settlement agreement explicitly stated that the payment compensated for emotional distress, anxiety, and humiliation, and not for physical injury.
The agreement included a clause titled “No Injuries Alleged,” disclaiming any physical harm.
The petitioner’s complaint sought damages for emotional distress but did not claim physical injury or sickness.
The petitioner conceded at trial that no physical injuries resulted from the harassment.
Under §104(a)(2) and applicable precedent, emotional distress damages are not excluded from income unless directly caused by physical injury.
The IRS appropriately included the settlement amount in gross income.
Judgment Details
Deficiency: $28,354 (income tax for 2019)
Penalty (§6662): $5,671 — conceded by IRS
Attorney’s Fees Deduction: $54,000 — allowed by IRS
Health Savings Account Adjustment: $1,979 — conceded by IRS
Final Disposition: Decision to be entered under Rule 155 recalculating deficiency consistent with concessions.
The Takeaway
The decision confirms that settlement payments for emotional distress arising from harassment or discrimination remain taxable unless tied to demonstrable physical injury. Courts will rely on the express language of settlement agreements to determine tax treatment.
Fortune-Paladino v. Commissioner, T.C. Memo. 2025-101, No. 4975-23., 2025 BL 353634, 2025 Tax CT Memo Lexis 106, Court OpinionSource: Case Mine
Citations
Statutes:
I.R.C. §61(a) — defines gross income.
I.R.C. §104(a)(2) — exclusion for damages on account of personal physical injuries or sickness.
I.R.C. §6662 — accuracy-related penalties.
I.R.C. §7491 — burden of proof provisions.
Cases cited:
Welch v. Helvering, 290 U.S. 111 (1933) — presumption of correctness of deficiency.
Anastasato v. Commissioner, 794 F.2d 884 (3d Cir. 1986) — burden of proof in unreported-income cases.
Commissioner v. Glenshaw Glass Co., 348 U.S. 426 (1955) — definition of gross income.
Commissioner v. Schleier, 515 U.S. 323 (1995) — scope of §104(a)(2) exclusions.
United States v. Burke, 504 U.S. 229 (1992) — nature-of-claim test for settlements.
Simpson v. Commissioner, 141 T.C. 331 (2013), aff’d 668 F. App’x 241 (9th Cir. 2016) — determining the nature of settlement proceeds.
Knuckles v. Commissioner, 349 F.2d 610 (10th Cir. 1965) — nature of claim governs tax treatment.
Bent v. Commissioner, 87 T.C. 236 (1986), aff’d 835 F.2d 67 (3d Cir. 1987) — damages awarded instead of income.
Devine v. Commissioner, T.C. Memo 2017-111 — emotional distress settlements taxable.
Walquist v. Commissioner, 152 T.C. 61 (2019) — burden and standard of proof.
Blohm v. Commissioner, 994 F.2d 1542 (11th Cir. 1993) — evidentiary link to unreported income.
Church v. Commissioner, 80 T.C. 1104 (1983) — nature-of-claim analysis.
Yates Indus., Inc. v. Commissioner, 58 T.C. 961 (1972), aff’d 480 F.2d 920 (3d Cir. 1973) — damages characterization.