Among the many injustices life dishes out on a daily basis is the fact that many women who are actively trying to become pregnant cannot do so, while every teenager with more hormones and free time than common sense seemingly can’t keep from getting pregnant.
It’s a struggle I witnessed personally when my older sister tried unsuccessfully for years to conceive a child, her painful emotional battle reaching its nadir when an apathetic doctor explained to her that, “some women just aren’t meant to have children.”
Fourteen years and three beautiful girls later, my sister got the last laugh. But the process was far from easy, which is the reality for many women. And this is precisely why the fertility industry has become a billion dollar business.
There are no shortage of available alternatives for women struggling to get pregnant; unfortunately, they are typically intrusive and expensive. One option, which is the thrust of our discussion here, is “egg donation,” whereby a female donor is supplied with hormones that increase her egg production. The eggs are then removed, fertilized in a laboratory, and ultimately implanted in the intended recipient.
The term “egg donation” is a bit of a misnomer, however, because rarely is the egg “donated” in the traditional, altruistic sense. Rather, the donor is typically compensated, and compensated well. This, as you might imagine, has led to a rather big tax conundrum: do the amounts received by the donor in exchange for her eggs constitute taxable income?
The issue has been a huge topic of conversation on egg donor message boards (yes, there is such a thing) and in the fertility industry at large. And for good reason: because until today, there was no answer. Hours ago, however, that all changed, when the Tax Court concluded that amounts received by a donor represented taxable compensation income.
What We Know About Egg Donation
Donating eggs is a selective, painful, and yes, lucrative, process. While any woman can apply to be a donor, only nonsmokers between the ages of 21 and 30 who have no family history of cancer or personal history of infertility or mental disorders will even pass the initial screening. For those who are ultimately accepted, they are then subjected to a series of psychological and physical evaluations, including blood tests, pap smears, breast exams, and pregnancy tests. As they near the extraction date, donors endure a series of intrusive physical examinations and hormonal injections. The injections, which are routinely done directly into the donor’s stomach, leave burning and bruising behind. There is no disputing that the experience leaves the donor physically damaged and emotionally drained.
Despite the prolonged, painful process, egg donation has been on the rise for young women for an obvious reason: it pays well. College newspapers and Craigslist are filled with offers to pay a qualifying donor as much $50,000 for her eggs; an amount that is too life-changing for many twenty-somethings to be ignored.
What We Don’t Know About Egg Donation
The tax consequences of dealing in the human body are largely unsettled, and they probably should be. As we’ll see at the end of this discussion, any precedent that establishes that a part of the body is property, or can be sold or donated, opens up a Pandora’s Box of potential abuse. As a result, the IRS and the courts have tread lightly in establishing such precedent. In fact, over 100 years of tax law reveals little more clarity about the tax consequences of dealing in in the human body than 1) breast milk is considered property, the donation of which may result in a charitable contribution, and 2) donating blood may be either the sale of property or the performance of a service, depending on the court.
It is no surprise, then, that until today, there was no precedent for how an egg donor treats the amounts received in exchange for the process for taxable income purposes. This afternoon, however, the Tax Court decided Perez v. Commissioner, 144 T.C. 4, (2015), and concluded definitively that the amounts represent taxable income.
Facts in Perez
Nichelle Perez, a California resident, contracted with Donor Source International, LLC (Donor Source) to sell her eggs to women who struggled to conceive on their own. During 2009, Perez went through two donation cycles and was paid a total of $20,000.
For each donation, Perez entered into two contracts–one with Donor Source and one with the anonymous intended parent. The contract with Donor Source made clear that Perez was not selling her eggs, intimating instead that she was being compensated for her physical suffering:
“Donor Fee: Donor and Intended Parents will agree upon a 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. The parties plainly acknowledge and agree that the funds provided to the Donor shall not in any way constitute payment to Donor for her eggs.”
The contract with the prospective parent read the same, stating that payment was “in consideration for all of her pain, suffering, time, inconvenience, and efforts.”
The underlined contractual language above was of critical importance to Perez. This is because generally, Section 61 of the Internal Revenue Code provides that gross income includes all income from whatever sources derived, including compensation for services. There is an exception found at Section 104(a)(2), however, which excludes from taxable income the amount of any damages (other than punitive damages) received on account of personal injuries or physical sickness.
Based on the language of the contract, Perez believed that the $20,000 she received in 2009 was to compensate her for the physical injuries she suffered as part of the egg donation process, and thus, fit within the ambit of Section 104 and was excludable from her taxable income. A cursory search of the internet reveals that many donors feel exactly the same way.
As a result, Perez did not report the $20,000 of taxable income, despite the fact that Donor Source issued her a Form 1099 in that amount.
The IRS disagreed, arguing that regardless of the contractual language, the $20,000 Perez received was in exchange for services provided; in essence, while Perez may not have been selling her eggs, she was providing a service when she went through the process of donating her eggs.
Tax Court Decision
With some trepidation, the Tax Court took on the issue of whether the $20,000 Perez received was in fact taxable compensation, or if it represented a tax-free recovery of physical damages. It is important to note, however, that just as important to Judge Holmes was what the case wasn’t about: it wasn’t about whether 1) human eggs are capital assets, 2) how to allocate basis in the human body, 3) the holding period for body parts, or 4) the character of gain from the sale of those parts. And from a tax geek’s perspective, that’s a damn shame, because determinations of that magnitude would have made for fascinating theater. The court didn’t have to take on these issues, however, because the contracts made clear that Perez was not selling her eggs, because she would be compensated whether she produced any useable eggs or not. So the issue was straightforward: is it compensation, or damages for physical injury?
To determine if the payments were a tax-free recovery of physical damages, the court looked next to the language of the Section 104 regulations; specifically, were the amounts received by Perez “damages” under the meaning of the regulations?
Reg. Section 1.104-1(c)(1) defines the term “damages” as “an amount received (other than workers’ compensation” through prosecution of a legal suit or action, or through a settlement agreement entered into in lieu of prosecution.”
Because Perez conceded she had neither sued nor settled with Donor Source, she attacked the very validity of the regulations, arguing that the IRS did not have the power to limit “damages” to amounts received in a lawsuit or due to the threat of one. Instead, “damages” should extend to situations where a taxpayer received compensation in money for a loss regardless of legal suit or action.
I’ll spare you the details of the court’s jaunt through the legislative history, but ultimately, Judge Holmes concluded that the regulations were in fact valid. And as a result, they failed to help Perez, because she did not receive the $20,000 as a result of a legal suit or action. More importantly, she did not receive the amounts from any type of action — legal or otherwise– taken after the physical injuries occurred; to the contrary, she entered into a contract with Donor Source providing for $20,000 of payment before the injuries took place.
Even more damning, the injuries were both anticipated and consensual; in fact, they were of the exact nature that Perez was advised to expect when she entered into her contract. Thus, Judge Holmes concluded:
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. Had Donor Source or the clinic exceeded the scope of Perez’s consent, Perez may have a claim for damages. Her physical pain was a byproduct of performing a service contract, and we find that the payments were not made to compensate her for some unwanted invasion against her bodily integrity but to compensate her for services rendered.
As a result, the amounts paid to Perez, and presumably to all future egg donors, represented taxable income.
Difficult a decision as it was, it was likely necessary to avoid the dangerous precedent mentioned at the outset of this column. If an egg donor could successfully argue that amounts received compensated her for injuries of a job she consented to and were thus tax-free, than what is to prevent a football player from arguing that part of his salary is intended to compensate him for concussions suffered, or a miner from contending that a portion of his compensation was intended to offset his future lung damage, resulting in a portion of the compensation in both cases becoming tax-free?
The tax law is harsh and unforgiving, and often times, precedent must be decided with an eye towards the future, and with consideration of the inevitable abuse of the authority established by enterprising taxpayers. Thus, while the decision in Perez is sure to be unpopular, it was the correct one.
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