Supreme Court Clarifies Test for Personal Injury Exclusion Under Irc Section 104(a)(2)
| Publication year | 1995 |
| Pages | 2737 |
1995, December, Pg. 2737. Supreme Court Clarifies Test for Personal Injury Exclusion Under IRC Section 104(a)(2)
Section 104(a)(2) of the Internal Revenue Code ("Code") provides for the exclusion from gross income of the amount of any damages received by a taxpayer on account of personal injuries or sickness.(fn1) Because of the enormous advantage that a taxpayer can gain from the application of § 104 (a)(2) and because of certain ambiguities in the statutory language, § 104(a)(2) has become a highly litigated provision of the federal tax law. This article discusses a recent U.S. Supreme Court decision that clarifies this area of the law.
In Commissioner v. Schleier,(fn2) the U.S. Supreme Court recently held that backpay and liquidated damages received in settlement of a claim under the Age Discrimination in Employment Act of 1967 ("ADEA") are not excludable from income. In reaching its decision in Schleier, the Court attempted to clarify the analysis required to determine whether amounts received as damages qualify for exclusion from income under Code § 104(a)(2).
This clarification was necessary in large part due to the confusion created by United States v. Burke,(fn3) in which the Court seemed to imply that damages were excluded from income under § 104(a)(2) if the cause of action giving rise to the damages was based on tort or tort-type rights. According to Burke, a cause of action is based on tort or tort-type rights if the remedies available to a plaintiff include "a broad range of damages to compensate the plaintiff 'fairly for injuries caused by the violation of his legal rights.'"(fn4)
This line of reasoning survives Schleier, but has been relegated to only one prong of a two-prong test.(fn5) Schleier provides a new test for determining excludability from income under § 104(a)(2):
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."(fn6)
The first prong of the Schleier test is derived from the Treasury Regulation promulgated under § 104(a)(2) and the earlier Burke decision. In Burke, the Court held that a payment received in settlement of a backpay claim under the pre-1991 version of Title VII of the Civil Rights Act of 1964 was not excludable under § 104(a) (2). Burke's adverse outcome was based on the Court's conclusion that Burke's claim was not based on tort or tort-type rights.(fn7)
In Burke, the Court determined that the "primary characteristic" of an action based on tort or tort-type rights is the availability of compensatory remedies.(fn8) The Court noted that "one of the hallmarks of traditional tort liability is the availability of a broad range of damages" for fair compensation to the plaintiff whose legal rights have been violated.(fn9) The Court continued:
Although these damages often are described in compensatory terms, in many cases they are larger than the amount necessary to reimburse actual monetary loss sustained or even anticipated by the plaintiff, and thus redress intangible elements of injury that are deemed important, even though not pecuniary in [their] immediate consequence[s].(fn10)
Burke held that the pre-1991 version of Title VII was not based on tort or tort-type rights because the remedial scheme thereof provided no compensation "for any of the other traditional harms associated with personal injury, such as pain and suffering, emotional distress, harm to reputation, or other consequential damages...."(fn11) Similarly, in Schleier, the Court found the remedial scheme of the ADEA "provides no compensation 'for any of the other traditional harms associated with personal injury'" because the ADEA's monetary remedies are limited to "back wages, which are clearly of an 'economic character,' and liquidated damages," which, in the case of the ADEA, serve no compensatory function.(fn12) This analysis allowed the Court's conclusion that a claim under the ADEA was not an action based on tort or tort-type rights.
In summary, Burke requires an evaluation of the remedial scheme of a cause of action to determine whether it is based on tort or tort-type rights. If the remedial scheme...
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