Supreme Court denies exclusion for age discrimination damages.

• Author: Barton, Peter C.

In a sweeping opinion that narrowly interprets the Sec. 104(a)(2) exclusion of damages from gross income, the Supreme Court recently ruled that all amounts received by an employee as damages for an employer's violation of the Age Discrimination in Employment Act of 1967 (ADEA) were taxable (Schleier, 6/14/95). This decision reversed both the Fifth Circuit and a reviewed opinion of the Tax Court. It continues the limitation of the Sec. 104(a)(2) exclusion that the Supreme Court began in Burke, 112 Sup. Ct. 1867 (1992), a sex discrimination case.

Although the Supreme Court in Schleier clarified the taxation of age discrimination damages, the opinion raises questions about the taxation of other types of discrimination damages that CPAs believed were excludible. This topic is important because most employees in the U.S. are covered by one or more of the Federal statutes prohibiting discrimination based on age, sex, race, color, religion, national origin or disability, as well as state antidiscrimination statutes.

Background

Sec. 61(a) taxes all income unless specifically excluded by another section of the Code. Sec. 104(a)(2) excludes from gross income "the amount of any damages received (whether by suit or agreement) on account of personal injuries or sickness." "Personal injury" is not defined in the Code, but Regs. Sec. 1.104-1(c) specifies that the taxpayer's claim must be based on tort or tort-type rights.

Prior to Burke, taxpayers had argued that amouhts received from employers for the violation of discrimination statutes qualified for the Sec. 104(a)(2) exclusion, since discrimination was a tort. These amounts typically included back pay and other damages allowed under the particular discrimination statutes. The Service had maintained that back pay was a contractual claim and thus taxable. However, by 1992, the Tax Court and most appellate courts that had considered the issue accepted the taxpayers' arguments and ruled that all amounts received for the violation of discrimination statutes qualified for the Sec. 104(a)(2) exclusion.

Burke was the first case in which the Supreme Court addressed this issue. The taxpayer in this case had settled a sex discrimination suit under Title VII of the Civil Rights Act of 1964 (CRA), which prohibits employment discrimination based on sex, race, color, religion or national origin. The CRA then in effect only allowed recovery of back pay; it did not allow any other damages or provide for a jury trial...