Tax Court denies C corporation sec. 104(a) (2) personal injury exclusion.

• Author: Barton, Peter C.

In P&X Markets, 106 TC No. 26 (1996), the Tax Court recently ruled that a C corporation cannot suffer a personal injury and, therefore, cannot exclude personal injury damages under Sec. 104(a)(2)

Sec. 61(a) taxes all income unless specifically excluded by another Code section. 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." Regs. Sec. 1.104-1 (c) specifies that the taxpayer's claim must be based on tort or tort-type rights. (A tort is a civil wrong, other than breach of contract, for which a court awards damages.) The exclusion applies to physical, mental and emotional injuries; "person al injury" is not defined in the statute or: in the regulations. In Schleier, 115 Sup Ct. 2159 (1995), the Supreme Court denied the Sec. 104(a)(2) exclusion to employees subject to age discrimination by narrowly interpreting"on account of personal injuries" and"tort-type rights." However, the Supreme Court did not define"personal injury."

In P&X Markets, a C corporation owned and operated a retail grocery store. The corporation's president was its sole shareholder. P&X Markets sued certain defendants for breach of contract, malicious prosecution, injury to P&X's reputation, intentional interference with P&X's business and fraud. The parties settled for $850,000. The settlement did not allocate the $850,000 among the various claims, some of which qualified as tort-type under Sec. 104(a)(2).

P&X reported only $83,608 on its 1989 Form 1120, U.S. Corporation Income Tax Return. (Presumably, this was P&X's estimate of the portion of the $850,000 that was not for tort-type claims.) The IRS included the difference, minus legal fees, in income. P&X argued that the settlement proceeds were for personal injury because the defendant's wrongful conduct fell entirely on its sole shareholder/president. P&X also cited Castner Garage, 43 BTA 1 (1940), in which a corporation was allowed a personal injury exclusion.

The Tax Court rejected these arguments and held that a corporation cannot suffer a Sec. 104(a)(2) personal injury. The Tax Court cited Boyette Coffee Co., 775 F Supp 1001 (CID. Tex. 1991), in which a district court held that Sec. 104(a)(2) applies only to individuals, not to corporations. The court in Boyette pointed to other provisions of Sec. 104(a),which exclude from gross income payments for workers' compensation, health insurance benefits, and certain...