Ninth Circuit misinterprets Schleier.

• Author: Orbach, Kenneth N.

The Supreme Court, in Schleier, 115 Sup. Ct. 2159 (1995), addressed whether back pay and liquidated damages awarded under the Age Discrimination in Employment Act of 1967 (ADEA) were excludible from gross income under Sec. 104(a)(2). In holding that they are not, the Court articulated two independent requirements a taxpayer must meet before a recovery may be excluded. 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."

Unfortunately, the two-part test is not a model of clarity. Recently, in fact, the Ninth Circuit, in Banks, 81 F3d 874 (1996), aff'g DC Wash., 1994, may have misinterpreted Schleier by deciding that payments to a taxpayer to settle a claim of breach of duty of fair representation were excludible from gross income under Sec. 104(a)(2).

Tort-Type Rights

In Burke, 504 US 229 (1992), the Supreme Court stated that a "hallmark" of traditional tort liability was the availability of a broad range of damages to compensate the plaintiff. The Schleier Court clarified that the availability of compensatory damages for intangible harms (e.g., pain and suffering, emotional distress, harm to reputation, or Other consequential damages) was a primary characteristic of such a broad range. The Schleier Court concluded that, since monetary remedies under ADEA were limited to back wages and liquidated damages, recovery under ADEA was not based on tort or tort-type rights.

On Account of Personal Injuries

The Schleier Court made clear that compensatory monetary damages must be directly linked to a personal injury in order to be received on account of that injury for Sec. 104(a)(2) purposes. For example, proceeds of a settlement for medical expenses, lost wages and pain and suffering arising from an automobile accident are excludible from gross income. The portion of the settlement for medical expenses and pain and suffering is clearly on account of personal injury; the part received for lost wages is also on account of personal injuries (provided the lost wages resulted from lost work time due to injuries sustained in the accident).

On the other hand, no part of Schleier's ADEA settlement (for back wages) was excludible from gross income. Although the age discrimination caused both personal injury (comparable to pain and suffering) and lost wages...