Rev. Rul. 93-88 expands exclusion for employee discrimination damages.

• Author: Barton, Peter C.

Rev. Rul. 93-88 clarified and expanded the exclusion from gross income for back pay and compensatory damages received by employees for employer violations of Federal discrimination statutes. This ruling covers discrimination based on race, color, religion, sex, national origin and disability.

Background

Sec. 104(a)(2) allows an exclusion for the amount of any damages received on account of personal injuries, whether by suit or settlement agreement. "Personal injury" is not defined in the Code, but Regs. Sec. 1.104-1 (c) specifies that the taxpayer's claim must be a tort-type claim. For the past several years, the application of Sec. 104(a)(2) to damages received as a result of violations of discrimination statutes has been uncertain. The Tax Court and several appellate courts have issued conflicting decisions on the taxation of race, sex and age discrimination damages.

In Burke, 112 Sup. Ct. 1867 (1992), the Supreme Court held that, to qualify as a tort-type claim under Sec. 104(a)(2), the discrimination statute must have tort-type remedies. In other words, the statute must allow the discrimination victim to recover compensatory and punitive damages. Compensatory damages include damages for future pecuniary losses, as well as for emotional pain, suffering, inconvenience, mental anguish, loss of enjoyment of life and other nonpecuniary losses.

In Burke, the taxpayer settled a sex discrimination suit brought in 1984 under Title VII of the Civil Rights Act of 1964 (CRA) - which prohibits employment discrimination based on race, color, religion, sex or national origin. However, the CRA in effect when Burke settled only allowed recovery of back pay. Therefore, the Supreme Court ruled that Burke's back pay was taxable; the CRA's original back pay remedy was not a tort-type remedy.

In 1991, Congress amended the CRA to also allow compensatory and punitive damages, effective Nov. 21, 1991. However, Congress only allowed these additional damages for intentional disparate treatment discrimination, which is employment discrimination against any individual based on race, color, religion, sex or national origin. The CRA also prohibits disparate impact discrimination, which is defined as the classification of employees based on race, color, religion, sex or national origin, in a way that tends to adversely affect their employment status and is unnecessary for business purposes. Only back pay is available for disparate impact claims. Burke did not rule on...