Severance payments as personal injury awards.

• Author: Wagman, Rich

Sec. 104(a)(2) states that gross income does not include "the amount of any damages received (whether by suit or agreement and whether as lump sums or as periodic payments) on account of personal injuries or sickness." Regs. Sec. 1.104-1(c) defines the term "damages received" as "an amount received (other than workmen's compensation) through prosecution of a legal suit or action based upon tort or tort-type rights, or through a settlement agreement entered into in lieu of such prosecution." To eliminate much of the confusion over the "personal injuries or sickness" language, Congress amended Sec. 104(a) in 1989, adding that See. 104(a)(2) would not apply to any punitive damages in connection with a case not involving physical injury or physical sickness.

Case law has varied widely on the excludability of personal injury claim awards, depending on the basis for the suit or settlement agreement. Awards have been held to be excludible in actions based on emotional distress, injury to reputation, sex, age or race discrimination, wrongful termination, alienation of affections and wrongful death. Under present law, courts are required to focus on the nature of the underlying claim to determine whether an award or settlement meets the tort or tort-type requirement set forth under Regs. Sec. 1.104-1(c).

The Supreme Court has ruled on Sec. 104(a)(2) on only one occasion. In Burke, 112 Sup. Ct. 1867 (1992), the Court reviewed the excludability of damages received under a sex discrimination suit pursuant to Title VII of the Civil Rights Act of 1964. Holding that the Civil Rights Act of 1964 failed to provide all the tort-like remedies available, any award would not be excluded under Sec. 104(a)(2). The Court did indicate that the result would most likely have been different if the suit had been litigated under the new Civil Rights Act of 1992, which provides for all the tort-based remedies.

Unfortunately, the Burke decision has done little to clear the Sec. 104(a)(2) waters. Opinions continue to be split on the question of whether employment-related damage awards or settlements qualify for the Sec. 104(a)12) exclusion. In addition to the divergent opinions on the subject, Congress has made the issue more difficult by passing new antidiscrimination legislation over the last few years (e.g., the Age Discrimination in Employment Act (ADEA) and the Americans With Disabilities Act (ADA)). Two recent Circuit Court decisions, both examining ADEA awards...