Taxability of damage awards for sex/gender discrimination.

• Author: Cassill, Arthur D.

The Small Business Job Protection Act of 1996 (SBJPA) made significant changes to the Code exclusion-from-income provisions for damage awards resulting from personal physical injury or physical sickness claims. The SBJPA made two amendments that affected Sec. 104(a)(2). The exclusion for punitive damages was eliminated, even if the damages are paid as a result of a personal physical injury or physical sickness. (This was not the case under prior law.) Further, the SBJPA specifies that emotional distress is not intended to be defined as a personal physical injury or sickness. The result is that damages awarded in cases originating from gender discrimination suits will no longer be excludible from income.

While the SBJPA cleared up some of the confusion surrounding the proper treatment of damage awards received under a variety of circumstances and issues, it may have also created new issues and conflicts. For instance, it appears that the treatment of damage awards associated with age discrimination and wrongful employment issues may have been settled, while issues dealing with damage awards and settlements for emotional distress have been made more complicated.

Types of Awards

Several types of judgments are associated with legal actions giving rise to damages, including compensatory damages, punitive damages and prejudgment interest; also included are damages for pain and suffering, loss of consortium, back pay, payments for emotional distress and for lost wages or profits. To be eligible for exclusion from income, damages must be sought through some legal action, giving rise to a tort or tort-like claim. This definition has been the focal point for damages arising from gender discrimination lawsuits. The focus is on determining the nature of the underlying action that results in a claim.

In general, damage amounts fall into two or three classifications with a specific intent behind the settlement feature. Damages for lost wages or profits (or amounts received as back pay) are generally categorized as compensatory in nature. Compensatory damages are amounts received arising out of tort or tort-like claims and may be pursued under the applicable legal statutes (such as the Age Discrimination in Employment Act or Title VII of the Civil Rights Act of 1964 and 1991, as amended (CRA)).

Compensatory damages include damages for physical injuries, emotional distress and physical sickness. Likewise, damage amounts received for loss of consortium or...