Vol. 7, No. 5, Pg. 32. Paying Back the Payback-Taxation of Discrimination Awards.

• Author: By J. Kevin Crain

South Carolina Lawyer

1996.

Vol. 7, No. 5, Pg. 32.

Paying Back the Payback-Taxation of Discrimination Awards

32Paying Back the Payback--Taxation of Discrimination AwardsBy J. Kevin CrainThe U.S. Supreme Court recently announced its very disturbing decision in Commissioner v. Schleier, 515 U.S. ___ , 115 S.Ct. 2159, 132 L.Ed.2d 294 (1995) (Schleier). The Schleier case reverses 35 years of tax precedents preserving tax-free treatment for deserving plaintiffs. The case unsettles what had been a very reliable part of the Internal Revenue Code (Code) for South Carolina practitioners.

THE FACTS

In Schleier, the taxpayer was a retired United Airlines employee who was fired at age 60 in accordance with company rules. The taxpayer sued United, alleging its policy violated the Age Discrimination in Employment Act of 1967 (ADEA), 29 U.S.C. § 623 et seq.

Ultimately, United settled the claims of Schleier and similarly situated employees for millions. Schleier's share of the class action award amounted to a mere $145,629. The settlement agreement specifically allocated his award between back pay and "liquidated" damages only. There was no specific provision for physical, mental or emotional injury.

Schleier reported the back pay portion of the award as taxable income on his 1986 federal return and omitted the liquidated damages award from his reported income, relying on § 104 of the Code:

Compensation for Injuries or Sickness Subsec. (a) in General Except in the case of amounts attributable to (and not in excess of) deductions allowed under section 213 (relating to medical, etc., expenses) for any prior taxable year, gross income does not include . . . 104 (a) (2) 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; ... Paragraph (2) shall not apply to any punitive damages in connection with a case not involving physical injury or physical sickness.

TAX REGULATIONS

Schleier also relied heavily on the Treasury Regulations interpreting Code § 104.26 CFR. § 1.104-1 (c) (Regulation) provides:

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Section 104 (a) (2) [of the Internal Revenue Code] excludes from gross income the amount of any damages received (whether by suit or agreement) on account of personal injuries or sickness. The term 'damages received (whether by suit or agreement)' means an amount received (other than workers' compensation) through prosecution of a legal suit or action based upon tort or tort type rights, or through a settlement agreement entered into in...