Vol. 8, No. 4, Pg. 36. Taxation of Damages and Settlements for Personal Injury or Sickness.

• Author: By Burnet R. Maybank III, Deana West and Rick Handel

South Carolina Lawyer

1997.

Vol. 8, No. 4, Pg. 36.

Taxation of Damages and Settlements for Personal Injury or Sickness

36TAXATION OF DAMAGES AND SETTLEMENTS FOR PERSONAL INJURY OR SICKNESSBy Burnet R. Maybank III, Deana West and Rick HandelSection 1065 of the Small Business Job Protection Act (Act) of 1996 amends the exclusion for damages received for personal injury or sickness provided in § 104 of the Internal Revenue Code (IRC).

Prior to amendment, Code § 104(a)(2) provided that gross income did not include "the amount of any damages received (whether by suit or agreement and whether as lump sum or as periodic payments) on account of personal injuries or sickness." The statute further provided that this exclusion from gross income did not apply to any punitive damages in connection with a case not involving physical injury or physical sickness.

Courts have disagreed on whether the exclusion applies to punitive damages received in connection with a case involving a physical injury or physical sickness. In fact, the Supreme Court has agreed to decide whether punitive damages awarded in a physical injury lawsuit are excludable from gross income. Ogilvie v. U.S., 66 F.3d 1550 (10th Cir. 1995),

cert. granted, 64 U.S.L.W. 3639 (U.S. March 25, 1996) (No. 95-966).

Moreover, some courts have interpreted the exclusion broadly to cover awards for personal injury or sickness that do not relate to physical injury or sickness. For example, some courts have held that the exclusion applies to damages intended to compensate for back pay or lost wages in cases involving certain forms of employment discrimination and injury to reputation where there is no physical injury or sickness.

Recently, the Supreme Court held in Schleier v. Commissioner, 115 S.Ct. 2159 (1995) that a settlement for back pay and liquidated damages received under the Age Discrimination in Employment Act of 1967 was not "on account of personal injury and sickness" and was not "tort or tort type rights" and, therefore, was includable in income.

The House Ways and Means Committee Report reasoned:

1. Punitive damages are intended to punish the wrongdoer. They are not intended to compensate for lost wages or pain and suffering. Since the damages are a windfall to the recipient, the damages should be included in taxable income. Including punitive damages in taxable income establishes a...