Magazine article The CPA Journal

Recent Developments in the Taxation of Federal Statutory Damages

Magazine article The CPA Journal

Recent Developments in the Taxation of Federal Statutory Damages

Article excerpt

What are personal injuries for purposes of exclusion from gross income?

IRC Sec. 104(a)(2) allows damages received for personal injuries to be excluded from gross income. Personal injuries are not defined. Court cases in the 1980s were liberal in their interpretation. However, two Supreme Court cases in the 1990s have taken a bard line in permitting exclusion under this section.

IRC Sec. 104(a)(2) states that "damages received on account of personal injuries" are excluded from gross income. However, neither the IRC or the legislative history provide much guidance as to what damages Congress intended to exclude by the section. As such, the courts have been forced to determine what "on account of personal injuries' means.

During the 1980s, the Tax and Circuit Courts generally expanded the coverage of IRC Sec. 104(aX2). However, the 1990s have produced two Supreme Court decisions that have limited the availability of the exclusion, and established a more difficult test to meet to qualify as damages for IRC Sec. 104(a)(2) exclusion.

Determinations of the applicability of IRC Sec. 104(a)(2) to damages received pursuant to the Civil Rights Act of 1964, Civil Rights Act of 1991, Age Discrimination in Employment Act, Fair Labor Standards Act, and Americans with Disabilities Act have been particularly inconsistent and controversial. However, the recent Supreme Court decisions may have clarified the basis for excluding damages.

Expansion During the 1980s

During the 1980s, the Tax Court and Circuit Courts of Appeal generally expanded the applicability of IRC Sec. 104(a)(2). In Roemer v. Commissioner (1983), the Ninth Circuit Court of Appeals stated that personal injury damages are not limited to actual physical injury and that the proper analysis of IRC Sec. 104(a)(2) is to look to the nature of the claim, not the nature of the award. If the underlying claim is "tort" or "tortlike," IRC Sec. 104(a)(2) would exclude the recovery from taxation.

In 1986, the Tax Court in Threlkeld v. Commissioner stated that IRC Sec. 104(a)(2) applies if "compensatory damages are received on account of any invasion of the rights that an individual is granted by being a person in the sight of the law."

In specifically applying the definitions provided in Trelkeld and Roemer to Federal statutory causes of action, the courts determined the following:

* IRC Sec. 104(a)(2) excluded from taxation any portion of the damages received under the Civil Rights Act of 1964, not specifically related to back pay;

* The liquidated damage portion of awards under the Fair Labor Standards Act prohibition against gender discrimination were "tort" or "tortlike" and excludable under IRC Sec. 104(a)(2); and

* Awards based upon the Age Discrimination in Employment Act were "tortlike" and properly excludable under IRC Sec. 104(a)(2).

The clear trend of the 1980s was for the courts to gradually expand the application of IRC Sec. 104(a)(2) to include more and more damages recovered under the various Federal anti-discrimination statutes.

The 1990s

In 1992 and 1995 decisions, the Supreme Court reversed the trend of expanding IRC Sec. 104(a)(2) and modifled the standards for exclusion.

Burke. In 1992, the Supreme Court decided the case of U.S. v. Burke In Burke the Sixth Circuit Court of Appeals determined that awards made under the Civil Rights Act of 1964 were "personal" and "tortlike" and therefore excludable under IRC Sec. 104(a)(2).

In reversing the Sixth Circuit, the Supreme Court essentially established two tests that must be met: * The action is a "tort" or "tortlike" personal injury action, and

* The statute provides for a broad range of damages to compensate the plaintiff.

Requiring this broad range of damages dramatically alters the analysis used in previous cases. The Burke Court looked to the remedies available under Title VII of the Civil Rights Act of 1964, prior to its amendment in 1991, and stated Title VII does not allow awards for compensatory or punitive damages, only back pay, injunctions, and other equitable relief. …

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