The Physical Consequences of Emotional Distress: The Need for a New Test to Determine What Amounts Are Excluded from Gross Income under § 104(a)(2)

By Wolfe, C. Anthony, IV | Washington and Lee Law Review, Fall 2012 | Go to article overview

The Physical Consequences of Emotional Distress: The Need for a New Test to Determine What Amounts Are Excluded from Gross Income under § 104(a)(2)


Wolfe, C. Anthony, IV, Washington and Lee Law Review


Table of Contents

I. Introduction ....................2274

II. Development of the "Personal Injury" Exclusion .....................2276

A. Early Development ......................2276

B. The "Personal Injury" Exclusion After Glenshaw Glass .......................2280

C. The 1989 Amendments ................2282

D. A Two-Part Test Emerges ..............2283

1. United States v. Burke ...................2284

2. Commissioner v. Schleier ..................2285

III. The Courts Refine § 104(a)(2)'s "On Account Of ' Requirement .......................2289

A. The "Direct Causal Link" .................2290

IV. The Small Business Job Protection Act of 1996 ..................2293

V. Section 104(a)(2)'s Exclusion After the 1996 Act ....................2296

A. The Circuits Reach the Right Outcome ...................2296

VI. The Tax Court Reaches Conflicting Results ..................2304

A. Sanford v. Commissioner ...................2304

B. Domeny v. Commissioner ....................2307

C. Parkinson v. Commissioner ..................2309

VII. Proposal: A New Test ...................2313

A. The "Origin" Requirement ....................2316

VIII. Conclusion ..............................2321

I. Introduction

Congress amended § 104(a)(2) of the Internal Revenue Code1 in 1996, inserting the word "physical" into § 104(a)(2)'s "personal injury or sickness" exclusion from gross income.2 Section 104(a)(2)'s gross income exclusion now applies to only damages received "on account of personal physical injuries or physical sickness."3 Congress's amendment further provided that "emotional distress shall not be treated as a physical injury or physical sickness."4 Before Congress's change, the exclusion from gross income applied to all "personal injuries," regardless of whether they were physical, nonphysical, or emotional.5

Since Congress amended § 104(a)(2), courts have struggled to uniformly apply the exclusion and have begun to extend it beyond only physical injuries and physical sicknesses.6 Part of this struggle is due to the inherent difficulty with defining the word "physical."7 Significantly, however, the struggle is mostly to do with the fact that the judicial test used to determine what amounts fall within § 104(a)(2)'s exclusion developed when the exclusion applied to all "personal injuries."8 Although Congress limited § 104(a)(2)'s exclusion to only physical injuries and physical sicknesses, courts have not adjusted the test used to determine what amounts fall within the exclusion.9 This Note proposes that courts modify the test used to exclude damage awards under § 104(a)(2) to accommodate the added "physical" requirement.10 The proposed test will allow § 104(a)(2) to be uniformly applied to only physical injuries and physical sicknesses in the way that Congress intended.

Every year taxpayers must calculate their gross income to determine the tax they must pay. To do this, taxpayers must know what amounts are included in gross income under § 61 n and what amounts can be excluded from gross income under other Tax Code provisions. In 2011, disputes over what amounts are included in gross income and what amounts can be excluded were among the most litigated taxation issues.12 Personal injury claimants - physical and nonphysical - are awarded millions of dollars each year.13 Thus, § 104(a)(2)'s gross income exclusion is consistently one of the most litigated exclusionary provisions.14

Part II of this Note outlines the history of the "personal injury' exclusion before Congress added the word "physical."15 Part III discusses judicial opinions limiting the scope of § 104(a)(2)'s "on account of language.16 Congress's amendment to § 104(a)(2) is detailed in Part IV,17 and the circuit courts' response to the amendment is discussed in Part V.18 Part VI of this Note analyzes three Tax Court cases that illustrate the struggle in applying the amended § 104(a)(2) exclusion. …

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