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Making People Whole Again: The Constitutionality of Taxing Compensatory Damages for Mental Distress

42 Pages Posted: 15 Dec 2010  

F. Patrick Hubbard

University of South Carolina - School of Law

Date Written: 1997


Until recently, Congress generally excluded tort awards and settlements for personal injuries to individuals from "gross income" and thus exempted them from federal income taxation. The sole test for this exclusion under section l04(a) of the Internal Revenue Code was whether tort recovery for personal injury was involved. Although this recovery could include items as diverse as mental distress and lost income, the nature of the specific elements of the damages award was irrelevant.

As a result, this exclusion covered all the elements of tort recovery, including such otherwise taxable items as lost income. Despite debate about the reasons for this approach, it was consistently followed for decades. However, in 1989, Congress began limiting the exclusion. This process began with an amendment to section 104(a) to provide that punitive awards were taxable as income unless they were in connection with a case "involving physical injury or physical sickness." In 1996, section 104(a) was again amended to subject all punitive damages to income taxation. Congress made another fundamental change in 1996 by amending the Code to provide, for the first time, that some compensatory awards for personal injury must be included in income. More specifically, section 104(a) was amended to provide that the traditional exclusion from income of "damages received . . . on account of personal injuries as sickness" did not apply to a victim's claim for "emotional distress" unless the claim had "its origin in a physical injury or physical sickness." Because of this new treatment of damages for mental distress, victims of torts like assault must now pay income tax on any award or settlement that compensates for the psychic trauma from the fear and terror of being assaulted.

Though there may be merit in the new approach to punitive damages, the change in the treatment of compensatory damages for mental distress raises serious constitutional questions.

Compensatory damages are meant to "make the victim whole again" by restoring the victim to the status quo before the tort. Moreover, damages for mental trauma do not replace something, like lost wages, that would otherwise be income. Thus, it is questionable whether compensation for mental distress constitutes income in any ordinary sense of the term. If these damages are not income, is it constitutional to tax them as such? Addressing this issue requires an examination of the legal framework for taxation of income and of the nature and purpose of compensatory damages for mental trauma. The constitutional framework is addressed in Part I of this Article. Part II summarizes the statutory approach to the taxation of tort damages. The nature of tort damages for mental distress is discussed in Part III. Part IV argues that it is unconstitutional to treat awards for mental distress as income.

Keywords: taxation of emotional distress, emotional distress, tort damages taxation, constitutional review, sixteenth amendment, income taxation, definition of income, constitutional interpretation

Suggested Citation

Hubbard, F. Patrick, Making People Whole Again: The Constitutionality of Taxing Compensatory Damages for Mental Distress (1997). Florida Law Review, Vol. 49, p. 725, 1997. Available at SSRN:

F. Patrick Hubbard (Contact Author)

University of South Carolina - School of Law ( email )

Main & Greene Streets
Columbia, SC 29208
United States

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