Compensatory and Punitive Damages for a Personal Injury: To Tax or Not to Tax?
Douglas A. Kahn
University of Michigan Law School
Florida Tax Review, Vol. 2, p. 327, 1995
Since the adoption in 1919 of the Revenue Act of 1918, damages received on account of personal injuries or sickness have been excluded by statute from gross income. This exclusion, which does not apply to reimbursements for medical expenses for which the taxpayer was previously allowed a tax deduction, is presently set forth in section 104(a)(2). One might expect that a provision having recently attained the ripe age of 75 years without change in its basic language would have a settled meaning. However, recent litigation under section 104(a)(2) bristles with unsettled issues. Does the exclusion apply to punitive damages? To prejudgment interest included in a personal injury recovery? To recoveries under various antidiscrimination statutes?
The Supreme Court entered the fray in 1992 with its decision in United States v. Burke, dealing with the application of section 104(a)(2) to recoveries in employment discrimination cases. The Court followed a regulation stating that the exclusion applies only to amounts received, through suit or settlement, based upon tort or tort-type rights, and held that a claim is tort or tort-type only if it can be redressed by a broad range of damages, such as those traditionally allowed in tort cases. Specifically, the Court found that a recovery under Title VII of the Civil Rights Act of 1984 was not within the section 104(a)(2) exclusion because Title VII, as it existed when the facts of the case arose, allowed only equitable relief and recoveries of backpay.
If the Court believed that the Burke decision would bring order to this corner of the law, it was sadly mistaken. Many questions remain. A principal purpose of this article is to suggest that these questions should be resolved with a close eye on the history of section 104(a)(2) and the policies supporting it.
Number of Pages in PDF File: 58
Keywords: Taxation, Punitive Damages, Personal Injury, Compensatory Damages
JEL Classification: H20, H24
Date posted: May 2, 2007