Abstract
There has been calls for the elimination of the “physical” requirement in section 104(a)(2). Thoughtful suggestions for reform have been made by the National Taxpayer Advocate (NTA), as well as the American Bar Association (ABA). The NTA argues that settlement payments for mental anguish and emotional distress ought to be excluded just as payments on account of physical injury are currently excluded from gross income. Similarly, the ABA is lobbying for legislative changes that would exclude noneconomic damages from taxable income. The ABA argues that current law penalizes taxpayers who are victims of discrimination by requiring them to pay taxes on the damages they receive.
In this article, I too argue for a statutory change, though a quite different change than the NTA/ABA suggestions. I submit that nearly all damages, including damages received on account of physical injury, ought to be taxable, and that juries must be apprised of tax consequences so that they can make proper adjustments to take account of these tax consequences. I will refer to this as the full inclusion proposal with jury awareness — for ease, the full inclusion proposal.
My proposed change is the more sound solution for several reasons. Full inclusion creates certainty and avoids wasteful tax gamesmanship. Furthermore, assuming informed parties, counsel, and juries, full inclusion need not harm individual taxpayers. This proposal works because under it, all settlement components are taxed the same. Jury tax awareness is critical to the proposal because it permits the jury to provide the intended (after-tax) compensation, and also because only by assuming an informed jury will parties be on equal footing for settlement negotiations. And because my policy, unlike the ABA and NTA suggestions, provides no incentive to make specious claims of emotional distress, it does not risk increasing societal skepticism of mental illness. Finally, and not of least importance, the tax preference for physical injuries has a gendered component: men, more than women, recover damages from physical injury, and therefore men, more than women, benefit from the tax rule in its current form. By taxing damages for physical injury just as we tax damages for nonphysical injury, we lessen the significance of this gendered distinction.
Recommended Citation
Morgan L. Holcomb,
Taxing Anxiety,
14 Fla. Tax Rev.
(2013).
Available at: https://scholarship.law.ufl.edu/ftr/vol14/iss1/3