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Florida Tax Review

Abstract

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?

If the Court believed that the Burke decision would bring order to this corner of the law, it was sadly mistaken. Just how broad must the range of recoverable damages be to make a claim tort or tort-type under Burke? Is a claim under the Age Discrimination in Employment Act of 1967 (ADEA)—which allows recovery of backpay plus, in cases where the employer's violation is willful, an equal amount as "liquidated damages"—tort-type? Did the Court mean to say that the exclusion applies to all damages received on a tort or tort-type claim, including punitive damages and prejudgment interest, or only to compensation for the personal injury that gave rise to the claim? The Court has granted certiorari in a case involving the excludability of ADEA recoveries, and, depending on the scope and clarity of its opinion in that case, it may find it necessary to hear additional cases to settle other issues on which the lower courts have not agreed.

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. Part II is a brief discussion of the history of the tax treatment of damages received for a personal injury. Part III is a discussion of policy justifications for excluding from gross income compensatory damages for personal injuries and the absence of any policy justification for excluding punitive damages. This Part also examines the policy justification for excluding that portion of a personal injury recovery that compensates for lost wages or profits. Part IV discusses the Supreme Court's decision in Burke and the decision's effect in subsequent litigation. Part V discusses punitive damages and sets forth the author's reasons for concluding that all punitive damages are included in income. Part VI examines whether damages (including liquidated damages) obtained under the ADEA are within the section 104(a) exclusion. The final Part VII briefly discusses the problems inherent in extension of the exclusion to all tort-type claims arising from a personal injury and whether that extension has led to inappropriate results.

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