IRS Proposes To Update Regulations On Exclusion of Damages Received on Account of Personal Physical Injuries or Physical Sickness To Eliminate Tort Test

December 14, 2009 is the deadline to comment on proposed regulations relating to the exclusion from gross income for amounts received on account of personal physical injuries or physical sickness published by the Internal Revenue Service (IRS) in light of amendments enacted by the Small Business Job Protection Act of 1996. 

The Small Business Job Protection Act of 1996 (SBJPA) amended Internal Revenue Code § 104 to delete the requirement that to qualify for exclusion from gross income, damages received from a legal suit, action, or settlement agreement must be based upon “tort or tort type rights” (the “tort test”). As amended by the SBJPA, Code § 104(a)(2) excludes from gross income the amount of any damages (other than punitive damages) received (whether by suit or agreement and whether as lump sums or as periodic payments) on account of personal physical injuries or physical sickness.

In keeping with this amendment, the proposed regulations published today (9/15/09) would amend the regulations to eliminate the tort test as a requirement for personal injury damages generally to qualify for exclusion under Code § 104.  Under the proposed regulations, the current requirement that “personal injuries or sickness” awards be “based upon tort or tort type rights” to qualify for exclusion under Code § 104(a)(2) also would be removed in light of recent judicial and statutory developments.  As a consequence, physical injuries could qualify for the Code § 104(a)(2) exclusion even though the injury giving rise to the damages is not defined as a tort under state or common law. Furthermore, the Code § 104(a)(2) exclusion also would not depend on the scope of remedies available under state or common law.  As a consequence, the proposed rule would allow the exclusion for damages awarded under no-fault statutes.

According to the proposed regulations, however, the tort test would not be eliminated as a requirement for punitive damage awards to qualify for income exclusion under Code § 104.  The preamble to the proposed regulations explains the IRS does not construe the SBJPA amendment as removing the tort test or otherwise extend Code § 104 to such awards.  Rather, the proposed regulations would provide that punitive damage awards do not qualify for income exclusion under Code § 104.

If adopted as proposed, the IRS has indicated that it intends to treat the proposed rules as effective for personal injury awards received after August 20, 1996, except for any amount received under a written binding agreement, court decree, or mediation award in effect on (or issued on or before) September 13, 1995. For amounts paid pursuant to a written binding agreement, court decree, or mediation award entered into or issued after September 13, 1995 and received after August 20, 1996, a taxpayer would be permitted to file a claim for refund of any tax overpayments paid within the period of limitations under section 6511.

If you have questions about or need assistance commenting on or responding to the proposed regulations or other employment, compensation, employee benefit, workplace health and safety, corporate ethics and compliance practices other related matters, please contact the author of this article, Curran Tomko Tarski LLP Labor & Employment Practice Group Chair Cynthia Marcotte Stamer.  Board Certified in Labor & Employment Law by the Texas Board of Legal Specialization and Chair of the American Bar Association RPTE Employee Benefits & Other Compensation Group, Ms. Stamer is experienced with assisting employers and others about compliance with compensation and employee benefit, workplace safety, equal employment opportunity and other labor and employment, as well as advising ad defending employers against tax, employment discrimination and other labor and employment, and other related audits, investigations and litigation, charges, audits, claims and investigations by the IRS, Department of Labor and other federal and state regulators. Ms. Stamer has advised and represented employers on these and other labor and employment, compensation, employee benefit and other personnel and staffing matters for more than 20 years. Ms. Stamer also speaks and writes extensively on these and other related matters. For additional information about Ms. Stamer and her experience or to access other publications by Ms. Stamer see here or contact Ms. Stamer directly.   For additional information about the experience and services of Ms. Stamer and other members of the Curran Tomko Tarksi LLP team, see here.

Other Information & Resources

We hope that this information is useful to you. If you or someone else you know would like to receive future updates about developments on these and other concerns, please be sure that we have your current contact information – including your preferred e-mail – by creating or updating your profile here or e-mailing this information here or registering to participate in the distribution of our Solutions Law Press HR & Benefits Update distributions here.  Some other recent updates that may be of interested include the following, which you can access by clicking on the article title:

For important information concerning this communication click here.   If you do not wish to receive these updates in the future, send an e-mail with the word “Remove” in the Subject here.

©2009 Cynthia Marcotte Stamer. All rights reserved.  

Comments are closed.

%d bloggers like this: