Taxation of Damage Awards: Current Law and Implications
Litigation Economics Digest
Congress, as part of the Small Business Job Protection Act of 1996, l has apparently settled the ambiguous issue of when damages are excludible from gross income by amending section 104(a)(2) of the Internal Revenue Code. Previously, this section stated that exclusion from gross income was allowed for "the amount of any damages received (whether by suit or agreement and whether as a lump sum or as periodic payments) on account of personal injury or sickness." The Small Business Job Protection Act amends this section by allowing an exclusion for "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." Hence, this law, which became effective with the President’s signature on August 20, 1996, does not allow an exclusion for punitive damages or for compensatory damages not connected with a physical injury. Heretofore, in some instances, punitive damages and compensatory damages associated with nonphysical injuries (e.g., emotional distress, sexual harassment, discrimination) were excludible.
Bowles, Tyler J., and W. Cris Lewis. “Taxation of Damage Awards: Current Law and Implications.” Litigation Economics Digest 2(1, Fall 1996):73-77.