Vanderbilt Law Review


Susan K. Matlow

First Page



The Internal Revenue Code (Code) sweeps into gross income "all income from whatever source derived," including, but not limited to, compensation for services, interest, dividends, rents, and alimony payments.' Specific statutory exclusions may exempt from gross income certain items that Congress has determined deserve favorable tax treatment. One such exclusion, section 104(a)(2), provides that gross income shall not include "the amount of any damages received (whether by suit or agreement and whether as lump-sums or as periodic payments) on account of personal injuries or sickness."' Congress enacted section 104(a)(2)'s predecessor in 1918," and in spite of subsequent revolutionary tax reform, this traditional exclusion remains in the present tax code. This exclusion relieves a taxpayer who has had the misfortune to be injured from including any subsequent damage award in gross income.'

Presently, neither the Code nor the related Income Tax Regulations define what constitutes a personal injury for the purposes of exclusion of damages under section 104(a)(2). Because the regulations do define "damages received" as amounts received through prosecution of a legal action based on "tort or tort-type rights" or through a settlement agreement, the essential requirement for exclusion is that the damages must derive from a tort or tort-type claim against the pay or Damages received on account of physical injuries clearly are personal and excludable from gross income even if lost earnings compose part of the award, and physical trauma is not a prerequisite for the exemption under section 104(a)(2).10

While the statutory exclusion for personal injury damages has remained static, courts have expanded the definition of what constitutes a personal injury and have brought within the scope of section 104(a)(2) certain types of damages whose exclusion from gross income is not justified by sympathy for personal injury victims. The courts have held that nonphysical torts such as injury to personal or professional reputation," employment discrimination, abridgment of constitutional rights,'" and tort-type remedies in contract actions' are within the scope of section 104(a)(2)

Part II of this Note examines the scope and legal background of section 104(a)(2), discusses its historical application in the punitive damages, defamation, and civil rights areas, and evaluates the tax consequences of alternative methods of calculating damages awards. Part III examines the present judicial expansion of section 104(a)(2) with particular emphasis on the conflict between the courts and the Internal Revenue Service (Service) concerning what constitutes excludable personal injury damages. Part III also considers the legislative amendment to section 104(a)(2) limiting the exclusion of punitive damages. Finally, Part IV explores a recommendation for future legislative action.

Included in

Torts Commons