IRS Clarifies Physical Injury Income Exclusion

IRS has issued final regulations under Code Section 104 regarding the exclusion from gross income of amounts received due to personal injury or physical sickness. The final regs reflect amendments made by the Small Business Job Protection Act of 1996 (SBJPA), and remove the requirement that in order for damages to qualify for exclusion they must be based upon “tort or tort type rights.”

Code Section 104 as amended by SBJPA provides that (1) punitive damages do not qualify for the income exclusion and (2) the income exclusion generally is limited to amounts received on account of personal “physical” injuries or “physical” sickness, and further provides that even though emotional distress is not considered a physical injury or a physical sickness, damages not in excess of amounts paid for “medical care” for emotional distress are excluded from income. The final regs reflect these statutory amendments and also provide that a taxpayer may exclude damages received for emotional distress “attributable” to a physical injury or physical sickness.

The regs apply to damages paid pursuant to a written binding agreement, court decree, or mediation award entered into or issued after September 13, 1995, and received after January 23, 2012.

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