Taxation of personal injury and sickness awards.

As part of the Small Business Job Protection Act of 1996 (SBJPA) (signed into law Aug. 20, 1996), Sec. 104 was amended to provide that gross income does not include "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." (Emphasis added.) The SBJPA also makes punitive damages of any kind taxable, except when awarded in a wrongful death action brought under a state law in effect on Sept. 13, 1995, which provides that only punitive damages may be awarded. An award of punitive damages in such a case is excludible to the extent received for personal injury or sickness.

Under the old law, gross income did not include damages received on account of personal injury or sickness However, this exclusion did not apply to punitive damages for nonphysical injury or sickness.

In O'Gilvie, 117 Sup. Ct. 452 (1996), the Supreme Court stated that punitive damages received before Aug. 21,1996 are not excludible from gross income. Also, in Schleier, 115 Sup. Ct. 2159 (1995), the Court held that damages recovered under the Age Discrimination in Employment Act of 1967 were not based on a tort-like claim and, therefore, not excludible from gross income.

Under the new law, damages for nonphysical injury or sickness (such as emotional distress) are not excludible from gross income, except to the extent these damages do not exceed medical expenses attributable to such distress. However, emotional distress damages are excludible if they are attributable to physical injury or physical sickness.

These new rules generally are effective for amounts received after Aug. 20, 1996. The new law does not apply to amounts received under a written binding agreement, court decree or mediation award in effect on, or issued on or before, Sept. 13, 1995.