[Federal Register Volume 74, Number 177 (Tuesday, September 15, 2009)]
[Proposed Rules]
[Pages 47152-47154]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E9-22221]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[REG-127270-06]
RIN 1545-BF81


Damages Received on Account of Personal Physical Injuries or 
Physical Sickness

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking.

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SUMMARY: This document contains proposed regulations relating to the 
exclusion from gross income for amounts received on account of personal 
physical injuries or physical sickness. The proposed regulations 
reflect amendments under the Small Business Job Protection Act of 1996. 
The proposed regulations also 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 proposed regulations affect taxpayers receiving damages 
on account of personal physical injuries or physical sickness and 
taxpayers paying these damages.

DATES: Written (paper or electronic) comments must be received by 
December 14, 2009.

ADDRESSES: Send submissions to: CC:PA:LPD:PR (REG-127270-06), room 
5203, Internal Revenue Service, Post Office Box 7604, Ben Franklin 
Station, Washington, DC 20044. Submissions may be hand delivered Monday 
through Friday between the hours of 8 a.m. and 4 p.m. to: CC:PA:LPD:PR 
(REG-127270-06), Courier's Desk, Internal Revenue Service, 1111 
Constitution Avenue, NW., Washington, DC, or sent electronically via 
the Federal eRulemaking Portal at http://www.regulations.gov (IRS REG-
127270-06).

FOR FURTHER INFORMATION CONTACT: Concerning the proposed regulations, 
Sheldon A. Iskow, (202) 622-4920 (not a toll-free number); concerning 
the submission of comments and/or requests for a public hearing, 
Richard Hurst at <a href="/cdn-cgi/l/email-protection#c89aa1aba0a9baace689e680bdbabbbc88a1babbaba7bda6bbada4e6bcbaada9bbe6afa7be"><span class="__cf_email__" data-cfemail="11437872797063753f503f596463626551786362727e647f62747d3f65637470623f767e67">[email protected]</span></a>.

SUPPLEMENTARY INFORMATION: 

Background and Explanation of Provisions

    This document contains proposed amendments to the Income Tax 
Regulations (26 CFR part 1) to reflect amendments made to section 
104(a)(2) of the Internal Revenue Code (Code) by section 1605(a) and 
(b) of the Small Business Job Protection Act of 1996, Public Law 104-
188, (110 Stat. 1838 (the 1996 Act)), and to delete the ``tort or tort 
type rights'' test under Sec.  1.104-1(c) of the Income Tax 
Regulations.
    As amended, section 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. These 
proposed regulations conform the regulations to these statutory 
amendments and clarify the changes for taxpayers and practitioners.

1. The 1996 Act Amendments

    Section 1605(a) of the 1996 Act amended section 104(a)(2) to 
provide expressly that punitive damages do not qualify for the income 
exclusion. The amendment was a response to divergent court opinions, 
some holding that punitive damages are received ``on account of'' a 
personal injury. See H.R. Conf. Rept. 104-737 (1996) at 301. The 
amendment is consistent with O'Gilvie v. United States, 519 U.S. 79 
(1996), holding that punitive damages are not compensation for personal 
injuries and do not satisfy the ``on account of'' test under section 
104(a)(2).
    Section 1605(a) also amended section 104(a)(2) to provide that the 
income exclusion generally is limited to amounts received on account of 
personal ``physical'' injuries or ``physical'' sickness. Section 
1605(b) of the 1996 Act further amended section 104(a) to provide that, 
for purposes of section 104(a)(2), even though emotional distress is 
not considered a physical injury or a physical sickness, damages not in 
excess of the amount paid for ``medical care'' (described in section 
213(d)(1)(A) or (B)) for emotional distress are excluded from income.
    The proposed regulations reflect these statutory amendments. The 
proposed regulations also provide that a taxpayer may exclude damages 
received for emotional distress ``attributable'' to a physical injury 
or physical sickness. See H.R. Conf. Rept. 104-737 (1996) at 301.

[[Page 47153]]

2. The Tort Type Rights Test

    The proposed regulations also eliminate the requirement that 
``personal injuries or sickness'' be ``based upon tort or tort type 
rights.'' That requirement in Sec.  1.104-1(c) was intended to ensure 
that only damages compensating for torts and similar personal injuries 
qualify for exclusion under section 104(a)(2). In United States v. 
Burke, 504 U.S. 229 (1992), the Supreme Court interpreted the tort type 
rights test as limiting the section 104(a)(2) exclusion to damages for 
personal injuries for which the full range of tort-type remedies is 
available. The Court held that section 104(a)(2) did not apply to an 
award of back pay under the pre-1991 version of Title VII of the 1964 
Civil Rights Act because the damages awarded under the statute provided 
only a narrow remedy and thus did not compensate for a tort type 
injury. The Burke interpretation precluded section 104(a)(2) treatment 
for similar personal injuries redressed by ``no-fault'' statutes that 
do not provide traditional tort-type remedies. Many critics thought the 
Burke remedies test was too restrictive.
    Later legislative and judicial developments eliminated the need to 
base the section 104(a)(2) exclusion on tort and remedies concepts. 
First, Commissioner v. Schleier, 515 U.S. 323 (1995), interpreted the 
statutory ``on account of'' test as excluding only damages directly 
linked to ``personal'' injuries or sickness. Second, the 1996 Act 
restricts the exclusion to damages for ``personal physical'' injuries 
or ``physical sickness.''
    Accordingly, under the proposed regulations, damages for physical 
injuries may qualify for the section 104(a)(2) exclusion even though 
the injury giving rise to the damages is not defined as a tort under 
state or common law. Nor does the section 104(a)(2) exclusion depend on 
the scope of remedies available under state or common law. In effect, 
the regulations reverse the result in Burke by allowing the exclusion 
for damages awarded under no-fault statutes.

Proposed Effective/Applicability Date

    These regulations are proposed to 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 the date 
these regulations are published as final regulations in the Federal 
Register. However, taxpayers may apply these proposed regulations to 
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. If applying the proposed regulations to 
damages received after August 20, 1996, results in an overpayment of 
tax, the taxpayer may file a claim for refund within the period of 
limitations under section 6511.
    Notwithstanding the date these regulations are proposed to become 
effective, the 1996 Act amendments to section 104(a)(2), including the 
amendment restricting the exclusion to amounts received on account of 
personal physical injuries or physical sickness, are effective for 
amounts 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. Since the 1996 
Act amendments, courts have applied the statutory effective date in 
holding that amounts received on account of nonphysical injuries are 
not excludable. Hennessey v. Commissioner, T.C. Memo 2009-132; Green v. 
Commissioner, T.C. Memo 2007-39. These regulations propose to conform 
existing regulations to amended section 104(a)(2). To the extent that 
existing regulations conflict with amended section 104(a)(2), the 
statute controls. See Murphy v. Internal Revenue Service, 493 F.3d 170, 
176 n* (D.C. Cir. 2007).

Special Analyses

    It has been determined that this notice of proposed rulemaking is 
not a significant regulatory action as defined in Executive Order 
12866. Therefore, a regulatory assessment is not required. It also has 
been determined that section 553(b) of the Administrative Procedure Act 
(5 U.S.C. chapter 5) does not apply to these regulations, and because 
the regulations do not impose a collection of information on small 
entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not 
apply. Pursuant to section 7805(f) of the Internal Revenue Code, this 
notice of proposed rulemaking will be submitted to the Chief Counsel 
for Advocacy of the Small Business Administration for comment on its 
impact on small business.

Comments and Requests for a Public Hearing

    Before these proposed regulations are adopted as final regulations, 
consideration will be given to any written (either a signed paper 
original with eight (8) copies) or electronic comments that are 
submitted timely to the IRS. The IRS and the Treasury Department 
specifically request comments on the clarity of the proposed rules and 
how they can be made easier to understand. All comments will be 
available for public inspection and copying.
    A public hearing will be scheduled if requested in writing by any 
person that timely submits written comments. If a public hearing is 
scheduled, notice of the date, time and place for the hearing will be 
published in the Federal Register.

Drafting Information

    The principal author of these regulations is Sheldon A. Iskow of 
the Office of Associate Chief Counsel (Income Tax and Accounting). 
However, other personnel from the IRS and Treasury Department 
participated in their development.

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

Proposed Amendments to the Regulations

    Accordingly, 26 CFR part 1 is proposed to be amended as follows:

PART 1--INCOME TAXES

    Paragraph 1. The authority citation for part 1 continues to read in 
part as follows:

    Authority:  26 U.S.C. 7805 * * *

    Par. 2. In Sec.  1.104-1, paragraph (c) is revised to read as 
follows:


Sec.  1.104-1  Compensation for injuries or sickness.

* * * * *
    (c) Damages received on account of personal physical injuries or 
physical sickness--(1) In general. Section 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. Emotional distress is not considered a physical injury or 
physical sickness. However, damages for emotional distress attributable 
to a physical injury or physical sickness are excluded from income 
under section 104(a)(2). Section 104(a)(2) also excludes damages not in 
excess of the amount paid for medical care (described in section 
213(d)(1)(A) or (B)) for emotional distress. For purposes of this 
paragraph (c), the term damages means an amount received (other than 
workers' compensation) through prosecution of a legal suit or action, 
or through a settlement agreement entered into in lieu of prosecution.

[[Page 47154]]

    (2) Cause of action and remedies. The section 104(a)(2) exclusion 
may apply to damages recovered for a physical personal injury or 
sickness under a statute, even if that statute does not provide for a 
broad range of remedies. The injury need not be defined as a tort under 
state or common law.
    (3) Effective/applicability date. This paragraph (c) applies 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 the date these regulations are published as final 
regulations in the Federal Register. Taxpayers also may apply these 
proposed regulations 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 August 20, 1996. If 
applying these proposed regulations to damages received after August 
20, 1996, results in an overpayment of tax, the taxpayer may file a 
claim for refund before the period of limitations under section 6511 
expires.
    Notwithstanding the date these regulations are proposed to become 
effective, the statutory amendments to section 104(a) under section 
1605 of the Small Business Job Protection Act of 1996, Public Law 104-
188, (110 Stat. 1838), are effective for amounts 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.
* * * * *

Linda E. Stiff,
Deputy Commissioner for Services and Enforcement.
[FR Doc. E9-22221 Filed 9-14-09; 8:45 am]
BILLING CODE 4830-01-P


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