by Thomas D. Begley, Jr., Esquire, CELA
Generally, “all income from whatever source derived” is considered gross income by the Internal Revenue Service (“IRS”).[1] However, income received as a result of a personal physical injury or a physical sickness is not considered income by the IRS.[2] However, punitive damages are considered taxable income.[3] The determining factor with respect to the treatment of litigation recoveries is the “origin of the claim” test. “The origin and character of the claim upon which an expense was incurred rather than the potential consequence upon the fortunes of the taxpayer” is the controlling test.[4]
The physical injury generally involves a touching that produces physical harm. The physical harm must be observable bodily harm.[5] Therefore, it would appear that most settlements involving sexual abuse victims are subject to taxation, because there is seldom observable bodily harm. Emotional distress is not treated as a physical injury or physical sickness.[6] However, damages for emotional distress would be excludable from income, if they flowed from a related physical injury. However, in a Worker’s Comp claim, personal injuries are sufficient. Physical injuries are not required,[7] because they are not tort-based claims.
In certain cases, such as wrongful death cases, the proceeds paid in connection with the wrongful death claim are excluded from income, even for parties who suffer a non-physical injury because the wrongful death victim did suffer a physical injury. The derivative claims are entitled to the same income tax exclusion. The survival claim is excluded from income, because of the physical injury to the decedent; however, the survival claim is included in federal and New Jersey estate tax and New Jersey inheritance tax. Disability insurance payments are taxable if the premiums for the disability insurance were paid by the employer, but are excluded from tax if the premiums were paid by the employee. Generally, payments for defamation are taxable income, unless there is a physical injury or physical sickness from which the defamation flowed.[8]
[1] I.R.C. §61.
[2] I.R.C. §104.
[3] I.R.C. §104, O’Gilvie v. United States, 519 U.S.C. 79 (1996).
[4] The United States v. Gilmore, 83 S. Ct. 623 (1963).
[5] P.L.R. 20041022.
[6] I.R.C. §104(a)(5).
[7] I.R.C. §104(a)(1).
[8] Anderson v. Commission, T.C. Memo 2003-168 aff’d 194 Fed. App.’s 47 (9th Cir. 2004).
