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Commissioner v. Schleier, 515 U.S. 323, 328 (1995) (citing United
States v. Burke, 504 U.S. 229, 248 (1992).)
Exclusion of Certain Damages
Section 104(a)(2) allows taxpayers to exclude from income
“the amount of any damages (other than punitive damages) received
(whether by suit or agreement * * *) on account of personal
physical injuries or physical sickness”. The flush language of
section 104(a) specifies that “emotional distress shall not be
treated as a physical injury or physical sickness.”
Treasury regulations provide that this exclusion is limited
to those damages received through litigation or settlement that
are based on “tort or tort type rights.” Sec. 1.104-1(c), Income
Tax Regs.
Damages are excludable from income under section 104(a)(2)
if they meet the two prong test set out in Commissioner v.
Schleier, supra, that payments received in settlement be: (1)
Received for claims “based upon tort or tort type rights,” and
(2) received “on account of personal injuries or sickness.”
Commissioner v. Schleier, supra at 335-337. Both requirements
must be satisfied for the damages to be excluded from income.
Id. at 333. Section 104(a)(2) was amended in 1996 to include the
requirement that damages be received for physical injuries or
sickness. Small Business Job Protection Act of 1996, Pub. L.
104-188, 110 Stat. 1755, 1838-1839. However, this does not alter
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