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narrowly construed. Commissioner v. Schleier, 515 U.S. 323, 328
(1995) (citing United States v. Burke, 504 U.S. 229, 233 (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.”
Regulations provide that the term “damages” means amounts
received (aside from workmen’s compensation) through litigation
or settlement of an action that is based on “tort or tort type
rights”. Sec. 1.104-1(c), Income Tax Regs.
The Court in Commissioner v. Schleier, supra, held that
damages are excludable from income under section 104(a)(2) if
they meet a two-pronged test. First, the taxpayer must
demonstrate that the underlying cause of action giving rise to
the recovery is “based upon tort or tort type rights”, and
second, the taxpayer must show that the damages were received “on
account of personal injuries or sickness.” Id. 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 personal physical
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