U.S. Circuit Court of Appeals says: Careful What you Tax for on a Tort Recovery
The U.S. government can tax an individual's compensatory damages for emotional distress and injury to reputation, a federal appeals court has ruled.
In its 3-0 decision, the U.S. Circuit Court of Appeals for the District of Columbia said legal recoveries for these amorphous injuries count as income for tax purposes. The court distinguished emotional distress and reputational harm from physical injuries, the compensation for which does not count as income and is not taxable under federal law.
The appeals court rejected a taxpayer's argument that compensating emotional and reputational injuries does not enrich an individual but merely makes that person ''whole.'' Thus, the person has not received any ''income'' but has simply been returned to where he or she was before the injury, the taxpayer argued.
The law excludes compensation for ''physical injuries'' from being taxed and states that ''emotional distress'' and other mental ailments do not count as physical harms. The code's exclusion of emotional distress from its definition of ''physical injury'' only makes sense if the law is interpreted as Congress allowing the Internal Revenue Service to tax nonphysical injuries, the appeals court ruled.
The court had no choice but to rule as it did, said Richard L. Kaplan, a University of Illinois College of Law tax professor.
The court's distinction between physical and nonphysical injuries might seem outdated in an era when modern medicine understands that mental anguish can be as painful and debilitating as a broken leg, Kaplan said Friday. But Congress, not the courts, drew that distinction in 1996 when it amended the tax code to deny the same tax protection to awards for emotional distress as to awards for physical injuries, he added.
