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Loss of Consortium Damages Excludable under IRC § 104(a)(2)

A couple of years back, Uncle Bill was in an unfortunate forklift accident.  Bill filed a lawsuit in Maine, where the accident occurred, and in the complaint, Bill alleged that the injuries and damages suffered were the result of acts of negligence, reckless, willful and/or wanton acts of the tannery for whom Bill was employed. The lawsuit requested damages for economic injuries (medical bills), for noneconomic injuries of mental anguish, loss of enjoyment of life, disability, pain, suffering, and other injuries and damages (collectively, “pain and suffering”), as well as damages for loss of consortium.

Although you have your suspicions that the accident was Bill’s fault, he nevertheless won his case against the tannery, and the jury awarded him $100,000. (You are not too proud to say that it turns your stomach thinking about what consortium was lost, but here we are.) Bill and Ethel were awarded damages last year, and they come to you on April 14 asking whether or not they must report the damages on their income tax return.

Legal Background

IRC § 104(a)(2) provides, in general, that gross income does not include the amount of any damages received (whether by suit or agreement) on account of personal physical injuries or physical sickness. Treas. Reg. 1.104-1(c)(1), in turn, provides that the term “damages received (whether by suit or agreement)” means an amount received through prosecution of a legal suit or action based upon tort or tort type rights or through a settlement agreement entered into in lieu of such prosecution. Treas. Reg. § 1.104-1(c)(1) provides “damages for emotional distress attributable to a physical injury or physical sickness are excluded from income under IRC § 104(a)(2).”[1]

Extension of IRC § 104(a)(2) to Spouse

The exclusion from gross income provided by IRC § 104(a)(2) is limited to amounts received on account of personal physical injuries or physical sickness; however, the legislative history to the 1996 amendment to § 1605 of the Small Business Protection Act of 1996 provides that if an action has its origin in a physical injury or physical sickness, then all damages[2] that flow therefrom are treated as damages received on account of personal physical injuries or physical sickness whether or not the recipient of the damages is the injured party, including damages received by an individual on account of a claim of loss of consortium due to the physical injury or physical sickness of such individual’s spouse are excludable from gross income.

Conclusion

In this case, Bill and Ethel recovered damages under the laws of Maine permitting recovery of a broad range of damages, including damages for pain and suffering, and damages for loss of consortium. Thus, Bill and Ethel received their damages in a suit or action based on tort or tort type rights within the meaning of Treas. Reg. § 1.104-1(c).

In addition, the amounts paid to Bill for (1) past and future economic damages and (2) past and future noneconomic damages (pain and suffering), and the amount paid to Ethel for past and future loss of consortium were directly attributable and linked to the physical injuries that Bill received when the forklift collided with the loading dock.

Thus, the amount in damages received by Bill for past and future economic damages (medical bills), the amount in damages received by Bill for past and future noneconomic damages (pain and suffering), and the amount in damages received by Ethel for past and future loss of consortium are compensation for the personal injuries that Bill sustained in the accident. Therefore, such amounts are excludable from Bill and Ethel’s gross income under IRC § 104(a)(2).


Footnotes:

[1] See also §1605 of the Small Business Protection Act of 1996, H.R. Conf. Rep. No. 104-737, at 301 (1996), reprinted in 1996 U.S.C.C.A.N. 1474, 1793 (legislative history notes that “… the exclusion from gross income applies to any damages received based on a claim of emotional distress that is attributable to the physical injury or physical sickness.”).

[2] Other than punitive damages.

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