[Federal Register Volume 77, Number 14 (Monday, January 23, 2012)]
[Rules and Regulations]
[Pages 3106-3108]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2012-1255]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[TD 9573]
RIN 1545-BF81


Damages Received on Account of Personal Physical Injuries or 
Physical Sickness

AGENCY: Internal Revenue Service (IRS), Treasury.

[[Page 3107]]


ACTION: Final regulations.

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SUMMARY: This document contains final regulations relating to the 
exclusion from gross income for amounts received on account of personal 
physical injuries or physical sickness. The final regulations reflect 
amendments under the Small Business Job Protection Act of 1996. The 
final regulations affect taxpayers receiving damages on account of 
personal physical injuries or physical sickness and taxpayers paying 
these damages.

DATES: Effective Date: These regulations are effective on January 23, 
2012.
    Applicability Date: For date of applicability, see Sec.  1.104-
1(c)(3).

FOR FURTHER INFORMATION CONTACT: Sheldon Iskow, (202) 622-4920 (not a 
toll-free number).

SUPPLEMENTARY INFORMATION:

Background

    This document contains final regulations that amend the Income Tax 
Regulations (26 CFR part 1) to reflect amendments made to section 
104(a)(2) of the Internal Revenue Code (Code) by section 1605(a) and 
(b) of the Small Business Job Protection Act of 1996, Public Law 104-
188, 110 Stat. 1838 (the 1996 Act). On September 15, 2009, a notice of 
proposed rulemaking (REG-127270-06) was published in the Federal 
Register (74 FR 47152). Written comments responding to the notice of 
proposed rulemaking were received. The comments are available for 
public inspection at www.regulations.gov or on request. A public 
hearing was requested and held on February 23, 2010. After 
consideration of all the comments, the proposed regulations are adopted 
without substantive change by this Treasury decision. The comments are 
discussed in the preamble.

Summary of Comments

    The proposed regulations deleted the requirement that to qualify 
for exclusion from gross income, damages received from a legal suit, 
action, or settlement agreement must be based upon ``tort or tort type 
rights.'' The proposed regulations provided, instead, that the section 
104(a)(2) exclusion may apply to damages recovered for a personal 
physical injury or physical sickness under a statute that does not 
provide for a broad range of remedies, and that the injury need not be 
defined as a tort.
    A commentator suggested that eliminating the tort type rights test 
would create confusion about what constitutes a personal injury. The 
commentator suggested that the regulations should retain the tort type 
rights test but clarify that meeting the test does not depend on the 
nature of the remedies or the state law characterization of the cause 
of action.
    The final regulations do not adopt this comment. Before the 1996 
amendment, the section 104(a)(2) exclusion was not limited to damages 
for physical injuries or sickness. The tort-type rights test was 
intended to distinguish damages for personal injuries from, for 
example, damages for breach of contract. Since that time, however, 
Commissioner v. Schleier, 515 U.S. 323 (1995), has interpreted the 
statutory ``on account of'' test to exclude only damages directly 
linked to ``personal'' injuries or sickness. Furthermore, under the 
1996 Act, only damages for personal physical injuries or physical 
sickness are excludable. These legislative and judicial developments 
have eliminated the need to base the section 104(a)(2) exclusion on 
tort cause of action and remedy concepts.
    A commentator requested that the final regulations address whether 
a claimant has constructive receipt or the current economic benefit of 
a damage award that is set aside for the claimant's benefit in a trust 
or fund, such as a qualified settlement fund described in Sec.  1.468B-
1. Other commentators asked that the final regulations define certain 
personal injuries as physical injuries and describe the circumstances 
in which emotional distress is attributable to physical injuries.
    The final regulations do not adopt these comments because they are 
beyond the scope of the proposed regulations, which did not propose 
rules on the issues raised by the comments. However, these comments 
will be considered if guidance is published on these topics in the 
future.

Effective/Applicability Date

    These regulations apply to damages paid pursuant to a written 
binding agreement, court decree, or mediation award entered into or 
issued after September 13, 1995, and received after January 23, 2012. 
This September 13, 1995, effective date derives from an exception set 
forth in section 1605(d)(2) of the 1996 Act to the statutory effective 
date of the amendments to section 104(a)(2).
    In addition, taxpayers may apply these regulations to amounts paid 
pursuant to a written binding agreement, court decree, or mediation 
award entered into or issued after September 13, 1995, and received 
after August 20, 1996, and if otherwise eligible may file a claim for 
refund for a taxable year for which the period of limitation on credit 
or refund under section 6511 has not expired. To qualify for a refund 
of tax on damages paid after August 20, 1996, under a written binding 
agreement, court decree, or mediation award entered into or issued 
after September 13, 1995, a taxpayer must meet the requirements of the 
1996 Act, including the requirement that excludable damages must be 
received on account of personal physical injuries.

Special Analyses

    This Treasury decision is not a significant regulatory action as 
defined in Executive Order 12866, as supplemented by Executive Order 
13563. Therefore, a regulatory assessment is not required. Section 
553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) does 
not apply to these regulations, and because the regulations do not 
impose a collection of information on small entities, the Regulatory 
Flexibility Act (5 U.S.C. chapter 6) does not apply. Pursuant to 
section 7805(f) of the Internal Revenue Code, the notice of proposed 
rulemaking that preceded these final regulations was submitted to the 
Chief Counsel for Advocacy of the Small Business Administration for 
comment on its impact on small business.

Drafting Information

    The principal author of these regulations is Sheldon Iskow of the 
Office of Associate Chief Counsel (Income Tax and Accounting). However, 
other personnel from the IRS and Treasury Department participated in 
their development.

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

Adoption of Amendments to the Regulations

    Accordingly, 26 CFR part 1 is amended as follows:

PART 1--INCOME TAXES

0
Paragraph 1. The authority citation for part 1 continues to read in 
part as follows:

    Authority: 26 U.S.C. 7805 * * *


0
Par. 2. In Sec.  1.104-1, paragraph (c) is revised to read as follows:


Sec.  1.104-1  Compensation for injuries or sickness.

* * * * *
    (c) Damages received on account of personal physical injuries or 
physical sickness--(1) In general. Section 104(a)(2) excludes from 
gross income the amount of any damages (other than

[[Page 3108]]

punitive damages) received (whether by suit or agreement and whether as 
lump sums or as periodic payments) on account of personal physical 
injuries or physical sickness. Emotional distress is not considered a 
physical injury or physical sickness. However, damages for emotional 
distress attributable to a physical injury or physical sickness are 
excluded from income under section 104(a)(2). Section 104(a)(2) also 
excludes damages not in excess of the amount paid for medical care 
(described in section 213(d)(1)(A) or (B)) for emotional distress. For 
purposes of this paragraph (c), the term damages means an amount 
received (other than workers' compensation) through prosecution of a 
legal suit or action, or through a settlement agreement entered into in 
lieu of prosecution.
    (2) Cause of action and remedies. The section 104(a)(2) exclusion 
may apply to damages recovered for a personal physical injury or 
physical sickness under a statute, even if that statute does not 
provide for a broad range of remedies. The injury need not be defined 
as a tort under state or common law.
    (3) Effective/applicability date. This paragraph (c) applies to 
damages paid pursuant to a written binding agreement, court decree, or 
mediation award entered into or issued after September 13, 1995, and 
received after January 23, 2012. Taxpayers also may apply these final 
regulations to damages paid pursuant to a written binding agreement, 
court decree, or mediation award entered into or issued after September 
13, 1995, and received after August 20, 1996. If applying these final 
regulations to damages received after August 20, 1996, results in an 
overpayment of tax, the taxpayer may file a claim for refund before the 
period of limitations under section 6511 expires. To qualify for a 
refund of tax on damages paid after August 20, 1996, under a written 
binding agreement, court decree, or mediation award entered into or 
issued after September 13, 1995, a taxpayer must meet the requirements 
of section 1605 of the Small Business Job Protection Act of 1996, 
Public Law 104-188 (110 Stat. 1838).
* * * * *

Steven T. Miller,
Deputy Commissioner for Services and Enforcement.

    Approved: December 6, 2011.
 Emily S. McMahon,
Assistant Secretary of the Treasury (Tax Policy).
[FR Doc. 2012-1255 Filed 1-20-12; 8:45 am]
BILLING CODE 4830-01-P