Rev. Rul. 76-133

Advice has been requested concerning the Federal income tax treatment of an amount received pursuant to the settlement of a suit and of the interest earned on the deposit of a portion of such amount, under the circumstances described below.

In 1973 the taxpayer, a minor who computes taxable income under the cash receipts and disbursements method of accounting, sustained personal injuries while attending a summer camp. A suit was filed on behalf of the taxpayer against the camp operator alleging that the operator's negligence was the cause of the taxpayer's injuries. Prior to trial the taxpayer's representatives agreed to settle the suit upon the operator's payment of 15,000x dollars to the taxpayer. The court approved the settlement agreement and awarded the taxpayer the agreed-upon amount. The court ordered the operator to pay 10,000x dollars into the registry of the court for the sole use and benefit of the taxpayer and 5,000x dollars directly to the taxpayers attorneys for services rendered.

Pursuant to a further order of the court following the operator's payment of the specified amount into the court registry, the clerk of the court transmitted the funds in the name of the taxpayer to a savings and loan association for deposit in five-year certificates of deposit. Under the terms of the certificate of deposit neither principal nor accrued interest can be withdrawn prior to maturity.

Section 61(a) of the Internal Revenue Code of 1954 provides that unless otherwise excluded by law, gross income means all income from whatever source derived, including interest.

Section 104(a)(2) of the Code provides, in part, that gross income does not include the amount of any damages received (whether by suit or agreement) on account of personal injuries.

Section 1.104-1(c) of the Income Tax Regulations provides that the term "damages received (whether by suit or agreement)" means an amount received (other than workmen's compensation) 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.

Accordingly, the amount of damages awarded the taxpayer in the instant case is excludable from the taxpayer's gross income under section 104(a)(2) of the Code.

Under section 61(a)(4) of the Code, interest is an item includible in gross income.

Section 451(a) of the Code provides that the amount of any item of gross income shall be included in the gross income for the taxable year in which received by the taxpayer, unless, under the method of accounting used in computing taxable income, such amount is to be property accounted for as of a different period.

Section 1.451-1(a) of the regulations provides the general rule that under the cash receipts and disbursements method of accounting items of income are includible in gross income when actually or constructively received.

Section 1.451-2(a) of the regulations provides, in part, that income is constructively received in the taxable year during which it is credited to a taxpayer's account, set apart for the taxpayer or otherwise made available so that the taxpayer may obtain it at any time. However, income is not constructively received if the taxpayer's control of its receipt is subject to substantial limitations or restrictions.

Section 1.451-2(b) of the regulations provides that if interest is not subject to withdrawal at the time credited, such portion is not constructively received and does not constitute income to the depositor until the taxable year in which the portion first may be withdrawn. However, in the case of certain deposits made after December 31, 1970, the ratable inclusion rules of section 1232(a)(3) of the Code apply.

Section 1232(a)(3)(A) of the Code, as amended by section 413(a) of the Tax Reform Act of 1969, and sections 1.1232-1(d) and 1.1232-3A(e) of the regulations require the holder of any certificate of deposit or other deposit arrangement issued with original issue discount to include in gross income the ratable monthly portion of the original issue discount with respect to any deposits made after December 31, 1970.

Section 1.1232-3(b)(1)(i) of the regulations states that for purposes of section 1232, the term "original issue discount" means the difference between the issue price and the stated redemption price at maturity. As explained in section 1.1232-3(b)(1)(iii) of the regulations, the term "stated redemption price at maturity" includes interest and any other amounts, however designated, payable at maturity.

Accordingly, the ratable inclusion rules of section 1232(a)(3) of the Code apply to the deposit made in the name of the taxpayer in the instant case, and the taxpayer must include original issue discount in gross income in accordance with section 1.1232-3A(e) of the regulations.