TOTAL AMOUNT RECEIVED IN PERSONAL INJURY SUIT, INCLUDING LOST WAGES, IS EXCLUDABLE FROM GROSS INCOME

Rev. Rul. 85-97

ISSUE

Are amounts received by a taxpayer, under the circumstances described below, excludable from gross income as damages received on account of personal injuries?

FACTS

The taxpayer was seriously injured when struck by a bus. To recover for the injuries suffered as a result of the negligent operation of the bus, the taxpayer sued the bus company. The complaint alleged that, as a direct and proximate result of being struck by the bus, the taxpayer had sustained serious and permanent injuries, had been unable to pursue normal employment activities and had lost wages, had suffered and would continue to suffer great pain of body and mind, had sustained permanent disability, deformity, and loss of earning capacity, and had incurred and would incur in the future hospital, doctors' and related bills in an effort to be cured of these injuries. The complaint asked for compensatory damages of 5x dollars. No punitive damages were requested. Prior to trial, the taxpayer and the bus company agreed to a settlement under the terms of which the taxpayer received a lump-sum payment of 3x dollars in exchange for a full release of all the taxpayer's claims against the bus company. The taxpayer had not deducted any medical expenses in a prior year.

LAW AND ANALYSIS

Section 61 of the Internal Revenue Code provides, in part, that except as otherwise provided in subtitle A, gross income means all income from whatever source derived.

Section 104(a)(2) of the Code excludes from gross income the amount of any damages received (whether by suit or agreement and whether as lump sums or as periodic payments) on account of personal injuries or sickness.

Section 1.104-1(c) of the Income Tax Regulations provides, in part, 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.

Rev. Rul. 61-1, 1961-1 C.B. 14, holds that the entire amount received by a railroad employee in settlement of any and all claims that the employee had against the railroad for personal injuries is excludable from gross income under section 104(a)(2) of the Code, even though the employee elected to apportion part of the settlement amount to "time lost" in order to receive railroad retirement credit for the time the employee was unable to work. The revenue ruling states that the fact that the "time lost payments" constituted compensation for purposes of the taxes imposed by the Railroad Retirement Tax Act does not preclude the application of the exclusion from gross income under section 104(a)(2). Thus, the ruling indicates that the exclusion provided by section 104(a)(2) extends to personal injury damages allocable to lost wages. Also cf., Norfolk & Western Ry. Co. v. Liepelt, 444 U.S. 490 (1980) (defendant is entitled to an instruction to jury that damages for lost future wages are not subject to federal income taxation).

In the instant case, the entire 3x dollars settlement amount, including the amount allocable to the claim for lost wages, represents compensation for personal injuries sustained by the taxpayer when the taxpayer was struck by the bus. Therefore, the exclusion provided by section 104(a)(2) of the Code extends to the entire settlement amount.

HOLDING

The entire 3x dollars settlement amount is excludable from the taxpayer's gross income under section 104(a)(2) of the Code and the regulations thereunder.

EFFECT ON OTHER REVENUE RULING

Rev. Rul. 61-1, 1961-1 C.B. 14, is amplified.