Leigh sued an overzealous bill collector and received the following settlement:

Question

Leigh sued an overzealous bill collector and received the following settlement:

Damage to her automobile that the collector attempted to repossess      $3,300

Physical damage to her arm caused by the collector                                15,000

Loss of income while her arm was healing                                                  6,000

Punitive damages                                                                                       80,000

a. What effect does the settlement have on Leigh's Gross income?

b. Assume that Leigh also collected $25,000 of damages for slander to her personal reputation caused by the bill collector misrepresenting the facts to Leigh's employer and other creditors. Is this $25,000 included in Leigh's gross inome? Explain.

Explanation / Answer

Damage to her automobile the collector attempted to repossess $3,300

This is a compensatory damage to restore the automobile and hence, will not be taxable.

Physical damage to her arm caused by the bill collector attempting
" to twist her arm " ------------------------------------------------------------------ $15,000

IRC section 104(a)(2) provides for an exclusion from gross income for damages received (whether by suit or agreement and whether as lump sums or as periodic payments) on account of personal injury or sickness. Hence, this would be non taxable.

Loss of income while her arm was healing ------------------------------------ $6,000

Damages received to compensate for economic loss, for example, lost wages, business income, benefits, are not excludable from gross income unless a personal injury caused such loss. Hence, if the reason for loss of income is the injury to arm, this amount could be excluded from income.

Punitive damages ---------------------------------------------------------------------$80,000

Punitive damages are not excludable from gross income under IRC section 104(a)(2). Hence, this would be taxable.

b)Assume Liz also collected $25,000 of damages for slander to her
personal reputation caused by the bill collector's misrepresentation of
facts to Liz's employer and other creditors. Is this amount includible in
Liz's gross income? Explain

This would be taxable and included in gross income.

Courts have interpreted the exclusion from gross income of damages received on account of personal injury or sickness broadly in some cases to cover awards for personal injury that do not relate to a physical injury or sickness. For example, some courts have held that the exclusion applies to damages in cases involving certain forms of employment discrimination and injury to reputation where there in no physical injury or sickness. The damages received in these cases generally consists of back pay and other awards intended to compensate the claimant for lost wages or lost profits. The Supreme Court recently held that damages received could not be excluded from income.23 In light of the Supreme Court decision, the Internal Revenue Service has suspended existing guidance on the tax treatment of damages received on account of other forms of employment discrimination.

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