Treasury Hearing on IRC 104 Regulations

Written by: Jeremy Babener, S2KM Contributing Author

Introduction

The United States Department of the Treasury will hold a public hearing on February 23, 2010 focused upon proposed regulations for section 104(a)(2) of the Tax Code. This section generally provides for the exclusion of physical injury and physical sickness damages (for lump sums and periodic payments). The proposed regulations would make two primary changes to current regulations. First, they would incorporate into regulations the amendments to section 104(a)(2) made in Small Business Job Protection Act of 1996. Second, they would eliminate the current regulatory requirement that for damages to qualify for the tax exclusion, they must be based upon “tort or tort type rights.” The government’s request for comments has generated several responses, which largely approve of the proposed changes, but disagree on the need for more.

Incorporating the 1996 Act
The proposed regulations reflect two significant legislative amendments to section 104(a)(2), both narrowing the exclusion’s applicability. The first prevents any punitive damages from qualifying for the tax exclusion. Thus, all plaintiffs’ punitive damage recoveries are taxable in the personal injury context. The second requires that the injury or sickness damages recovered derive from “physical” origins. Thus, section 104(a)(2) now excludes damages “on account of personal physical injuries or physical sickness.” Specifically, the regulations note that damages for emotional distress are not excluded unless attributable to physical injury or physical sickness.

Eliminating the “Tort or Tort Type Rights” Requirement
Treasury’s current regulations only allow damages to qualify for the section 104(a)(2) tax exclusion if they are “based on tort or tort type rights.” The requirement was interpreted by the Supreme Court to disallow the exclusion of damages where the relevant law provides only a narrow remedy. Thus, damages awarded pursuant to “no fault” statutes could not be excluded for plaintiffs’ taxable income. The proposed regulations explicitly eliminate this hurdle, allowing the exclusion to apply even where a statute “does not provide for a broad range of remedies” and the injury does not constitute a tort under state or common law.

Public Comments
The American Association for Justice (formerly the Association of Trial Lawyers of America) and the National Employment Lawyers Association agree with the elimination of the “tort or tort type rights” requirement. However, both argue that damages for emotional distress, even when not resulting from physical injury or physical sickness (i.e. distress resulting from sexual harassment), should be excluded from tax. However, while academic articles have made the same argument, the legislative history from the 1996 Act demonstrates that Congress intended to tax such damages.

Single Claimant 468B

The Treasury also received two submissions relating to the issue of whether single-claimant qualified settlement funds can fund structured settlements without causing plaintiffs to receive income for tax purposes. If they can, plaintiffs could use them without sacrificing the tax benefits of the structured settlement. The issue has been discussed previously on S2KM, and by this author. Most recently, the Treasury removed the issue from its Priority Guidance Plan.

Richard Risk, a structured settlement attorney, commentator and founder of the Society of Settlement Planners (SSP)wrote to the Treasury requesting that the February hearing consider the issue. Risk argued that such regulations are necessary and consistent with judicial precedent. Joseph Ricci , Executive Director of the National Structured Settlements Trade Association (NSSTA) wrote to the Treasury in opposition. Ricci argued that the issue is not relevant to the February hearing, and that such regulations would significantly reduce the use of structured settlements.

The hearing will take place on February 23 at the Internal Revenue Building in D.C. Public submissions are available at regulations.gov.

S2KM footnotes:

• This article was written for informational purposes only, and should not be construed as or replace legal advice.
• Jeremy Babener and S2KM Limited have agreed to feature occasional articles written by Babener on S2KM's blog. Except for articles including Jeremy Babener's byline or interviews featuring Babener, he does not contribute to or endorse S2KM opinions or writing.
• Babener is a third year law student at NYU School of Law who has written extensively about structured settlements. In addition to S2KM's blog, Babener's writing appears on other Internet sites including:
  
  • S2KM's structured settlement public policy wiki, featuring:
    • Commentary by Jeremy Babener, Robert Wood and Joseph Dehner;
    • Treasury's proposed 104(a)(2) regulations and analysis;
    • Treasury's hearing announcement for the proposed regulations; and
    • Public comments about the proposed regulations.
      
  • TaxStructuring.Com. - Jeremy Babener's newly launched tax resource site.