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79 9 October 1996 Doctrine: 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 are excluded from gross income. The damages are not taxable. Facts: The petitioners in this case are the husband and two children of a woman who died of toxic shock syndrome in 1983. They received a jury award of $1,525,000 actual damages and $10 million punitive damages in a tort suit brought by Kelly (petitioner) based on Kansas law against the maker of the product that caused the death of Betty O Gilvie (Kellys wife). Kelly paid federal income tax insofar as the proceeds represented punitive damages, but immediately he sought for a refund. Petitioners concerns are legal entitlement to that refund. The litigation represents the consolidation of two cases brought in the same Federal District Court: the husbands suit against the Government for a refund, and the Government suit against the children to recover the refund that the Government had made to the children earlier procedurally speaking. The Federal District Court held on the merits that the language found under 26 U.S.C. 104(a)(2), excluded from the gross income the amount of any damages received . . . on account of personal injury or sickness". The statutory phrase also includes punitive damages which entitle Kelly to acquire and the children to keep, their refund. However, the Court of Appeals for the Tenth Circuit, the Fourth, Ninth and Federal Circuits reversed the District Courts decision. It held that the exclusionary provision does not cover punitive damages. Issue: 1. Whether or not the provision applies to punitive damages received by the petitioners in a tort suit for personal injuries - NO

On the Government's side, the provision is applicable only to those personal injury lawsuit damages that were awarded by reason of, or because of, the personal injuries. They would make the section inapplicable to punitive damages, where those damages are not compensation for injury but instead are private fines levied by civil juries to punish reprehensible conduct and to deter its future occurrence. Moreover, the Government says that such damages were not "received . . . on account of" the personal injuries. But, such damages were awarded "on account of "a defendant's reprehensible conduct and the jury's need to punish and to deter it. The Government concludes that these punitive damages fall outside the statute's coverage, and the court agreed with the Governments interpretation of the statute. In Commissioner vs Schleier, 515 US 323, the court came to resolving the statute's ambiguity in the Government's favor. The case did not involve damages received in an ordinary tort suit, but rather it involved liquidated damages and backpay received in a settlement of a lawsuit charging a violation of the Age Discrimination in Employment Act (ADEA). ADEA liquidated damages are not covered, they are punitive in nature. They are not designed to compensate ADEA victims. That the statute covers pain and suffering damages, medical expenses, and lost wages in an ordinary tort case and excluded from income. The court concludes that punitive damages are not covered because they are an element of damages and not "designed to compensate victims. Hence, they are punitive in nature. Also, the court finds the Government's reading more faithful to the history of the statutory provision as well as the basic tax related purpose that the history reveals in which it excludes compensatory damages that restore a victims lost, nontaxable capital. The court asked why Congress might have wanted the exclusion to have covered these punitive damages, and they found no very good answer. Those damages are not a substitute for any normally untaxed personal (or financial) quality, good, or "asset." They do not compensate for any kind of loss. Petitioners make three arguments to the contrary. However, they are not persuasive to defeat the Governments interpretation. His first argument does not overcome the courts interpretation of the provision in Schleier, nor does it change the provision's history. Second, petitioners argue that the purposes might have led Congress to exclude lost wages from

Ratio: "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." 26 U.S.C. 104(a)(2) (1988 ed.) (emphasis added). The punitive damages received by the petitioners were not received "on account of" personal injuries. Therefore, the provision, stated above, does not apply and the damages are taxable.

income would also have led Congress to exclude punitive damages .The court says that it is one of degree. Tax generosity presumably has its limits. The element of punitive award does not exist in the case, and the damages at issue are not all compensatory but entirely punitive. Lastly, petitioner relied upon a later enacted law. However, Congress' primary focus was upon what to do about nonphysical personal injuries, not upon the provision's coverage of punitive damages under pre-existing law. By: Mymannah Lou O. Dimacaling