IRS allows exclusion for wrongful death payment, which included payment for emotional distress

The IRS recently determined, in a private letter ruling, that a survivor could exclude from income a payment received for the wrongful death of another. The payment was intended to provide compensation for wrongful death and personal injury, including a resulting claim for emotional distress.

Background

An individual was killed in an accident. The individual's survivor successfully brought claims for wrongful death and intentional infliction of emotional distress. The survivor was awarded compensatory damages, prejudgment interest and punitive damages.

Subsequently, a government entity passed a law to provide compensation to the survivors of all the individuals who were killed in the accident. The law was intended to provide compensation for wrongful death and physical injury, including claims for emotional distress. The law voided all prior court judgments. The original payor of the damages transferred an amount to the government entity, which, in turn, would pay the survivors and all other claimants.

The survivor took a payment from the government entity. The survivor asked the IRS if the payment would be excluded from gross income under Code Sec. 104.

Exclusion

Generally, compensatory damages received by a taxpayer on account of personal physical injury or physical sickness are excluded from gross income while damages on account of emotional distress are not. Congress amended the Code Sec. 104 exclusion in the Small Business Job Protection Act of 1996. Among other things, the 1996 Small Business Act provides that the income exclusion is generally limited to amounts received on account of personal physical injuries or physical sickness. The 1996 Small Business Act further provides that even though emotional distress is not considered a physical injury or a physical sickness, damages not in excess of the amount paid for medical care for emotional distress are excluded from income.

Proposed regs

The IRS has issued proposed regs relating to the exclusion from gross income for amounts received on account of personal physical injuries or physical sickness. The proposed regs also provide that a taxpayer may exclude damages received for emotional distress attributable to a physical injury or physical sickness. Additionally, the proposed regs eliminate the requirement that injuries or sickness be based on tort or tort-type rights.

IRS analysis

The IRS determined that the survivor's recovery, awarded by the government entity, would be for the wrongful death of the decedent. The wrongful death recovery would be received on account of a personal injury under Code Sec. 104(a)(2). Therefore, the recovery payment would be excluded from the taxpayer's gross income.

LTR 201019005