In 2000, the IRS relied on the dictionary definition of physical injury: bodily harm or hurt, excluding mental distress, fright, or emotional disturbance. Making things worse, the IRS and courts have interpreted Congress’ use of the word “physical” in ways that tax victims that you wouldn’t expect. The House and Senate committees went further, writing that taxation of emotional distress recoveries should extend to recoveries for “physical symptoms (e.g., insomnia, headaches, stomach disorders) which may result from such emotional distress.” The IRS and courts have implemented that writing, taxing recoveries for emotional distress except when resulting from physical harm. The House and Senate Committees based this policy on the assumption that non-physical recoveries are “generally to compensate the claimant for lost profits or lost wages that would otherwise be included in taxable income.”Ĭongress was right to tax severance compensation but wrong to treat victims of non-physical injuries like departing employees. Congress responded by limiting tax-free treatment to recoveries for personal physical injuries and physical sickness. Employees were avoiding tax by treating severance payments as tax-free compensation for personal injuries. In 1996, Congress recognized an abusive tax strategy used by employers and employees. We see this problem every day as we serve plaintiffs, defendants, counsel, and others involved in personal injury litigation. It’s time to fix this-for victims of sexual abuse and post-traumatic stress disorder at a minimum. And since then, the IRS has interpreted the legislation using a now-dated understanding of the key language used: “physical injuries.” From 1918 to 1996, the US Treasury and Congress exempted these amounts from tax because they “make the victim whole.” Congress changed the rule in 1996 with good intentions, but the legislation was unintentionally broad. When victims sue for justice and win, their recoveries replace value they previously lost. Today’s rules unfairly tax victims of invisible injuries, including many instances of sexual abuse and PTSD.
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