Taxing Anxiety

In this article, I argue for a statutory change to the disparity in the taxation of damages. I submit that nearly all damages, including damages received on account of physical injury, ought to be taxable, and that juries must be apprised of tax consequences so that they can make proper adjustments to take account of these tax consequences. I will refer to this as the full inclusion proposal with jury awareness - for ease, the full inclusion proposal. My proposed change is the more sound solution for several reasons. Full inclusion creates certainty and avoids wasteful tax gamesmanship. Furthermore, assuming informed parties, counsel, and juries, full inclusion need not harm individual taxpayers. This proposal works because under it, all settlement components are taxed the same. Jury tax awareness is critical to the proposal because it permits the jury to provide the intended (after-tax) compensation, and also because only by assuming an informed jury will parties be on equal footing for settlement negotiations. And because my policy, unlike the ABA and NTA suggestions, provides no incentive to make specious claims of emotional distress, it does not risk increasing societal skepticism of mental illness. Finally, and not of least importance, the tax preference for physical injuries has a gendered component: men, more than women, recover damages from physical injury, and therefore men, more than women, benefit from the tax rule in its current form. By taxing damages for physical injury just as we tax damages for nonphysical injury, we lessen the significance of this gendered distinction. Part II of this article sets the stage by describing the evolution of section 104(a) and the taxation of damages. In Part III, the article turns to a comprehensive, to-date discussion of how courts are treating disputes about damages. Parts IV and V discuss the possible solutions: Part IV explains the NTA and the ABA position - achieving parity by expanding the exclusion; and Part V explains the full inclusion proposal - achieving parity by eliminating the exclusion - and explains why full inclusion is the better solution. Part VI concludes