Receive Tax-Free Punitive Damages for Employers Who Make You Sick?

I was going through a series of articles that I received from the Texas Psychological Association (TPA), and I was absorbed by an article, “Are Damages For Depression Tax-Free?”. This title is eye catching for me as a mental health and information specialist because many individuals are unaware of tax issues relative to punitive damages that emanate from physical injuries, physical sickness, and mental health. The first few sentences of the article place the reader in the scenario as the individual who: is fired by an employer, falls into a deep depression and subsequently sues the employer. The question presented is whether the money received from settlement is taxable. This discussion interests me because many individuals are in situations that permit them to say, “My employer is making me sick!”

So, let us first gain some insight into what exactly is meant by “Damages for Depression”. The “Damages” that is referred to in this article is referencing the money that is awarded by the court for any loss or injury that resulted as a result of a wrong or negligent act of another party. The damages awarded by the court are punitive in the example provided, if the employer was found to be the cause of depression or any other physical sickness or injury. The main purpose of awarding punitive damages is to punish the defendant for the injury that they caused. The article informs us that damages in cases of physical injuries are tax-free under Section 104 (26 USC § 104- Compensation for injures or sickness). The only thing is that the code clearly states that emotional distress is not treated as a physical injury or physical sickness. Depression can potentially fall into this category.

Those of you who are concerned because of the potential taxation of punitive damages that are received for emotional injuries should be made aware that there are advocates for the cause. Nina Olson is a National Taxpayer Advocate who appears before Congress addressing various tax issues on behalf of the general public. In her 2009 Annual Report, she has a section titled "Exclude Settlement Payments for Mental Anguish, Emotional Distress, and Pain and Suffering from Gross Income". She argued the case for uniformity in the taxation of emotional and physical injuries.  Ms. Olson requested that tax law be amended to include emotional injuries as a tax-free entitlement. I must note that this was done with the use of evidence-based research to demonstrate the physical elements of depression and other disorders.

Advocates who present issues such as this one to Congress  are necessary. It is the only way that government officials and the general public are made aware of the evidence-based research that affects public policy. Members of the mental health community are well aware of the biological, psychological, and social issues that surround various mental health disorders such as depression. The medical community also acknowledges the biological causes of mental disorders. One online medical research source, Medline Plus, advertises that they are a trusted source for health information since it is a service provided by the U.S. National Library of Medicine. This trusted source indicates that depression is a serious medical illness that involves the brain.

So, if we were to look at the scenario that was provided by the article, it would appear that depression should be a tax-free punitive damage because it is a serious medical illness that involves the cognitive and chemical activity in the brain. My opinion is that there should be no discrimination between physical and emotional injuries that is caused by another party. If evidence is provided that supports the claim and punitive damages were awarded, than the compensation received should be tax-free. It almost seems as if the IRS is penalizing the victim for punishing the transgressor by taking a portion of what was awarded for their injuries. That seems like further victimization. 

For more information on tax law, check out the Robert W. Wood, contributor to Forbes magazine.