Murray was recently released from his position with X Company after reporting to the Environmental Protection Agency improper handling of chemicals. After the report was made public, his employer sought retribution by firing Murray and, according to the courts, engaged in behaviors directly defaming Murray’s character and reputation. The courts stated that a financial award was owed to Murray for “damages to his personal and professional reputation and for his mental suffering.” Murray claims that the damages should not be included in the calculation of gross income as the funds are collection of lost human capital. Although recovery of lost of capital would not be required for inclusion to Murray’s gross income, the issue requires further analysis for tax considerations.
According to IRC §104(a)(2), federal tax requirements state that damages paid for personal injury are not subject to calculation of personal gross income. However, the issue remains whether this should include injury to only personal reputation or to also include professional defamation which inflicts business injury upon an individual. Several court cases can be used to further analyze this disputed topic.
Based on the ruling in Glynn v. Commissioner 76 T.C. 116, 120 (1981), payments for injury to professional reputation are not able to be excluded from gross income per IRC §104(a)(2). This case defines the Internal Revenue Code exclusion to only include financial awards granted for personal injury. Furthermore, Wallace v. Commissioner, 35 T.C.M. 954, 959 (1976), requires that the courts clearly define whether the damages are personal or professional in nature. The purpose of this ruling is to provide a clearly distinguished type of injury inflicted upon the individual for a more effective analysis of the potential for exclusion according to IRC §104(a)(2).
These two cases help define the issue and analyze the court’s responsibility for taxable consequences when granting awards based on personal or professional damages. However, under Draper v. Commissioner, 26 T.C. 201, 204 (1956), the courts determined that the main source of damage where an award was provided by the courts for personal or professional injury should be utilized in the determination of taxable income. Thus, the courts must determine whether a financial award is being sought primarily in relation to personal or professional injury.
In this scenario, the courts stated that Murray’s award was granted for damages to his personal reputation as well as for his mental suffering. The courts did mention that damages were made to his professional reputation; however, the complete statement of the court holds greater weight on the personal injuries inflicted upon Murray with the inclusion of damages caused to his mental state. Therefore, the professional damage was more of a byproduct of the personal injury sustained by Murray and was not the primary purpose to collect a financial award from the previous employer.
Given these facts, the exclusions provided by IRC §104(a)(2) apply to the award granted by the court to Murray for damages. The award is granted for damages to personal injuries to his mental state and reputation; therefore, the award should not be included in the calculation of gross income per the definition under Draper v. Commissioner, 26 T.C. 201, 204 (1956). Murray is not required to claim the award on his federal personal income taxes.