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Hi and welcome to Just Answer!Changes you are referred were made by the Small Business Job Protection Act of 1996 (SBJPA). There were several reasons for changes.Because a business entity cannot suffer a personal injury within the meaning - this applies to recoveries by individuals only. The 1996 amendment added the word physical to the clause “on account of personal physical injuries or physical sickness.” Thus, in order for damages to be excludible from income, the judgment or settlement must be derived from personal physical injuries or physical sickness. Previously that section was extensively litigated with respect to what was personal injuries.In addition, the 1996 amendment added to the flush language “For purposes of paragraph (2), emotional distress shall not be treated as a physical injury or physical sickness. The preceding sentence shall not apply to an amount of damages not in excess of the amount paid for medical care “¦ attributable to emotional distress.” Therefore that section now provides that, in cases of non-physical injury, such as discrimination, fraud, etc., amounts excludable for emotional distress are limited to actual “out of pocket”• medical costs. A footnote in the Conference Committee Report to the 1996 Act states that the term emotional distress includes physical symptoms, such as insomnia, headaches, and stomach disorders, which may result from emotional distress.The main purpose of these changes - to reduce litigation and address several court cases - for instance Robinson v. Commissioner, 102 T.C. 116, 122 (1994), aff’d in part and remanded, 70 F.3d 34 (5th Cir. 1995) and Kightlinger v. Commissioner, T.C. Memo. 1998-357. In Robinson, the Court incorporated the parties’ allocation of damages in its judgment by reference to their settlement agreement. However, the Service successfully argued that the allocation was not a “bona fide allocation that was reached at arms length.”• Robinson, 102 T.C.at 133. Although both of these cases are pre 1996 Amendment cases, they show how in cases where there was not an impartial and objective determination of the allocation of the award to its components, a reconsideration of the allocation is warranted.See for reference - http://www.irs.gov/pub/irs-utl/lawsuitesawardssettlements.pdf Let me know if you need any clarification.
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