Personal injury recoveries and workers’ compensation covered injuries
Under Section 104, payments for personal injuries and sickness are generally excluded from gross income. Since 1996, the damages must be for personal physical injuries or personal physical sickness. The IRS generally requires that an overt manifestation of physical injuries and “observable bodily harm” exist for an exclusion to be available. In a 2008 ruling, the IRS assumed that there were personal physical injuries from sexual molestation. It is not very clear what constitutes a physical sickness vs. a physical injury. The commentary “Tax-Free Physical Sickness Recoveries in 2010 and Beyond” in the Tax Practice publication (Volume 67, No. 9 of August 30, 2010) discusses this topic.