Want to Understand American Priorities? Just Look at How Workplace Injuries are Taxed

Hannah Finnie

Hannah Finnie is a student at Harvard Law School and a member of the Labor and Employment Lab.

Let’s say someone’s physically injured on the job – we’ll call them Bob. Bob receives worker’s compensation for his injury, as well as an award for resulting emotional distress from that injury. According to the tax code, Bob can exclude the income he received from his worker’s compensation award and the emotional distress award from his taxable income – meaning he doesn’t have to pay taxes on it at all. In short: great news for Bob. But now let’s take someone who’s been discriminated against in the workplace – like a woman, Jaime, who is sexually harassed in violation of Title VII – and wins her case. Her resulting awards, which could include a settlement award and an emotional distress award, just like Bob’s, will count as taxable income. In other words: not as great for Jaime.

Two harms, two very different tax outcomes. Why does the tax code treat these two workplace injuries so differently?

In 1996, Congress passed the Small Business Job Protection Act (SBJPA) and made a whole host of changes, big and small. One of those seemingly small changes was an amendment to section 104(a) of the internal revenue code, aka the tax code. The amendment changed the language around what kinds of workplace injuries could and could not be taxed. From 1918 all the way until 1996, the section excluded damages “received…on account of personal injuries” from one’s taxable income. The courts, according to Karen Brown, a scholar on this topic, tended to interpret “personal injury” to include all kinds of injuries, both physical and non-physical. But the 1996 amendment changed all that: Congress specified that non-physical injuries and all awards stemming from them could be taxed, but physical injuries and the awards stemming from them would still enjoy tax-exempt status.

So what changed in 1996? Was the move simply a way for the IRS and the country to collect more revenue by creating a new category of taxable income? Probably not: in general, according to Brown, the SBJPA actually reduced revenue. It slashed taxes across the board for small businesses and increased the kinds of income you could exclude from your taxes. In other words: it was designed to lose – not gain – revenue.

Even the 9th circuit, when the IRS tried to argue a similar physical/non-physical distinction before Congress enshrined it into law, found the distinction beyond reason says Brown. Rejecting the IRS’ arguments, the court said that the bureau had “illogically distinguishe[d] physical from non-physical personal injuries.”

Though it’s unclear what prompted Congress to conceive of the delineation after 70 years, one thing is clear: who the distinction benefits, and who it hurts. Using statistics of fatal occupation injuries broken down by gender as a proxy, the National Women’s Law Center found that men are significantly more likely than women to file worker’s compensation and physical-injury claims at work. According to the Bureau of Labor Statistics data NWLC analyzed, in 2019 4,896 men were killed because of a fatal occupation injury while 437 women were (this data does not account for potential differences in labor force participation rates).

Meanwhile, using claims filed with the Equal Employment Opportunity Commission (EEOC), the National Women’s Law Center found that women, people of color, and individuals with disabilities are more likely to file workplace discrimination claims, which would be counted as non-physical injuries. NWLC found that over the last two decades, more than two-thirds of all EEOC claims involve claims based on race or sex (the data is not disaggregated by race, just whether or not race itself was a charge).

In other words, awards that men are more likely to file for – worker’s compensation – are not taxable, while awards that women and people of color are more likely to file for – discrimination awards – are taxable.

Our tax code reflects our moral values and is a system of promoting behavior we want and discouraging behavior we don’t want. It’s a reflection of priorities and choices our members of Congress make, and that we make by electing our representatives. So this distinction boils down to one very simple question, which is: what do we consider harmful? What do we want to encourage? Discourage? By taxing discrimination awards, we are quite literally diminishing the value of discriminatory harm. Conversely, by refusing to tax physical injuries, we’re elevating physical harm above things like emotional distress, the effects of racism and sexism on a person’s life, and mental health.

The good news is this fictitious and prejudicial distinction can be demolished just as easily as it was built – and there may enough enthusiasm to make it happen.  

Congress can make a legislative fix, undoing what it did in 1996 and re-writing section 104(a) of the internal revenue code to prohibit taxation on discrimination awards. Scholars on this issue advocate for exempting non-physical injuries from taxation just like physical injuries in order to incentivize people who experience discrimination at work to file claims by offering higher awards. Notably, this would not change anything for employers that discriminate – their punishment would be the same, regardless of whether or not the employee’s award was taxed (though some scholars also propose increasing penalties against the employer outside of paying out the award). Previous Congresses have tried to do just that, most recently through a bill called the Civil Justice Tax Fairness Act, which would restore the tax-free treatment of non-physical damages. The bill was introduced in the House and Senate in 2013 and 2014 but never got out of committee to a vote. However, because this is a tax and spending issue, Congress can also likely make the change through the budget reconciliation process, meaning it wouldn’t be able to be filibustered.

The other reason to think this fix stands a chance is that the progressive base is more steeped in the idea of tax policy as a vehicle for progressive change than at any time in recent memory. Debates around a wealth tax and how to use taxes to further progressive policies have been at the center of Democratic and progressive conversations over the last few years. The income tax was originally created to push the most progressive of aims: to redistribute wealth. Today we’re having similar conversations, and there’s no reason to think this change to what kinds of workplace injuries we tax and don’t can’t or won’t be a part of that discussion.

Removing the tax code’s delineation between physical and non-physical injuries is, of course, a small start. It will only get us back to where we were 25 years ago, before Congress created the distinction in the first place. But it should be a priority for Congress and for progressives nonetheless, because taxes not only reflect our values, they propel them, too. Treating discrimination at the workplace as seriously as physical work-related injuries is a value – and a tax policy – worth fighting for.

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