The IRS has new guidance in relation to the on "on account of" test. Previously emotional distress has to be clearly be “on account of” a physical injury in order for settlements related to such distress to be excludable from income. The new guidance supports the exclusion of not only damages directly linked to personal injuries or sickness but also damages for emotional distress, even not necessarily attributable or related to a physical injury or physical sickness, to the extent that the damages for emotional distress are not in excess of amount paid for medical care related to such emotional distress. This is a loosening of the rules apply to damages paid under a written binding agreement, court decree or mediation award entered into or issued after September 13, 1995, and received after January 23, 2012.
Taxpayers who paid tax on a settlement that would be excludable under the new guidance on a return that is within the statutory period for amending to claim a refund (3 years from due date of return) may amend if such amounts were paid under a written binding agreement, court decree, or mediation award entered into or issued after September 13, 1995.