Further Thoughts on Fireside Bank
Survey of Corporate Lawyers Says Lawsuits Are Terrible

Taxing Emotional Distress

We drift off topic a bit today, but the case warrants a mention on any employment related legal blog, so off topic we go. Ask any employment lawyer outside California about "the Murphy case" and they won't think about employee breaks and hours of pay, they think about taxation. The case even has its own wikipedia entry. On August 22, 2006, the United States Court of Appeals for the District of Columbia Circuit published an opinion in Murphy v. Internal Revenue Service (No. 05-5139, DC Cir. 08/22/2006), ruling that the taxation of non-economic damages for emotional distress and loss of reputation is unconstitutional because such a tax violates the Sixteenth Amendment of the U.S. Constitution. In December, the Circuit vacated that opinion and ordered a rehearing on the matter. That hearing will take place today.

In the original opinion, written by Chief Judge Douglas H. Ginsburg (former Reagan appointee to the SCOTUS whose nomination was derailed by dope-smoking admissions), and joined by Judges Judith W. Rogers and (former California Supreme Court Justice) Janice Rogers Brown, the court held:

Marrita Murphy brought this suit to recover income taxes she paid on the compensatory damages for emotional distress and loss of reputation she was awarded in an administrative action she brought against her former employer. Murphy contends that under § 104(a)(2) of the Internal Revenue Code (IRC), 26 U.S.C. § 104(a)(2), her award should have been excluded from her gross income because it was compensation received "on account of personal physical injuries or physical sickness." In the alternative, she maintains § 104(a)(2) is unconstitutional insofar as it fails to exclude from gross income revenue that is not "income" within the meaning of the Sixteenth Amendment to the Constitution of the United States. We hold, first, that Murphy's compensation was not "received ... on account of personal physical injuries" excludable from gross income under § 104(a)(2). We agree with the taxpayer, however, that § 104(a)(2) is unconstitutional as applied to her award because compensation for a non-physical personal injury is not income under the Sixteenth Amendment if, as here, it is unrelated to lost wages or earnings.

Ms. Murphy was a whistleblower who alleged that she was blacklisted for complaining about violations of environmental statutes. Her case included a significant claim for emotional distress and loss of reputation. She paid taxes upon her recovery, then sued for a refund, arguing that In victory, her attorney David K. Colapinto remarked: “The government had the audacity to argue that compensatory damages for emotional distress and loss of reputation are not ‘make whole’ damages and can be taxed as income because the economic value of human life is ‘zero.’ Hopefully, today’s ruling marks the beginning of the end of this arcane and regressive policy of taxing non-physical compensatory damage awards.” Now that the briefs are in, the IRS position looks better than average for a losing party seeking reconsideration. The TaxProfBlog has had a lot to say about it, as has The Volokh Conspiracy and the National Employment Lawyer's Association. Murphy's brief can be read here.


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