The day before Independence Day a D.C. federal appellate reversed their decision in the case of Murphy v. IRS. The courts decided that payments made as damages for personal injury are taxable by the United States congress. It’s no coincidence that the decision came the day before a holiday as it is clearly an effort to avoid negative publicity surrounding this milestone case.
Marrita Murphy was awarded damages for emotional distress and loss of reputation after she complained to the whistleblower office about environmental hazards at her job at the New York Air National Guard. After winning her whistleblower case in 1994 she was awarded $70,000.00 by the Department of Labor Administrative Review. Murphy claimed that the Guard blacklisted her and gave her bad references after she made her complaint to the Labor Department about Environmental conditions.
Shortly after receiving the money she found herself paying a hefty tax bill of more then $20,000.00. However Murphy asked for a refund of the tax on grounds that her damages were not income, but compensation for a personal injury which cannot be taxed. She fought the tax bill and eventually found herself in a legal battle against the United States Internal Revenue Service.
On August 22nd 2006, a D.C. federal appellate panel decided in Murphy v. IRS, that Murphy’s award was not income but compensation for the loss of a personal attribute, which could not be taxed. The court noted that Murphy was awarded damages for emotional distress and loss of reputation. The court was essentially treating her award as they would treat awards for physical injuries, which are protected from.
After the decision there was quite a bit of backlash form the government as well as from bloggers and legal experts around the world. The ruling raised the wider issue on the constitutionality of the tax code provisions that allows for taxing of awards from personal injuries. Legal experts around the country claimed the ruling was a significant threat to the IRS’s ability to collect taxes and that it would open the door for other constitutional challenges to the tax code. This case could "launch a thousand constitutionality arguments that people would have thought laughable before," claimed Yale Professor Michael Graetz.
Although the IRS called for a full appeals court to hear the matter, the same three-judge panel decided to rehear the case. On December 22nd, the Friday before Christmas, the panel announced they would rehear the case instead of allowing the entire D.C. Circuit to review the case. Although there is no supporting evidence, it seems likely that the court made this announcement in such proximity to the holiday in order to avoid negative publicity for having to rehear a popular case. This is a tactic known to most political scientists as it often used in political media representation.
During the hearing the IRS urged the court to treat damages to people differently from damages to property. The IRS claimed that compensation awarded for the loss of an arm or leg is not a payment to make the person whole, but rather the payment was part of a "forced sale." According to this logic if a person suffers mental breakdowns because they witnessed the death of their child any payment for the mental illnesses can be taxed because the victim was forced to sell their mental health for the amount of the award. Therefore any money gained from a forced sale would be considered income of the victim and can be taxed.
After hearing both side’s arguments the court agreed with the IRS’s "forced sale" argument saying that "Murphy’s situation seems akin to an involuntary conversion of assets; she was forced to surrender some part of her mental health and reputation in return for monetary damages," –Murphy v. IRS, p. 2. The court announced on July 3rd that Murphy must pay taxes on the income she received from the Labor Department. Again, the courts issued their announcement just before another national holiday, making another obvious attempt to avoid negative publicity by manipulating the media.
"We reject Murphy’s argument in all aspects," claimed Chief Justice Douglas H. Ginsburg. "We hold that a tax upon such damages is within Congress’s power to tax. Murphy no doubt suffered from certain physical manifestations of emotional distress, but the money awarded her was for mental pain and anguish and for injury to professional reputation."
"We conclude (1) Murphy’s compensatory award was not received on account of personal physical injuries, and therefore is not exempt from taxation pursuant to § 104(a)(2) of the IRC; (2) the award is part of her "gross income," as defined by § 61 of the IRC; and (3) the tax upon the award is an excise and not a direct tax subject to the apportionment requirement of Article I, Section 9 of the Constitution. The tax is uniform throughout the United States and therefore passes constitutional muster. The judgment of the district court is accordingly affirmed."
"Murphy intends to seek further review in the courts," said her attorney David Colapinto. "The decision makes a mockery of make-whole remedies under civil rights law. So don’t get hurt, because you’re never going to be made whole. Uncle Sam will take a tax cut."
"The Court’s reversal stands reality on its head. When whistleblowers suffer retaliation, they do not ‘sell’ their mental health," continued Colapinto. "If people are injured in a car accident, they do not ‘sell’ their arms or legs. These are real human losses, and compensation to restore that human loss was never indented to be ‘income’ under our Constitution or the tax code."
"This decision is a terrible setback for all victims of civil rights abuses. It permits congress to enact retaliatory taxes, stripping people from the constitutional protections afforded property. Damages to whistleblowers are not part of a business transaction – forced or otherwise. They are part of harm caused by illegal conduct. This decision threatens fundamental human rights," claimed Setphen Kohn, President of the National Whistleblower Center.
Further Reading
Associated Press: Court: Mental Anguish Awards Are Taxable
NY Times: Nonphysical Injury Awards May Be Taxed, Court Rules
National Whistleblower Center Press Release: Court Reverses Itself On Key Tax Case
