Paul L. Caron

Wednesday, August 23, 2006

Blogosphere Commentary on Murphy

Blogosphere commentary on yesterday's bombshell tax decision in Murphy v. United States, No. 03cv02414 (D.C. Cir. 8/22/06) (blogged here):

It is pretty rare to see a tax provision struck down on constitutional grounds. Even rarer to see one which goes to the theoretical question of income.

Let 1000 lawsuits bloom. Evey tax nut in the country is probably getting ready to file suit challenging some tax or another using Murphy as a template.

[M]y favorite case in Federal Income Tax was Eisner v. Macomber, since I frankly found the boundaries of Congress's taxing authority far more interesting than hair-splitting about life insurance, sale-lease-backs, or the characterization of loss. So I am quite interested to see . . . that the D.C. Circuit has declared a small portion of the Internal Revenue Code to exceed Congress's power to tax income.

I know essentially nothing about the Sixteenth Amendment, but it will be interesting to see if the SG petitions for certiorari in this case (assuming it doesn't go en banc). I suspect the Supreme Court would take the case.

With a night to sleep on it, I am more convinced that yesterday's D.C. Circuit decision in Murphy is unlikely to stand. I think there are two major flaws in the decision....

The first flaw is the decisions conclusion that the "framers" of the 16th amendment authorizing the modern income tax would have not considered damages for emotional distress "income." Joseph M. Dodge, in his essay in Tax Stories, notes that there were at least two competing conceptions of income at the time. One concept was based on the "principal and income" concepts of trust law. One was the "Haig-Simons" concept, which is more or less covers most of what we think of as income now. Murphy ignores this debate entirely and concludes on the thin evidence of an Attorney General opinion and a House committee report that "income" was a settled concept....

Once the Murphy court decided that damages for personal injuries weren't "income," they concluded that the tax on them was unconstitutional without further analysis. This appears to be the weakest part of their analysis. The federal government has broad taxing powers. The courts struck down the pre-1913 income tax as a violation of the constitutional requirement that "direct" taxes be apportioned among the states based on population. Many non-income taxes are recognized as constitutional, including gift, estate and excise taxes....My point? Even if it's not income, compensatory damages are still subject to Congress's power to tax unless they are a "direct" tax, which they probably aren't.

Assuming the court is correct that such an award is not "income" for purposes of the Sixteenth Amendment -- which I will assume because I don't know enough about the meaning of "income" in that Amendment -- why does it follow that the tax is unconstitutional? ...

in order to invalidate the tax in the Murphy case, it is not enough to hold that the award is not "income." It would be necessary further to hold that the tax is a "direct" one, prohibited by Article I -- and to explain why it is not otherwise authorized by the Necessary and Proper Clause. The court of appeals did not peform these analyses, and thus its opinion is woefully incomplete. My very rough sense is that the tax on the award in Murphy is authorized by Article I, section 8, and by the Necessary and Proper Clause, and, more importantly, is not a prohibited "direct" tax under Article I, section 9, just as with estate taxes (see Manufacturers National Bank, 363 U.S. 194) and gift taxes (see Bromley v. McCaughn, 280 U.S. 124). If I'm correct about this, then the tax on the award of damages therefore is constitutional, wholly without regard to whether it is a tax on "income" -- although, again, I caution that I'm out of my league on this question, and would appreciate further information or clarification in the comments.

This will probably simplify life for employment lawyers, since savvy plaintiffs have been claiming all kinds of strange physical injuries to try to justify a non-taxable verdict or settlement.

The D.C. Circuit is the most important circuit court when dealing with federal agency and IRS issues so this opinion will be given a great deal of deference by the other circuits. As important an issue as this is, I would expect the IRS to appeal it to the Supreme Court. In the meantime, employment attorneys need to rethink the way they are structuring settlements for tax purposes and inform clients (and past clients) about this decision so that they can consult with their tax advisors and determine if the filing of an amended tax return is in order.

[I]t is heartening to see a court take seriously the principle of enumerated powers with regard to federal legislation.

[A]n utterly stunning and unexpected decision ... [W]e will be doing a special podcast with Attorney Rob Wood on this ruling tomorrow, and will rush to get it up and on the system for you to listen to by late Wednesday or first thing Thursday. I expect interest will be high and we plan on getting you the facts as quickly as we can. Clearly, section 104 (a)(2) is the very foundation of the settlement industry and anything that impacts it at the lower court level is going to be a matter of intense focus and interest.

I don't have much to say about the opinion but one thing did strike me. The court writes:

The Sixteenth Amendment simply does not authorize the Congress to tax as "incomes" every sort of revenue a taxpayer may receive.... [B]ecause the "the power to tax involves the power to destroy," it would not be consistent with our constitutional government, and the sanctity of property in our system, merely to rely upon the legislature to decide what constitutes income.

Yet "the sanctity of property in our system" does not generally protect people from taxes on their capital. Not only may the federal government impose taxes on transactions involving property (such as importation, gift, or disposition on death), but state governments are free to tax property in a wide range of ways, including by imposing a percentage tax on all possessed property....

Rather, the limits on the federal income tax are limits specific to the federal government — limits that originated in the Direct Tax Clause and were then made much looser by the Sixteenth Amendment. They stem from concerns about federal power, not about government power more generally. And they thus have to do not with "the sanctity of property" as such, but rather with what only states and not the federal government should be able to do as to that property.

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» MURPHY'S LAW, INDEED from Roth & Company, P.C.
With a night to sleep on it, I am more convinced that yesterday's D.C. Circuit decision in Murphy is unlikely... [Read More]

Tracked on Aug 23, 2006 6:36:17 AM

» MURPHY'S LAW, INDEED from Roth & Company, P.C.
With a night to sleep on it, I am more convinced that yesterday's D.C. Circuit decision in Murphy is unlikely... [Read More]

Tracked on Aug 23, 2006 6:37:57 AM

» When Income Isn't: The Murphy Decision from Taxable Talk
Yesterday, the D.C. Circuit ruled that 104(a)(2) of the Internal Revenue Code (Title 26, U.S.C.) is "...unconstitutional insofar as it permits the taxation of a... [Read More]

Tracked on Aug 23, 2006 9:07:13 AM

» Employment Law and the 16th Amendment? from Workplace Prof Blog
Yup, you read it right. An important case, Murphy v. IRS, 05-5139 (D.C. Cir. Aug. 22, 2006), has come down from the D.C. Circuit Court of Appeals finding that the taxing of emotional distress damages under the Internal Revenue Code [Read More]

Tracked on Aug 24, 2006 6:53:37 AM


The DC Circuit is the most important court of appeals when it comes to federal agency issues, but it is perhaps the least important court of appeals when it comes to income tax issues, due to its extremely small geographic jurisdiction (about 62 square miles). This is not to say the DC Circuit has not issued some very significant tax decisions. But it gets no deference from the other federal courts of appeal so far as tax issues are concerned.

Posted by: Jake | Aug 23, 2006 6:03:39 PM

Interesting read. I think the culture of legal academia spends too much time talking about the past, and too little time talking about the future. I think predicting the law, rather than reviewing it in hindsight, is the most (only?) valuable contribution legal experts can make.

I wish there was a legal blog where tax experts could go and predict what will come of this case. Perhaps they could even vote.

This case is also a fascinating study of the butterfly effect.

Depending on what becomes of this case, the actions which lead to Ms. Murphy’s $70,000 lawsuit may have permanently limited congress' ability to define taxable income, and thus shaken the foundations of the federal government (In my opinion taxes are the most important tool by which the government governs.) The person who fired Ms. Murphy could have never known the ramifications of what he did.

Posted by: AMG | Aug 23, 2006 7:50:23 AM