Paul L. Caron

Thursday, August 24, 2006

MSM Finally Picks Up Murphy Story

We noted yesterday the failure of the MSM to pick up the story of the Tuesday bombshell decision of the D.C. Circuit in Murphy v. United States, No. 03cv02414 (D.C. Cir. 8/22/06).  Bloomberg picks up the trail in Tax Law Ruling by Court May Encourage New Challenges, by Ryan J. Donmoyer, an article syndicated in various newspapers like the New York Times:

A federal appeals court decision that cited the Constitution to bar the government from taxing some types of damage awards may encourage challenges to other sections of U.S. tax law, legal experts said....

Tax law experts said the ruling will encourage legal challenges to other parts of the tax code defining what income can be taxed. They also said the government is likely to appeal the decision to the Supreme Court. "It's certainly going to launch a thousand constitutionality arguments that people would have thought laughable before,'" said Yale University law school professor Michael Graetz, a former tax official in President George H.W. Bush's administration.

Former IRS Commissioner Donald C. Alexander, now a partner at the law firm Akin, Gump, Strauss, Hauer & Feld LLC in Washington, said the case will likely be appealed to the Supreme Court. `I think it will be appealed, the Supreme Court will hear it, and the Supreme Court will reverse it,'' Alexander said. In the meantime, tax experts predict challenges to the taxation of other money including some insurance proceeds, gambling winnings and windfalls such as found money.

"It is difficult to overstate the importance and potential harm of this decision,'' said Paul Caron, a tax professor at the University of Cincinnati College of Law. Graetz said tax lawyers will have fewer concerns that their constitutionality claims will be deemed frivolous because most thought the issue decided in the case was frivolous before yesterday's ruling. ``Now it's hard to know what's frivolous and what's serious,'' he said.

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As promised, bitter blogger Daniel Shaviro took his turn at the Murphy decision, the one that ruled that taxing personal... [Read More]

Tracked on Aug 24, 2006 3:23:07 PM


Gregory: Thanks for that very helpful comment. I'm not sure I'm persuaded, however. Here's one way of thinking about what I understand your argument to be:

1. Congress originally chose to tax all gross "income," with the understanding that "income" would mean whatever it means on the broadest permissible reading of the 16th Amendment.

2. At first, Congress specifically excluded these sorts of awards from "income."

3. Then it changed its mind, and got rid of the exclusion, on the assumption, and with the specific intent, that "income" under sections 1 and 61 would include such awards and thus that such awards would be taxed.

4. Because, on the court's view, income in the 16th Amendment does *not* include such awards, it follows that "income" in the statute does not, either, pursuant to No. 1, above.

5. Ergo, there's no statutory tax on these awards, notwithstanding the amendment in No. 3, above, and the constitutional argument need not be reached.

That's the argument about what the court should have done, right?

I suppose I don't agree on the statutory question, i.e., on Point No. 4. The court held -- I think correctly -- that when Congress eliminated the exclusion, it intended to tax such awards. That's certainly true. If this means, as the court says, that now "income" in the statute means more than "income" in the Constitution, so be it. In other words, I think the court gets the statutory question correct . . . and any argument that leads to the conclusion that Congress did not intend to tax these awards is highly suspect. The legislative intent here is fairly clear, if the reports I've read are correct.

In any event, two more fundamental points:

1. It's not the case, *even under Pollock,* that all "income" is a "direct" tax. Pollock concedes that income derived from, e.g., employment and "privileges" is indirect. The Sixteenth Amendment, in other words, encompasses some taxes that were not "direct," even under Pollock. Thus, determining whether it's "income" is simply irrelevant to the question of whether it's "direct." To be sure, if it is direct, then the fact that it's income gets you around the Article I problem . . . but the question of "income vel non" is simply not important to the initial question on which the constitutional problem turns.

2. It follows, as you suggest, that if this same exact tax were denominated an "excise" tax rather than an "income" tax, it would be indirect and thus constitutional. Well, if that's the case -- and I agree that it is -- then the fact that this is called an "income" tax should make no constitutional difference. It's not the statutory label that matters -- it's whether it's direct or not. What Congress did here, in other words, is exactly equivalent to "imposing an excise tax on the settlement" in the manner you describe (e.g., "Anyone receiving an award of damages for emotional injuries shall pay a tax on the award at the rate applicable on the taxpayer's marginal income under Section 1."). If that statutory language would have survived Article I scrutiny, then so should the current sections 1/61 as applied to this award.

Does that make sense? Thanks for helping me think this through.

Posted by: Marty Lederman | Aug 25, 2006 8:21:56 AM

You might be right in arguing that the tax could be upheld as an indirect excise tax if it had been imposed that way. If the statute said "Anyone receiving an award of damages for emotional injuries shall pay a tax on the award at the rate applicable on the taxpayer's marginal income under Section 1" or some such thing, then the court would have to determine whether there was any constitutional basis for upholding the tax. But that's not what happened here. The tax here was imposed under section 61, as a tax on "gross income" which is defined as "all INCOME from whatever source derived." If what was received is not INCOME, then the statute does not purport to tax it. I don't think the fact that Congress might have been able to impose an excise tax on the settlement is relevant -- they did not impose an excise tax on the settlement.

The Court did a very bad job describing what was unconstitutional. The Court held that the amendment to section 104(a)(2), which previously excluded personal injury awards, and was changed to exclude personal physical injury awards, was unconstitutional. As others have pointed out, section 104(a)(2) doesn't impose any taxes. It is an exclusion provision. The taxes are imposed by section 1 on income under section 61. What the Court should have said, I think, is that Congress may well have intended by amending section 104(a)(2) to include emotional distress damages as income. However, emotional distress damages cannot be "income" within the original meaning of the 16th amendment upon which section 61 is based. So the income tax laws do not reach the award.

Gregory Germain
Associate Professor of Law
Syracuse University College of Law

Posted by: Gregory Germain | Aug 24, 2006 2:35:51 PM

On whether tort damages are "income" under the 16th Amendment, consider what happens in a Hobbesian state of nature where there is no civil law system to award damages through court judgments. The tort victim's recourse (barring physical violence) is to exercise self-help by seizing the tortfeasor's property. Of course, the tortfeasor will view this reciprocal act as another tort (conversion) or theft.

Fast forward to the contemporary real world. Seizing another's property without a court judgment to back you up is theft (or tortious conversion). Theft proceeds are "accessions to wealth" constituting taxable income under Glenshaw Glass. If anyone has an argument to the contrary (besides, perhaps, the DC Circuit panel in Murphy), I'd love to hear it.

Assume instead the tort victim files suit, gets a money judgment against the tortfeasor, and enforces the judgment by seizing the tortfeasor's property. Substituting tort damages awarded by a court for the proceeds of theft makes the receipt of funds no less an accession to wealth subject to income taxation. (Mind you, I am not suggesting the tort system is tantamount to systematic theft.)

Posted by: Jake | Aug 24, 2006 9:40:43 AM

Andy, Yes, I was kidding regarding the public and the AmLaw100, but my point is that the same lawyers (I don’t know about Mr. Alexander personally) who constantly harp about the need to appear perfect, detail-oriented, and such (at all times) will excrete a soundbite when talking to the press.

I don’t think that there are too many direct implications on other areas of the code, except that the government may have to write better briefs when defending against constitutional challenges. After a bit of brainstorming, I only came up with two other sections that might be implicated, and I have to research a bit more about the 16th amendment’s history to make sure I am right on this.

Anyway, Mr. Alexander’s comments (if in context), demonstrate a flippant attitude toward the law which, when the public hears it, makes them think that we have a flippant attitude toward the law. In most cases this means that the public thinks that the law is just an extension of raw, partisan, politics. Of course, tax law is probably not the worst example of this, since unlike many other constitutional issues, the IRC is subject to prospective constitutional scrutiny by the courts. For example, I have seen prosecutors tell high school students that they “have no rights” in high schools (when, in fact, they do, and there are some undecided issues about this). A student that takes such a flippant line uncritically might well allow his person to be searched without suspicion, or his pocket bible to be confiscated.

Posted by: S.cotus | Aug 24, 2006 8:28:16 AM

"I think the DC Circuit’s analysis was coherent, and well-researched. I think the government dropped the ball."

you (and the court) may well be right. i just happen to be shocked by the implications of this decision on numerous other items that the Code deems income. i'd feel better if the court discussed, in dicta, the implications of their ruling on mark-to-market accounting, lottery tickets, etc. etc.

true enough, the judicial role is limited, and there is no reason to decide issues not before the court. but, in making a decision that is obviously so far-reaching, i'd appreciate it if they gave some greater discussion of their decision's reach, even if they expressly stated that that was dicta.

i do not know enough about the constitution (or tax law, regrettably) to know whether this decision was right or wrong. i do feel that the opinion was insufficient-- i felt rather confused after reading it. an issue of this magnitude demands better analysis.

and, as far as mr. alexander, if i were 105 years old (or however old he is), i really wouldn't give a damn about what i did or did not say to anyone or anything. i think you're picking a rather strange fight here-- perhaps you're just put off more generally by the bar's flippant attitude towards the public in general, rather than mr. alexander?

"Many of them can’t even name over 60 of the firms in the AmLaw100."

are you kidding? my parents can't even remember the name of the firm i'm working for. i'd be surprised if most of the public could name even 1, much less 60, unless Jacoby & Meyers has cracked the top 100.

Posted by: andy | Aug 24, 2006 7:37:43 AM

Well, I'm not a tax lawyer, let alone a tax prof -- indeed, until Tuesday I had never paid any serious attention to the Sixteenth Amendment or to the constitutional limitations on Congress's taxing power. I’m merely a ConLaw generalist. But even so, I'm fairly confident in predicting that the Supreme Court will not reverse this decision -- because the panel itself, or the DC Circuit sitting en banc, will do so first.

I'm actually fairly surprised that the vast majority of esteemed tax profs -- who, I should emphasize, know much more about this than I do -- have responded to the decision by arguing, as Ginsburg did, about whether the damages award is, or is not, "income." As if the federal government’s taxing power is limited to income alone! Of course, many federal statutes tax things other than "income," and have done so since the Framing. This decision will presumably encourage litigation about the constitutionality of all of those taxes.

Will those taxes be defended on the grounds that they are assessed against "income"? Of course not. As I've tried to argue in an updated post over at Balkinization -- -- it is simply a non sequitur to say, as the Murphy court did, that if the subject of a federal tax is not income, then the tax is unconstitutional. The question the court must address in order to assess constitutionality -- but that the court and DOJ have alarmingly failed thus far even to mention -- is whether the tax is "direct." If it's "direct," it's arguably unconstitutional, not because the subject matter is beyond Congress's Art. I, sec. 8 taxing power, but because the tax is not apportioned. But if, as I suspect, the tax is not "direct," then it really makes no difference whether it's on "income" or not, because there wouldn't be any constitutional problem with it.

Am I correct in suggesting, as I do in that post, that the *only* case in which the Court has ever held that a tax was "direct" is Pollock, which was viewed, even at the time, as wrongly decided, and which the Court quickly reversed in all but name? And if that's so, is there any good case to be made that the tax on a *federal* award of damages is a "direct" tax subject to the apportionment requirement? (If the framers had actually intended that taxes on federal damage awards must be apportioned by state census figures, they would have been pretty ridiculous; so I take it there's a fairly strong case to be made that such a tax is *not* "direct.")

If I'm right about this, I predict the direct/indirect question will be at the center of any petition for rehearing that DOJ files, and that the panel or the en banc court will reverse on the ground that the tax is not "direct" and is therefore constitutionally unobjectionable whether or not it is assessed on "income."

But I'd really appreciate some feedback from the tax profs out there: Am I simply missing an obvious reason why this tax, unlike numerous other federal taxes, is "direct" -- a reason so obvious that it was not even worth arguing about in the briefs or discussing in the opinion of the court? Or is this opinion, as I have argued, shockingly inadequate in that it fails *even to mention* the issue on which the constitutionality of the tax should turn -- and if so, why aren't tax profs and practitioners everywhere saying so?

Thanks in advance,

Marty Lederman

Posted by: Marty Lederman | Aug 24, 2006 7:01:37 AM

Andy, Well, this is a problem. I think that lawyers have a duty to always give their best analysis of the law. Whether this applies to out-of-court statements is somewhat up in the air.

On one hand, many government attorneys and prominent practitioners have told me that they feel as if they are free to tell the “lay people” anything they want, because they wouldn’t know better, and unlike judges or clients, they “don’t deserve” good legal analysis. There is something to be said for this. Most people didn’t go to law school, and they just want an easy soundbite, anyway. Many of them can’t even name over 60 of the firms in the AmLaw100.

On the other hand, others think that a lawyer has an ethical duty to always accurately state the law, and to do otherwise betrays an oath that he took when he was admitted to the bar.

But, I think that Mr. Alexander should be given the benefit of the doubt. Did he give a complete analysis of the case and it just wasn’t published? Or did he just give a soundbite to the non-lawyers, who don’t deserve better, and wouldn’t know the difference. I think he should respond.

All in all, this case may shed some light on the way we think about tax problems, and the way tax lawyers may have become boxed in.

I think the DC Circuit’s analysis was coherent, and well-researched. I think the government dropped the ball.

Posted by: S.cotus | Aug 24, 2006 6:53:11 AM

i don't think Bloomberg would be terribly interested in reprinting Mr. Alexander's complete thoughts on the constitutionality of section 104(a)(2) of the Internal Revenue Code of 1986 (as amended).

If he makes an errant comment during a tax panel, or in a tax notes article, i think you might be right to express some indignation, but aren't statements of the sort that Mr. Alexander provided to Bloomberg pretty much par for course with respect to a general news publication?

And, he may very well have said more-- he probably did. I'm guessing the reporter asked him several questions, and that he responded at length (though I'm admittedly too unimportant to know what it's like to be interviewed by any news publication-- I never even made it into the "Student of the Week" feature of my high school paper, something that EVERYONE ELSE seemed to be featured in. But that's another story).

Let's save our scorn for the D.C. Circuit, not those who are kind enough to take time out of their 800 dollar an hour schedules to respond to questions from the press.

Posted by: andy | Aug 24, 2006 6:24:45 AM

At first I thought that this would just stoke the fires of tax protestors. But, these quotes indicate that tax lawyers will make “frivolous” arguments. Every tax lawyer knows what a frivolous argument is and what is not a frivolous argument. These pundits (who are professors and partners) seem to have no confidence in real tax lawyers. Now, whether tax lawyers know what is a “meritorious” argument or not is a matter of perspective, because there are all sorts of arguments that are without merit in one circuit, but with argument in another.

I also don’t get why some people are not welcoming more constitutional litigation on tax matters. The beauty of the US is that we subject every statute and regulation to constitution scrutiny. Somehow tax lawyers have become a tad complacent in doing this. I know that some of these partners equate constitutional arguments with poor people, but the constitution applied to people with “income” (or revenue that might not be “income”) just as well.

Whether it will be upheld is a different story. However, for a lawyer to declare, without providing his reasoning that it will not be upheld, I think is irresponsible. Mr. Alexander should have provided his legal reasoning, rather than just making vague political allusions. It doesn’t even appear that he read the case. Now, if he were to provide at least a sketch of his reasoning, then I would be prepared to listen, but right now, Mr. Alexander, who has a generally good reputation, sounds like those people who were saying that “The Supreme Court always reverses the 9th” or “The Supremes Court will side with the government in Hamdan.” This sort of reasoning is out of place amongst legal scholars.

This case was well-briefed (with an amicus brief), and, in general there was no Supreme Court precedent on point.

Posted by: S.cotus | Aug 24, 2006 5:08:22 AM