Paul L. Caron

Friday, September 1, 2006

More on Murphy

More views on Murphy v. United States, No. 03cv02414 (D.C. Cir. 8/22/06):

Charles Miller, a spokesman for the Department of Justice, says the matter is under review, and no determination has been made as to the government’s next step. Employment law practitioners on both sides praised the ruling and hailed it as very significant....

The decision is important not only to the employment law community but also to those in the tax law field. Erik Jensen, a tax law professor at Case Western Reserve University in Cleveland who has written about the 16th Amendment, says, "For many years, it has been assumed that Congress can define income as it wishes," he says. "I like the idea of a court taking the language of the 16th Amendment seriously." Jensen finds the ruling defensible, but says the court should have "at least considered the threshold indirect/direct tax issue. It is conceivable that a court could treat a tax like that in Murphy as an indirect tax instead of a direct tax. If it is an indirect tax, then the only constitutional concern is the uniformity rule, which requires that the tax must be uniform in its application across the United States."

But Jensen agrees with the court on its original intent analysis: "To the extent that original intent is relevant, I am skeptical that the drafters and ratifiers of the 16th Amendment would have thought that emotional distress damages would be considered income."

This case involves the thorny issue of the definition of income.... Fortunately, we don’t have to wade into that thicket in order to notice a couple of problems with this decision.

First, in finding constitutional infirmity in taxing emotional distress damages as income, the court blamed the wrong section of the tax code. §104(a)(2), the section the court held unconstitutional, is an exclusion section. The IRC is structured such that gross income is broadly defined (“from whatever source derived”) in §61, with the definition only limited by specific exclusions in other sections of the IRC. To the extent that the IRC includes emotional distress damages in gross income, §61—not an exclusion section like §104(a)(2)—is the culprit. Thus, the court should have held §61 unconstitutional, not §104(a)(2). Professor Maule discusses this issue in a worthwhile blog post located here.

Second, the Sixteenth Amendment inquiry is not the end of the constitutional analysis in this case, because that amendment is not the sole source of congressional tax authority in the Constitution. The basic taxation power of Congress is found in Article I, §8, which says that “The Congress shall have Power To lay and collect Taxes, Duties, Imposts and Excises, to pay the Debts and provide for the common Defence and general Welfare of the United States…” This power is limited in Article I, §9, which says that “No Capitation, or other direct, Tax shall be laid, unless in Proportion to the Census of Enumeration herein before directed to be taken.” Thus, it is likely that Congress could levy an income tax even in the absence of the Sixteenth Amendment, just as it levies taxes on gasoline, tobacco, etc. Some commentators believe it was ratified in order to reverse the Supreme Court’s Pollock opinion, which held that an income tax was a direct tax and thus had to be apportioned based on census data. If this view of the Sixteenth Amendment is correct, then the Murphy opinion failed to wrestle with the issue of whether Article I, §8 can be cited as independent constitutional authority for the power to tax emotional distress damages as income.

Like many others, both within and without the tax profession, I am riveted by this case. Why? It's not just the technical flaws. Those aren't infrequent when tax cases reach the courts, particularly when the tax expertise isn't quite what it ought to be. It's also the inspiration that the opinion is giving to the tax protest movement. Specifically, the folks who have argued that wages are not gross income because they are not income have relied on the idea that wages are received in return for "human capital" and thus cannot be "incomes" within the meaning of the Sixteenth Amendment....

What happens if these arguments are made in front of a judge who analyzes the tax law in the same manner as did the three-judge panel of the D.C. Circuit in Murphy? Imagine how small the jump from "unconstitutional to tax damages from human capital" to "unconstitutional to tax wages" looks to someone who doesn't quite grasp the nuances and accepts the language of the Murphy opinion on its face. It will take only one such case. Just one. What will Congress do? Start the process for a constitutional amendment? Hope for a Supreme Court reversal? How long will either of those reactions take? Remove wages from the income tax base and tax revenues plummet.

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i note that the court conveniently glossed over the basic conclusion of comm. v schlier: that mental distress is not a personal injury, of the type which 104 excludes compensation for.

as justice scalia noted in that case, if you're hit over the head with a baseball bat, cracking your skull, that would be a personal physical injury, compensation for which would be excludable under sect. 104. on the other hand, if i tell you your tie is ugly, i cause you personal mental injury, of which the compensation is not excludable under sect. 104. both are bad, only one is excludable under 104, especially so in its most recent version.

as noted by someone else, this will be a boon to the tax protest loonies.

this is one of the more stretched decisions, with tortured logic, that i've seen in some time. i submit that it will be reversed by the USSC.

the concept of human capital having an assignable value was tossed out years ago, when companies weren't allowed to assign an amortizable basis to an in-place workforce, as the result of a sect. 338 election. the case escapes me at the moment, but it, and goodwill, were the basis for sect. 197 coming into existence.

Posted by: cpinva | Sep 2, 2006 12:14:28 AM