Paul L. Caron

Friday, July 6, 2007

Tax Profs Dissect D.C. Circuit Panel's Revised Opinion in Murphy: "Sanctimonious Crapola"?

Below the fold, these Tax Profs provide their perspective on the D.C. Circuit panel's opinion on rehearing in Murphy v. IRS, No. 03cv02414 (7/3/07), which upheld the taxation of Mrs. Murphy's compensatory personal injury award:

Bryan Camp (Texas Tech):

I read the opinion as a HUGE CYA and nothing more. I think this paragraph is of signal importance to understanding why the opinion reads as it does:

Murphy appealed the judgment of the district court with respect to her claims under § 104(a)(2) and the Sixteenth Amendment. In Murphy v. IRS, 460 F.3d 79 (2006), we concluded Murphy's award was not exempt from taxation pursuant to § 104(a)(2), id. at 84, but also was not "income" within the meaning of the Sixteenth Amendment, id. at 92, and therefore reversed the decision of the district court. The Government petitioned for rehearing en banc, ARGUING FOR THE FIRST TIME, even if Murphy's award is not income, there is no constitutional impediment to taxing it because a tax on the award is not a direct tax and is imposed uniformly. In view of the importance of THE ISSUE THUS BELATEDLY RAISED, the panel sua sponte vacated its judgment and reheard the case. ...[self-serving cites omitted]...In the present opinion, we affirm the judgment of the district court BASED UPON THE NEWLY ARGUED GROUND that Murphy's award, even if it is not income within the meaning of the Sixteenth Amendment, is within the reach of the congressional power to tax under Article I, Section 8 of the Constitution.

So the opinion just skips over the question of whether the damages from emotional distress are income within the meaning of the constitution. Presumably, this is so Ginsburg can just avoid saying "Yep, our prior opinion blew it big time." So now he just coyly holds that damage awards for emotional distress are income within the meaning of section 61 and then goes right to the issue of whether such a tax is a "direct" tax. That's what I see as the import of the court's statement about Congress can label anything it wants as "income," even a fictional $100,000. And I think (please correct me if I'm wrong Greg) that comes close to what Greg was suggesting: that the statutory definition of "income" might indeed exceed the constitutional definition but, even if so, that would not make the resulting tax unconstitutional. Only here the Court ignores that second step and, as a work-around to its earlier blunder, just ignores any 16th amendment analysis and asks (a) did Congress seek to tax it and (b) is the tax a direct tax.

If I'm reading this right, it is not a satisfactory opinion at all, with all its dodging and weaving and sanctimonous crapola about the government raising a "new" argument. You logically do not get to the Article I issue until you've gone through the 16th Amend. issue. By dodging the issue of whether an economic increase in wealth is the touchstone of the legal definition of income, Ginsburg creates confusion in the law, fuels doubt, and sows needless seeds of litigation.

By the way, I was reading the debates and relating to the 1861 and 1862 revenue acts yesterday and came to realize that a huge debate was over taxing imputed income from home ownership. Cool.

Joseph Dodge (Florida State):

The latest Murphy opinion decides that (1) Congress made an implied amendment to the Code that treats non-excluded (emotional distress) damages as income (and therefore subject to tax), and (2), even if such damages are not income as an accession to wealth, Congress has the power to tax such damages under Article I (as an indirect tax).

There are some good aspects and not-so-good aspects of this case. On the positive side, the opinion reinforces the holding of Penn. Mutual Indemnity Co, which is that it doesn't matter if Congress calls something income (thereby taxing it) which isn't income under Amend. 16, because the tax can be vaid as an indirect tax. The second positive aspect is that the decision says (in a footnote) that the "in lieu of" test has no independent significance apart from the accession-to-wealth idea. Thus, an accession to wealth is income even if it is in lieu of non-income. Third, the panel seems to concede both that the original intent of the 16th Amendment isn't so clear on the damages issue, and that the Supreme Court doesn't really seem to have adopted an originalist approach to the 16th Amendment.

The main downside is that the panel wasn't willing to hold that emotional distress damages are an accession to wealth under the catch-all clause of sec. 61 as construed since Glenshaw Glass. The opinion merely sets up arguments on both sides, and then says we don't have to decide this issue. I think the issue is straightforward. The concept of wealth under the income tax is material wealth, not utility or opportunity cost. The baseline for measuring income or gain is basis, which derives from previously taxed income. Emotional well-being can have no basis. The notion of human capital (which also has no basis as a matter of positive law, but in theory might have some basis) is inapposite. Human capital and emotional well-being are not the same thing. This aspect of the opinion gives comfort to tax protestors who find costs (or basis) where none exists.

In order to get to the Article I issue, the panel has to find that Congress has taxed the emotional damages. Instead of the straightforward approach of saying that the removal of an exclusion (in the 1996 amendments to sec. 104) throws the issue back into sec. 61's catch-all clause (where the accession to wealth test gives the correct result of inclusion), the panel instead holds that the 1996 amendment actually operated as an implied amendment to the catch-all clause of section 61, so that said clause now reads: "accessions to wealth plus emotional damages awards." I object in principle to the notion of implied repeals and amendments. It leads away from the notion of text as positive law, and gives judges too much discretion. Congress could have added a provision (like sec. 71) saying that non-excluded damages were income. However, this aspect of the case is not very significant, in my opinion, because courts rarely decide cases on the bases of approaches to statutory construction (or approaches to rule-making). A judge will just pull something from the hat that serves his or her purpose. Stated differently, judges don't consider attitudes expressed in cases about statutory construction or rule-making to be real binding rules of law. It's judicial discretion pretending to be law, but ultimately isn't law and only of marginal importance.

I especially object to the off-hand statement that the implied amendment is to the catch-all clause of sec. 61. What reason is there to insist that the implied amendment is to the catch-all clause? It makes no difference where the implied amendment is located. It could be in sec. 791K, or 8853Z. In this case, why isn't it in sec. 104 itself, as a necessary implication of removing an exclusion? Alternatively, you could say it's in sec. 61 (other than the catch-all clause). The non-catch-all clauses of 61 are iterations of particular categories of items treated as income and thereby taxed. The implied amendment adds another such category. The catch-all clause embodies a broad concept that transcends particular iterations. It's awkward to interpret the catch all clause to mean "accessions to wealth plus non-excluded damage awards." The Court offers no reason for this move, which creates (unnecessary) tension with the 16th Amend. Just as statutory action shouldn't be construed to be futile, so should a constitutional amendment not be treated as meaningless. Since Pollock has been overruled on the issue of whether an income tax is a direct tax (although the opinion doesn't quite admit it), treating the amendment as being to the catch-all clause obliterates the 16th Amend. The only remaining role (which is only a negative one) would be if Congress said that property values were "income" so as to avoid the apportionment requirement, and a Court would have to say that it's not income within Amend. 16. .

Deborah Geier (Cleveland State):

I can't understand why the panel skirted the issue of whether the cash was a wealth accession, which it clearly was. The court said: "[G]ross income in section 61(a) must, and we therefore hold it does, include an award for nonphysical damages such as Murphy received, REGARDLESS OF WHETHER THE AWARD IS AN ACCESSION TO WEALTH." (Emphasis mine.) That's just unnecessarily confusing and confused.

I wish it had clarified, once and for all, that cash received that has not been taxed before (i.e., that is not a recovery of basis) or that will be taxed in the future (i.e., loan proceeds) is a wealth accession and thus gross income unless the Code provides otherwise. It didn't need to try to argue that something could be "gross income" without being a "wealth accession." I wish it had also clarified that Raytheon was a "basis" case and nothing more--that it created no new "in lieu of" test beyond an inquiry regarding whether the cash constituted basis recovery, which was the actual issue in Raytheon, itself. The court IMPLIED that there is no broad-ranging "in lieu of" test that goes well beyond Raytheon's basis inquiry, but it didn't say so clearly.

Oh, well, at least the bottom-line result was right, even if the reasoning was a bit confused, in my opinion.

Gregory Germain (Syracuse):

The Court of Appeals for the District of Columbia Circuit has given the federal government an early birthday present by reversing its prior decision in Murphy v. I.R.S., 460 F.3d 79 (D.C. Cir. 8/22/06), which had held that Congress lacked the constitutional power to tax an emotional and reputation damages award. Murphy v. IRS, (July 3, 2007).

For those who have not been following the Murphy saga, the court of appeals previously shocked the tax community by ruling that Murphy’s damages award was not “income” under the original 1913 intent of the drafters of the 16th Amendment because it was simply a recovery of human capital, and not an accession to wealth. The academic community was repulsed by the decision, fearing that the court’s flawed theories would bolster the frivolous claims of tax protestors.

The government responded to the decision by seeking en banc review by the full circuit court. In response to the en banc petition, the original hearing panel once again surprised the academic community by, on its own motion, vacating its original ruling and setting a new briefing schedule and hearing. In my previous commentaries (here, here, and here), I was critical of the federal government’s new brief on two accounts.

First, the government took an unnecessarily aggressive position concerning the scope of its taxing powers under Article I of the Constitution. Instead of simply arguing that Congress had the power under Article I to tax Murphy’s award as an excise, the government advanced heavily-debated academic theories of original intent that would all but obliterate the Constitution’s direct taxing clause. I could see no reason for the government or the court to address the continued viability of the direct taxing clause when the tax before the court did not come within the clause. The argument that the Murphy tax constituted an excise, and thus was not subject to the direct taxing clause, could be easily established through a review of judicial precedents, without using speculations about original intent to overturn 200 years of judicial precedent about the meaning of the direct taxing clause.

Second, and more important, the government failed to advance a theory upon which the court could even reach the Article I powers question. The government erroneously and unnecessarily conceded in its brief that the word “income” has the same meaning in both the 16th Amendment and the taxing statute (IRC section 61). Under the government’s concession, Murphy’s award would either be taxable as income under BOTH the 16th amendment and the taxing statute, or it would be taxable under NEITHER the 16th amendment and the taxing statute. Either way, Congress’s Article I power to tax the award would be irrelevant, because the tax would either be validated by the 16th Amendment or simply not imposed by Congress. After the government’s concession, it seemed that the Court would either have to reject its original view of the 16th Amendment’s meaning, or reaffirm its previous ruling.

I suggested that the government should have argued that, while the meaning of the 16th amendment may have been fixed in 1913, Congress controls the meaning of its statutes. Because Congress intended, by the elimination in 1996 of the exclusion for non-physical injuries, to include such awards as “income” in its taxing statutes, Congress effectively and prospectively established the meaning of the statutory word “income” to include non-physical injury recoveries. Thus, if the 1913 enactors of the 16th Amendment had, as the panel previously claimed, a more narrow view of the word “income” than did the 1996 Congress, the Court would have to decide whether Congress had the power under other provisions of the Constitution (Article I) to tax the award. This theory would give the Court the ability to recognize Congress’s broad power to tax transactions under Article I without having to speculate about the unexpressed intent of the enactors of the 16th Amendment.

Fortunately, the court did not feel bound by the government’s concessions. The court avoided considering the original meaning of the 16th Amendment by first recognizing, as I had recommended, that Congress had prospectively defined the meaning of “income” in its statutory enactments by eliminating the exclusion for non-physical injury recoveries, and by second recognizing that Congress had the power to tax non-physical injury awards as excises under its Article I powers. The court also properly rejected as unnecessary the government’s entreaty to consider the scope of the direct taxing clause.

While the academic community should view the decision as a victory for proper tax policy, many will be left feeling unsatisfied by the court’s failure to address the scope of the 16th Amendment. I believe that the court was in great error in its original opinion when it attempted to imagine whether the enactors of the 16th amendment would have thought that emotional distress damages were subject to taxation as “income.” The issue was simply not in the actual contemplation of the enactors, who were concerned solely with granting Congress the power to impose a broad based income tax that covered income from property, without the difficult requirement of apportionment that had been imposed by the Supreme Court in its controversial opinions in the Pollock v. Farmers’ Loan & Trust Co. cases, 157 U.S. 429, 579 (1895), 158 U.S. 601, 637 (1895). In my view, the enactors intended to give Congress the power to define income within broad bounds, subject only to the limitation that the same income should not be taxed twice to the same person. Congress’s later development of the basis tracking mechanism for avoiding the double-taxation of previously-taxed income should be recognized as the sole outside boundary of Congress’s definitional power. While the original Murphy decision has been vacated, the court’s failure to repudiate its erroneous theory leaves a lingering odor that may attract tax protestors as if it were a sweet perfume. The decision is an important victory for tax policy and effectiveness, but does not entirely satisfy an academic’s desire for clarity and certainty.

Alan Gunn (Notre Dame):

The key part of the statutory portion of the opinion seems to be Judge Ginsburg's argument that the 1996 amendment to 104 would be meaningless if all damages for non-physical injury weren't gross income. That's just wrong: it ignores the difference between the complete exclusion of 104(a)(2), which excludes even things like compensation for lost wages when it applies, and the much-more-limited "in lieu of" test, under which recoveries that take the place of taxable items are taxable.

Oh well, it has been said that "ignorance is the best of law reformers," and the result may be OK, despite the inadequacy of the opinion (perhaps a consequence of poor advocacy by the taxpayers' lawyers). Still, it would be interesting to see what the court would do with something like an award for loss of support in a "palimony" case.

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Professor Dodge said:

"However, this aspect of the case is not very significant, in my opinion, because courts rarely decide cases on the bases of approaches to statutory construction (or approaches to rule-making). A judge will just pull something from the hat that serves his or her purpose."

It is easy enough to say that canons of construction reflect no more than a judge's policy preferences. Numerous cases say that the Code "must be liberally construed in favor of the taxpayer." Numerous others say that "deductions are a matter of legislative grace and must be strictly construed." It's hard to believe that either statement reflects a reasoned analysis of law, rather than one's own policy preferences.

But most canons aren't like that. If one sees a sign that says "12 year olds and under admitted free," I don't think anyone would hesitate to say that the "espressio unius" canon applies. That is, one would reasonably infer that a 40 year old would not get in free. Not because 40 year olds having to pay suits one's "purpose" or because that canon is "pulled out of a hat," but because language has meaning and canons often help resolve that meaning.

"Stated differently, judges don't consider attitudes expressed in cases about statutory construction or rule-making to be real binding rules of law."

*Of course* canons are not binding rules of law; they are *aids* in determining the meaning of a law as embodied in statutory language, not Law themselves. I would hope that no one considers any canon (unless codified) a binding rule of law, but they often do help. Additionally, EVERYONE, not just judges, uses canons of constructions in everyday life (e.g. the 12 year olds example above).

Canons get a bad name because they are so often used indiscriminately or dishonestly. But that, I think, reflects more on the persons using them than the canon's validity. If canons are honestly and consistently applied -- and are used for the sole purpose of making sense out of the law, rather than loading the dice for one party ("deductions are a matter of legislative grace") -- I think they have a lot to offer.

Putting all that aside, I think the DC Circuit was correct to note that it did not have to play a "battle of the legislatures" and determine what the Congress in 1920 or whatever meant when it enacted section 61 and pit it against the intent of the legislature that enacted 104. Taxpayers, for any given taxable year, are bound by the will of Congress as embodied in a single enactment, not the will of this Congress and that Congress and that other Congress and maybe some other Congress.

I'm glad that the court addressed the issue the way they did. Maybe emotional damages weren't income in 1940, and maybe they were. But who cares? Looking at the will of Congress in 1998 (or whatever year was at issue in Murphy) and looking at section 61 in light of section 104, it is clear enough that section 61 reached some emotional damage awards.

Posted by: andy | Jul 6, 2007 10:20:27 AM