The lawyers for Marrita Murphy yesterday filed a cert petition with the U.S. Supreme Court seeking review of Murphy v. IRS, 493 F.3d 170 (D.C. Cir. 7/3/07).
After full briefing and oral argument, the Appeals court initially held that Murphy’s award was not income and the tax on her damages violated the U.S. Constitution. Then, under pressure from the Bush Administration, the judges decided to rehear the case. In this ruling, Murphy II, the D.C. Circuit reversed its own previous decision, declaring that nonphysical compensatory damages are taxable as gross income.
For the first time the issue of whether compensatory damages for non-physical injuries are taxable income is squarely before the Supreme Court. This is a major issue impacting all cases in which any person obtains compensatory damages for a mental distress or illness, or for physical problems resulting from or associated with emotional distress.
David K. Colapinto, General Counsel for the National Whistleblower Center and attorney for Marrita Murphy said he is requesting that the Supreme Court review the issue because "The D.C. Circuit’s reversal stands reality on its head. ... The D.C. Circuit’s decision in the Murphy case is the first time that any court has construed the tax code to imply an 'excise' tax on the 'privilege' of utilizing the 'legal system' to vindicate a federal statutory right. However, Congress did not pass a special tax demanding payment from people who use the legal system to prevent retaliation against whistleblowers or to vindicate civil rights. It was error for the D.C. Circuit to imply such a tax."
Although some members of the tax bar and academia impulsively criticized Murphy I, claiming it would encourage tax protesters, at least one commentator concedes that reaction was overblown. 132 BNA Daily Tax Report, "Tax Decisions and Rulings," p. K-1 (July 11, 2007) (noting one commentator’s observation that “criticism of the initial Murphy ruling may have been a little too enthusiastic, especially the claim that it would encourage tax protestors” because tax protesters will make their own arguments anyway). Also see Romond, Russell F., “Note: Income, Taxes and the Constitution: Why the D.C. Circuit Court of Appeals Got It Right In Murphy [I],” 12 Fordham J. of Corp. & Fin. Law, 587, 593 (2007) (Noting initial criticism by tax professors and others “to denounce” Murphy I as “flawed,” “odd,” “bizarre,” and “horrible.”).
However, after Murphy II there remains “confusion and ambiguity,” and because the D.C. Circuit really did not repudiate anything in Murphy I, the unresolved issues will “fuel tax cases for years to come.” Robert W. Wood, “Waiting to Exhale: Murphy Part Deux and Taxing Damage Awards,” Vol. 116, No. 4, Tax Notes, 265 (July 23, 2007). Notably, other commentators have published articles pointing out that the D.C. Circuit was correct in Murphy I, while other commentators have published articles taking the opposite view. See, e.g., Wood, supra., Vol. 116, No. 4, Tax Notes at 265; Romond, supra., 12 Fordham J. of Corp. & Fin. Law, at 593; Steven T. O’Hara, “Thinking Outside the Code,” Vol. 116, No. 6, Tax Notes (Aug. 20, 2007); “Case Commentaries,” 8 Transactions: Tenn. J. Bus. L. 445, 474 (2007); Rose, Elizabeth, “Murphy’s Mistakes: How the Circuit Court Should Analyze Section 104(a)(2) Upon Rehearing,” 60 Tax Law 533 (2007); Germain, Gregory L., “Taxing Emotional Injury Recoveries: A Critical Analysis of Murphy v. Internal Revenue Service,” 60 Ark. L. Rev. 185 (2007); Fatino, John F., “The Tax Treatment of Verdicts and Settlements Following the Adoption of the Jobs Creation Act of 2004: Paradise Found for the Employment Lawyer?” 27 N. Ill. U. L. Rev. 1 (2006); Robert W. Wood, “Top Ten Reasons Why ‘Murphy’ Is My Favorite Tax Case,” Vol. 190, No. 1, Daily Tax Report (BNA Oct. 2, 2006) (Murphy I’s “teachings may help generations of taxpayers.”).
Regardless, the widespread attention and commentary that the Murphy case has generated indicates the importance of the case and underscores why, more than a decade after Section 104(a) was amended in 1996, there is no reason to delay review of the questions presented.
The Writ should be granted to resolve uncertainties about whether personal injury damages are taxable and decide, consistent with nearly 80 years of case law, that the “make whole” personal injury damages are not “income,” and thus are not taxable.