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TAX COURT REJECTS 'MURPHY'-TYPE ARGUMENT, IMPOSES PENALTIES

February 21, 2007

Murphy's law doesn't work in the Tax Court.

Marcia Green was a non-tenured Humanities instructor at San Francisco State University. She filed a discrimination complaint after she was turned down for a tenured position. The complaint wasn't upheld and the university stopped assigning her to teach courses. She sued and in 2002 won a $2.3 million judgement when the jury found the university retaliated against her because of her discrimination complaint.

Ms. Green filed a 2002 Form 1040 that omitted her lawsuit proceeds. The IRS disagreed with her position and assessed her a $909,000 tax deficiency and a $181,000 "accuracy-related" penalty. The accuracy related penalty applies when you understate your liability by 20% or more without reasonable cause.

Since 1996 the Internal Revenue Code has stated that personal injuries can be excluded from income only when they are for "physical" injuries. Before it withdrew its own decision, the Federal Circuit Court of Appeals held in Murphy that the 1996 provision was unconstitutional.

The Tax Court ruled against Ms. Green yesterday. The Tax Court didn't discuss the Murphy case in its decision; in fact, it ignored Murphy's "return of human capital" argument entirely. The opinion simply stated that the damages are income under the long-standing Glenshaw Glass reasoning. The 1996 change in the law required damages to be "physical" to qualify for exclusion. They weren't, so they didn't, and the taxpayer lost.

By imposing the accuracy-related penalty, the court seems to say that the Murphy logic wasn't even enough to pass the laugh test. That may not be entirely accurate; its decision might simply be saying that she didn't rely on professional advice when she decided to not report the income. Even so, it doesn't look like the Tax Court is very impressed with the Murphy rationale.

Cite: Green, T.C. Memo 2007-39.

Link: Complete Tax Update Murphy coverage.

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