Tax Update Blog: Murphy decision Archives

MURPHY'S END

April 22, 2008

The dramatic life of the Murphy case came to a quiet end yesterday when the U.S. Supreme Court declined to take the case.

The U.S. Appeals Court for the D.C. Circuit shocked the tax world with its initial Murphy decision, in which it ruled that damages awarded a whistleblower were not taxabe under the Constitution. The initial D.C. Circuit decision implied that any item not considered "income" in 1913 could not be subject to an income tax today.

Most tax students criticized the Murphy decision, and the three-judge panel quietly withdrew its decision and issued a more conventional ruling holding that the whistleblower damages were taxable.

A whistleblower advocacy group issued a press release that blames "pressure from the Bush administration" for the D.C. Circuit's reconsideration of its own decision. That's a strange way to describe near-universal criticism by the tax bar, unless Karl Rove's tentacles extend further than I would have ever guessed.

The TaxProf rounds things up.

Link: Complete Tax Update coverage of Murphy.

Tags: dan shaviro.Murphy.tax policy.

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GOVERNMENT FILES BRIEF OPPOSING SUPREME COURT REVIEW OF 'MURPHY' DECISION

March 19, 2008

The taxpayer in the controversial Murphy decision asked the U.S. Supreme Court to review the case. The TaxProf reports that the government has filed its reply brief to the request for review.

The Murphy case briefly threatened much tax law that had long been taken for granted, until the D.C. Court of Appeals, which initially held for the taxpayer, changed its mind. I expect the Supreme Court to decline to hear the case.

Link: Tax Update coverage of Murphy.

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WHISTLEBLOWER MURPHY ASKS FOR SUPREME COURT HEARING

December 17, 2007

Marrita Murphy, the whistleblower who rocked the tax world when she won a since-reversed decision ruling that taxing her damage award was unconstitutional, has asked the Supreme Court to hear her case.

Gregory Germain examines the Murphy certiorari petition at the TaxProf Blog today.

In sum, I would be very surprised if the Supreme Court granted this petition. Most of Ms. Murphy’s arguments are flawed and easily refuted. They have identified no real conflict among the circuits. Certainly, no other court has adopted the roundly rejected theories expressed in Murphy I, which form the core of the petition. Yes, the Court of Appeals in Murphy II did a poor job with the statutory issues, but ultimately they reached the right ruling.

I'll be shocked if the Supreme Court decides to take this case.

Link: Complete Tax Update Murphy Coverage

Tags: Murphy.TaxProf.

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MURPHY DEAD TO THE TAX COURT

September 28, 2007

The Federal Appeals Court for the DC Circuit buried it's controversial Murphy decision over the summer. Before the DC court changed its mind, Murphy said emotional damages -- and potentially many other items now subject to income tax -- were tax exempt because they weren't "income" when the income tax was enacted in 1913.

Yesterday the Tax Court danced on Murphy's grave. Paul Ballmer received a $337,000 emotional damages award in 2001 and failed to pay any income taxes on it. The IRS caught up with him, assessing tax and penalties. Mr. Ballmer cited the defunct original Murphy decision in trying to convince the Tax Court not to assess tax, or at least penalties.

The Tax Court seems to believe that Mr. Ballmer had no intention of paying tax on his award from the start, and his reliance on Murphy was a last-minute improvisation:

On cross-examination, petitioner admitted that he had not reviewed the flush language of section 104(a), which provides "emotional distress shall not be treated as a physical injury or physical sickness" for purposes of excluding damages received from gross income under section 104(a)(2). Petitioner further admitted that he had not sought the advice of a tax professional in regard to his conclusions that no provision of the Code required him to file a return or that the damages he received were not income.

Petitioner's attempt to cloak his argument of reasonable cause in the initial Murphy decision is also unpersuasive. First, as discussed above, the Court of Appeals for the D.C. Circuit vacated its initial decision and has since determined that damages for emotional distress are gross income. Further, there is no evidence before the Court that petitioner performed an analysis similar to that of the D.C. Circuit, nor that he received any advice from a competent tax professional, at the time he chose not to file a return for 2001.

Mr. Ballmer may have fallen for tax protest arguments:

Petitioner further testified that he had reviewed the Internal Revenue Code for several years and could find no provision that required him to file a return

The "years of study" line is a standard tax protestor catchphrase (see here, for example). It's amazing that you can spend so much time with the Code without coming across Section 6012.

Cite: Ballmer, T.C. Memo 2007-295.

Link: Tax Update Murphy coverage

UPDATE: The TaxProf has more.

Tags: misdirected study.Murphy.tax protestors.

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MURPHY IS DEAD

September 18, 2007

The Federal Appeals Court for the D.C. Circuit has turned down the appeal for the rehearing of the Murphy case. That means the case, which at one time seem poised to disrupt decades of federal tax law before the D.C. panel reversed itself, is final, barring an unlikely Supreme Court reversal.

The TaxProf and the TaxGirl have more.

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TAX PROFESSORS WEIGH IN ON MURPHY

July 06, 2007

The Tax Prof has rounded up learned opinion on this week's new Murphy decision (update: link fixed). Bryan Camp of Texas Tech focuses on something I had noticed: how the court blames the government's attorneys for the initial bad opinion.

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.

I love his conclusion:

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.

Is "crapola" a legal term?

Link: Complete Tax Update Murphy Coverage.

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MORE ON 'MURPHY'

July 05, 2007

The TaxProf has his trademark comprehensive roundup of the Federal Circuit's reversal of its own decision exempting whistleblower damages from federal taxes.

Our report on the new decision is here.

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'MURPHY' GOES OUT WITH A WHIMPER

July 03, 2007

The "National Whistleblower Center" reports that the Federal appellate panel that issued the spectacular Murphy decision -- the one ruling the taxation of personal injury damages unconstitutional -- has changed its mind. The panel from the U.S. Federal Circuit Court of Appeals, which withdrew its much-criticised decision in late December, today issued a new decision holding that such damages are taxable.

I haven't yet found the actual updated decision; I will link it as soon as I do. The original decision seemed likely to unleash a wave of litigation on the scope of the term "income" under the constitution, as it implied that only items considered "income" in 1913 could be subject to the income tax.

Practitioners and academics mostly were appalled by the original decision. The three-judge panel withdrew its original decision after the full circuit had signaled that it would likely reconsider the decision.

Link:

Today's decision

Full Tax Update Murphy Coverage

UPDATE:

How Appealing has a post on this:

Today's ruling may strike many as unremarkable, and indeed it would be if this same three-judge panel, in August 2006, had not issued a decision in this very case holding that "insofar as §104(a)(2) permits the taxation of compensation for a personal injury, which compensation is unrelated to lost wages or earnings, that provision is unconstitutional."

The Wall Street Journal Law Blog also has coverage:

"Why are you bothering us with a tax case just hours before the Fourth of July!?" you’re surely asking. “Go home Law Blog!”

Well we care for a couple of reasons. First, it's rare for a three-member appeals court panel to agree to rehear a case and then reverse itself. Last August, the same three judges ruled that the award didn’t represent "income" as defined by the 16th Amendment — and thus wasn’t taxable. The court had also called “unconstitutional” a 1996 provision in the tax code that permitted taxation of damage awards for mental distress and loss of reputation. In December, the panel vacated its judgment and said it would rehear the case. (The more common scenario would have been for the entire D.C. Circuit to review the decision — i.e., en banc,)

Second, the ruling is a significant win for the IRS. The original ruling last year had set off a firestorm, causing tax lawyers and professors their own emotional distress, with most lambasting the decision. "Let 1000 lawsuits bloom," wrote UCLA law professor Stephen Bainbridge on his blog. Yale law professor Michael Graetz said the case would "launch a thousand [other] constitutionality arguments that people would have thought laughable before."

One thing this case teaches us: the Courts are hip to the public relations technique of issuing embarrassing news at holiday times, when it is least likely to attract attention. The panel withdrew its original decision on December 22, the Friday before Christmas; maybe there's another explanation for the issuance of the new decision today, but the cynical explanation does fit the data.

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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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DES MOINES LAWYER PUBLISHES LAW REVIEW PIECE ON 'MURPHY' ISSUES

February 20, 2007

The TaxProf notes that John Fatino of the Whitfield and Eddy law firm has published "The Tax Treatment of Verdicts and Settlements Following the Adoption of the Jobs Creation Act of 2004: Paradise Found for the Employment Lawyer?" in the Northern Illinois University Law Review. It covers the issues that rose to prominence following the now-withdrawn Murphy decision on whistleblower damages.

Mr. Fatino seems to think that the original Murphy logic may hold up:

Shortly before this article went to press, a panel of the United States Circuit Court of Appeals for the District of Columbia held § 104(a)(2) unconstitutional, in so far as it permits the taxation of an award of damages for mental distress and loss of reputation, because such items would not have been income to the framers of the Sixteenth Amendment to the United States Constitution. Practitioners should closely examine this opinion for additional grounds of attack on the taxation of physical and non-physical injuries. Moreover, there is an excellent discussion as to whether a payment on account of physical injury is compensation for loss of capital.

Congratulations to Mr. Fatino for his work and for getting published.

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MURPHY'S LAW UNDONE?

December 26, 2006

A three-judge panel of the Federal Circuit Court of Appeals shocked the tax world in August when they barred as unconstitutional the taxation of emotional damages. The broad language of the Murphy decision threatened many long-accepted elements of the tax law.

Last Friday the same three judges had second thoughts. They have vacated their own decision and scheduled a rehearing on it in April.

The IRS had petitioned the appeals court for an "en banc" rehearing, in which all 12 (I think) D.C. Circuit appeals judges would re-hear the case. The three original Murphy panel members ordered the rehearing "on the court's own motion," so they will do the rehearing themselves.

Presumably the three judges wouldn't have bothered with the rehearing -- including a full briefing schedule and oral arguments -- absent serious doubts about their original decision.

Hat tip: The TaxProf, who has an excellent set of links to the relevant documents and prior coverage.

Link: Complete Tax Update Murphy Coverage.

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MURPHY LAWYERS RESPOND TO REHEARING PETITION

November 10, 2006

The attorneys for Marrita Murphy have filed thier response to the governments request for a rehearing of the case, which ruled taxation of personal injury damages unconstitional (via the TaxProf).

Link: Full Tax Update Murphy coverage.

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MURPHY DEVELOPMENTS

October 30, 2006

The TaxProf reports that the taxpayers in Murphy have been given extra time to respond to the governments request for a rehearing of the Murphy decision by the full court. The decision, which ruled the taxation of Ms. Murphy's "whistleblower" damages unconstitutional, was made by a three-judge panel of the DC Circuit Court of Appeals.

The TaxProf also discusses a subscriber-only article in the National Law Journal about Murphy.

Link: Full Tax Update Murphy coverage

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MURPHY TO GET FULL-PANEL REHEARING?

October 20, 2006

The TaxProf thinks that the full Federal Circuit Court of Appeals may be leaning towards a rehearing of the Murphy decision. He notes that the court has asked Ms. Murphy's attorneys to respond to the government's request for a rehearing of the three-judge panel's report, and observes:

This suggests that the D.C. Circuit may be considering granting the the petitiion, as Rule 40(a)(3) provides:

(3) Answer. Unless the court requests, no answer to a petition for panel rehearing is permitted. But ordinarily rehearing will not be granted in the absence of such a request.

In short, if they weren't thinking about allowing a rehearing, they wouldn't bother to get a response from the other party to the government's request.

The Murphy decision held that the Constitution doesn't permit the taxation of compensatory damages. It's a bafflingly bad decision.

Link: Complete Tax Update Murphy coverage.

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MAULE ON MURPHY REHEARING PETITION

October 17, 2006

Dr. Maule ponders the recent petition by the government for an en banc review of the Murphy decision. He had pointed out that Murphy fails to properly deal with the statute involved, even without addressing the constitutional issues; yet the petition for hearing brushes past the statutory construction problem. He worries:

Now, in addition to concerns over the chances of the petition being granted and the en banc outcome being decided correctly, there is another worry, namely, that the inability to understand how Internal Revenue Code inclusion and exclusion provisions work will become a problem not just for three judges but for many more. Perhaps this matter can be clarified at oral argument. That, of course, assumes a favorable reaction to the petition. It's tough to imagine the full court letting the three-judge panel's horrific opinion stand without comment.

For Dr. Maule it's a brief post, and as always, well worth reading in full.

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IRS REQUESTS RE-HEARING ON MURPHY

October 06, 2006

The government yesterday asked the Court of Appeals for the Federal Circuit to have the full panel of judges re-hear the Murphy case. Murphy, in holding that "whistleblower" damages weren't "income" under the constitution, threatens to undermine much of the federal income tax.

The government's brief addresses the constitutional issues directly, raising many of the same points discussed here. The brief explains the source and broad scope of Congress's taxing power, and how the 16th Amemdment only removed the requirement that income taxes treated as "direct" taxes be apportioned among the states by population.

The brief also attacks the Murphy holding that the damages aren't taxable because they aren't properly considered "income":

The panel compounded its error by concluding that damages for nonphysical personal injuries were not considered income at the time the Sixteenth Amendment was ratified. That analysis is incorrect, but in any event focuses on the wrong question. The critical question is whether § 104(a)(2), or more accurately § 61, involves any direct tax that would have been subject to the apportionment requirement, but for the Sixteenth Amendment. If the answer to that question is no -- and it is -- then there is no need to reach the question whether a tax on damages for nonphysical injuries is a tax "on incomes, from whatever source derived," within the meaning of the Sixteenth Amendment. 6

In any event, the historical materials belie any consensus at the time of the framing of the Sixteenth Amendment that damages for nonphysical injuries are not income. Especially in light of the breadth of the Sixteenth Amendment -- which excludes "taxes on income, from whatever source derived" from the apportionment requirement on direct taxes -- and the capacious construction the Supreme Court has given to "income" in the Sixteenth Amendment and statutory contexts, the panel erred in concluding that damages for nonphysical injuries do not constitute income.7

(emphasis added)

Footnote 7 refers to the Tax Stories essay we discussed here.

The brief also attacks Murphy's "return of human capital" argument, noting that the taxpayer had no basis in her "human capital" for measuring gain or loss.

The brief, while of course an advocacy piece, is a nice short course on the constitutional basis for the income tax. You can read the whole brief here.

Of course, the TaxProf has more.

Orin Kerr at The Volokh Conspiracy comments:

I don't know much about tax law and know next to nothing about the Sixteenth Amendment, but I just read the government's petition for rehearing in the Murphy v. IRS case I blogged about awhile back: The brief sure seems pretty devastating to me.

I'm no lawyer, but I remain baffled how the original 3-judge panel could have reached the conclusion they did in Murphy.

Link:

Complete Tax Update Murphy Coverage

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TAX ANALYSTS CONTINUES TO BLANKET MURPHY

September 06, 2006

After taking a few days to get in gear, Tax Analysts is flooding the zone with coverage of the Murphy case, which held taxation of non-physical personal damages unconstitutional.

The Personal Injury practioner's perspective

Robert W. Wood has one of the more favorable views of Murphy I've seen so far. Perhaps it's no coincidence that damage awards are his bread and butter, and he is (as Tax Analysts notes) "the author of Taxation of Damage Awards and Settlement Payments (3d Ed. Tax Institute 2005 with 2006 update), available at http://www.damageawards.org."

I think Mr. Wood's arguments are mostly wishful thinking from a personal injury litigator. For example:

In any event, historical analysis then blossomed. Murphy went on to argue that the code was drafted shortly after the 1913 passage of the Sixteenth Amendment. Murphy focused on three sources that the Supreme Court quoted 80 years later in O'Gilvie. It is worth repeating those sources because Murphy's argument -- accepted by the D.C. Circuit -- was that those timely musings indicated the contemporaneous common understanding of the word "income."

What happened between 1913 and 1918? Oh, yeah, World War I! The world looks a lot different after a world war that led to an unprecedented expansion of government and millions of deaths. Yet the Murphy court found an 1918 attorney general opinion and a 1918 as if they were the Federalist Papers of the 16th amendment.

Mr. Wood is correct, though, when he says:

"Deftly, the D.C. Circuit just wiped away volumes of tax case law and decades of jurisprudence, and dramatically threw into disarray the post-1996 law of section 104."

He also provides a good practical analysis of what practitioners should do (hint: If you are fighting a case like this, it may be a good time to settle) and he carefully lays out the options the IRS has in fighting the result.

Tax Analysts also runs another Murphy piece today, co-authored by a former district counsel and a longtime IRS agent, but it is bare bones and doesn't add anything to to the discussion.

Link: Complete Tax Update coverage of Murphy.

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MURPHY PILE-ON AT TAX ANALYSTS

September 05, 2006

It's a big Murphy day at Tax Analysts, headed up by a news story "Experts Ponder Murpy Decision's Many Flaws." ($link) Reporter Sheryl Stratton gets responses to the case from some of the biggest names in tax lawyering.

George Yin, former Chief of Staff for the Joint Committee of Taxation and now at the University of Virginia, weighs in:

"We law professors must not be doing our jobs right if three federal judges and their clerks can reach a conclusion like this one," Yin said.

Yin has identified several flaws in the court's technical analysis. The first is that the court was not familiar with the concept of basis. The court's opinion reads as if recovery is made to make a taxpayer whole, he said. The logic of comparing the value of what is lost to the value of what is received to determine whether there is an accession to wealth would lead to virtually any exchange as not creating income, he said.

Former Bush Treasury policy chief Pamela Olson is also cited:

The reaction among members of the tax bar has been uniform incredulity, said Pamela Olson, former Treasury assistant secretary for tax policy, now at Skadden, Arps, Slate, Meagher & Flom LLP in Washington. At the same time, tax advisers must figure out what to tell clients whose claims are potentially affected by the decision, she said.

The article quotes Yale professor Michael Graetz as finding the decision "odd." The piece also notes the role of the TaxProf Blog in aggregating the reaction to the decision.

While most of the tax folk Stratton talked to expect the decision to be overturned, Loyola (Los Angeles) professor Theodore Seto isn't so sure:

Predicting what the Supreme Court will do in a particular case is a risky business, Seto said, but he doubts that a majority would adopt the circuit court's originalist approach. Beyond that, Seto is less certain. "Unlike many of my colleagues, I believe that non-tax lawyers (there are nine of them on the Supreme Court) might well conclude that the damages in question are not 'income' and that this raises potential 16th Amendment problems," he said.

An excellent roundup. Watch the free Tax Analysts home page; they make some pieces temporarily available there, and I hope the Stratton article gets there.

Lee Sheppard also devotes her space ($link) to Murphy today. She finds the decision itself untenable, but she says the IRS brought it on itself by not providing adequate guidance.

Even State Tax columnist David Brunori ($link) jumps on the pile:

Bizarre? For so many reasons. First, the court upheld a constitutional challenge to the definition of income. That is a green light for every kook in the world to make their favorite "the income tax is unconstitutional" argument. Second, the court actually said that because there were no such things as damages for emotional distress when the 16th Amendment was ratified, they can't be taxed today. Does the court have any idea of how many things are around today that weren't in 1913? How about stock options?

So much good stuff, so many subscriber-only links...

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TAX POLICY BLOG ON MURPHY

September 01, 2006

The Tax Foundation's Tax Policy Blog has made its first post on Murphy, the recent Federal Circuit decision holding the taxation of personal injuries unconstitutional.

Though the Tax Foundation tends to lean right on tax policy issues, it resists the temptation that has overcome some conservatives to view this as some sort of anti-tax victory:

This case involves the thorny issue of the definition of income. We have wrestled with this definition in the past (click here for one such report). 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.

They promise more posts on issues presented by the ruling.

Link: Complete Tax Update coverage of Murphy

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MURPHY - CATALYST FOR REFORM, OR JUDICIAL POWER GRAB?

August 31, 2006

As word on the Murphy decision seeps out of the tax world into the mainstream media, a new set of reactions begins to emerge. As one might expect, the reaction outside of the tax community is different to that of us tax drones, and it reflects their philosophical approach to taxes.

Bruce Bartlett, writing in National Review online, sees it as a step towards a national consumption tax:

I would like to see the court go further in regards to the question of whether interest constitutes income. To economists, some portion of the interest we receive on our savings is merely compensation for loss — loss of the immediate enjoyment we would receive if we consumed our income today instead of saving it.

The New York Sun editorial page says:

Time and a higher court will tell whether Ms. Murphy gets to keep her $20,665 in tax payments. We wish her luck. Whatever the final result, Ms. Murphy has performed a service by offering three judges an opportunity to give the IRS a scare. No other person or institution in America is above the law, and there's no reason the IRS should be the exception.

While I am sympathetic to these sentiments, these folks miss the bigger picture. The Constitution allocates the taxing power, and the legislative power, to Congress, subject only to a requirement that "direct" taxes be apportioned among the states according to population. The courts tended to use the "apportionment" requirement to assert themselves in tax policy until the 16th amendment was passed, removing the issue of whether taxes on income were "direct" taxes. Since then, the courts have wisely deferred to the elected branches in determining how the taxing power is to be exercised.

It is unwise to invite the judiciary back to the tax policy table. These folks may be cheered by a judicial meddling in tax policy that they endorse, but not all judges are conservative, and they won't all meddle in ways that the Sun or Mr. Bartlett would approve.

The traditional role of the courts in tax policy is to hold the executive branch - the IRS - accountable to the law as enacted. There have been any number of decisions overturning the IRS on this score. Murphy doesn't "scare" the IRS. It scares Congress itself by subjecting their policy choices to black-robed second-guessing.

The Murphy decision, if upheld, will make it impossible for legislators to make tax policy with any certainty that it will pass muster with the judges that then happen to be on the bench. Better for the courts to step back from the brink and let tax policy arguments take place in the branches directly accountable to the tax-paying voters.

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AMITY SHLAES ON MURPHY

August 30, 2006

Excellent article by Amity Shlaes in Bloomberg.com on the implications of the Federal Circuit's recent Murphy decision (Hat tip: TaxProf Blog). From the article:

There is another signal from Murphy, subtler but equally distressing. Americans tend to believe that activity that is taxed is somehow suspect, whereas untaxed activity is more virtuous. Now the court is confirming to citizens what their lawyers already tell them: Litigation is virtuous. More virtuous than buying a lottery ticket, for lottery winnings are taxable.

The hope is that the Supreme Court, which is likely to hear the case, will lay Murphy to rest. Then Congress can alter the law if it likes. But as it stands, Murphy is dangerous. It confirms what Americans already believe: The world owes them.

You'll want to read the whole thing.

Prior Tax Update Coverage of Murphy:

More Murphy

Murphy's Law, Indeed

HAD A TAXABLE NON-PHYSICAL INJURY? MAYBE YOU NEED TO FILE A REFUND CLAIM

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MORE MURPHY

August 24, 2006

As promised, bitter blogger Daniel Shaviro took his turn at the Murphy decision, the one that ruled that taxing personal non-physical damages was a constitutional violation. Bitter? Bitter and personal:

Ginsburg has one policy-minded hobby horse in the opinion. He abhors the idea that, under the Sixteenth Amendment, Congress can define income however it damn pleases. But again, if common sense were permitted under his theory of judging (if his biases can even be dignified with such a term), he would recognize that this (simply including gross and net receipts of cash) is not the place where policing by the courts is needed to make sure that our government remains one of limited and enumerated powers.

Meanwhile, Dr. Maule takes on a correspondent who unwisely suggested that the doctor's initial post was so off-base that he should take it down. You can view the massacre here.

The Wall Street Journal Law Blog has also finally noticed the excitement in the tax blogosphere. The Taxprof notes that big-time media is also picking up the story.

Academic response to Murphy is overwhelmingly negative, but if you want to hear a few good words about it, visit the comments at the TaxProf's place.

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FORESHADOWING

August 24, 2006

Bitter blogger tax prof Daniel Shaviro is back from vacation, and he promises a piece on the Murphy decision holding taxation of non-physical personal damages unconstitutional. I don't think he's going to agree with it:

Two quick thoughts, admittedly before reading it, are: (a) I am inclined to wonder if the good Judge has graduated from marijuana, his vice in the good old days, to crack cocaine; and (b) under the radical right judges we have these days, all kinds of doctrine that has been good since the 1930s is up for grabs.

Tax author Kaye A. Thomas has posted an article on Murphy: Judicial activism at its worst.

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MURPHY'S LAW, INDEED

August 23, 2006

With a night to sleep on it, I am more convinced that yesterday's D.C. Circuit decision in Murphy is unlikely to stand. I think there are two major flaws in the decision.

WHAT IS INCOME?

The first flaw is the decisions conclusion that the "framers" of the 16th amendment authorizing the modern income tax would have not considered damages for emotional distress "income." Joseph M. Dodge, in his essay in "Tax Stories," notes that there were at least two competing conceptions of income at the time. One concept was based on the "principal and income" concepts of trust law. One was the "Haig-Simons" concept, which more or less covers most of what we think of as income now. Murphy ignores this debate entirely and concludes on the thin evidence of an Attorney General opinion and a House committee report that "income" was a settled concept.

WHO CARES IF IT'S INCOME?

Once the Murphy court decided that damages for personal injuries weren't "income," they concluded that the tax on them was unconstitutional without further discussion. This appears to be the weakest part of their analysis.

The federal government has broad taxing powers. The courts struck down the pre-1913 income tax as a violation of the constitutional requirement that "direct" taxes be apportioned among the states based on population. Many non-income taxes are recognized as constitutional, including gift, estate and excise taxes. As one professor puts it:

Thus, in order to invalidate the tax in the Murphy case, it is not enough to hold that the award is not "income." It would be necessary further to hold that the tax is a "direct" one, prohibited by Article I -- and to explain why it is not otherwise authorized by the Necessary and Proper Clause. The court of appeals did not perform these analyses, and thus its opinion is woefully incomplete. My very rough sense is that the tax on the award in Murphy is authorized by Article I, section 8, and by the Necessary and Proper Clause, and, more importantly, is not a prohibited "direct" tax under Article I, section 9, just as with estate taxes (see Manufacturers National Bank, 363 U.S. 194) and gift taxes (see Bromley v. McCaughn, 280 U.S. 124).

(Emphasis added).

My point? Even if it's not income, compensatory damages are still subject to Congress's power to tax unless they are imposing a "direct" tax, which they probably aren't.

The TaxProf has a good roundup of links and discussion of Murphy (not mine, alas). One theme of a number of these links is the notion that the Murphy decision is just about a narrow issue of personal injury damages. It claims no such modest goals. It subjects every item subject to income to a test of what the word income meant in 1913; it settles on a "common understanding" of the term and potentially subjects every item now subject to the income tax to the 1913 definition. Every day many millions of dollars are exchanged in transactions undreamed of in 1913. Under this logic, what income can Congress safely tax?

I doubt the full D.C. Circuit, or the Supreme Court if it comes to that, will be willing to throw out the long-settled Glenshaw Glass approach of deference to Congress and introduce such disruption to the tax law.

Links:

Tax Update initial discussion of Murphy

Stuart Levine's discussion

UPDATE: Dr. Maule takes his shot at the decision:

Where the court goes haywire is its conclusion that section 104(a)(2) is unconstitutional. This conclusion reflects a total misunderstanding of how the Internal Revenue is structured. There is no need to comment on, or decide, the constitutional validity of section 104(a)(2), and doing so opens up a hornet's nest of problems.

Well worth reading in full.

ONE MORE UPDATE: The TaxProf now has commentary from 10 academics on Murphy. They don't have much good to say about the legal basis for the decision. One makes the point that the rest of us have perhaps been reluctant to make (glass houses and all that):

By the way, wasn't the opinion's author they guy who lost a seat on the Supreme's for smoking dope?

Like totally, dude!

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HAD A TAXABLE NON-PHYSICAL INJURY? MAYBE YOU NEED TO FILE A REFUND CLAIM

August 22, 2006

The Federal Appeals Court for the D.C. Circuit came out with a shocker of a tax case today (hat tip: Volokh Conspiracy). A 3-judge panel ruled that damages for personal injuries were not understood as income when the 16th Amendment was ratified; as a "return of human capital," says the court, such payments are not taxable.

In sum, every indication is that damages received solely in compensation for a personal injury are not income within the meaning of that term in the Sixteenth Amendment. First, as compensation for the loss of a personal attribute, such as wellbeing or a good eputation, the damages are not received in lieu of income. Second, the framers of the Sixteenth Amendment would not have understood compensation for a personal injury -- including a nonphysical injury -- to be income. Therefore, we hold § 104(a)(2) unconstitutional insofar as it permits the taxation of an award of damages for mental distress and loss of reputation.

A few years back Congress legislated that only damages for "physical" injuries would be tax-exempt, while damages for emotional injuries and the like would be taxable. This decision would strike that down. Taxpayers who extended 2002 until October 2003 with taxable injury income on their 2002 returns can keep their rights to a refund alive by filing a claim by October 15, 2006.

My initial thoughts: I would be very surpised to see this decision hold up, as it goes against what I understand to be the accepted constitutional wisdom. Constitutional attacks on the definition of income have failed almost invariably. Conventional scholarship, I believe, holds that "income" was not a particularly well-defined term when the income tax was enacted, and it took a series of Supreme Court cases, such as Glenshaw Glass and Eisner v. Macomber, to come to the current understanding. To say the "framers" of the 16th amendment would have said such damages would not be income relies on a settled definition of income that probably did not exist at the time.

Of course, I would not have expected any three judges to rule this way. The government will surely appeal, and the full D.C. circuit is likely to hear it; if the case survives the full panel, the Supreme Court will surely take the case. We'll be hearing a lot more about this decision in the coming weeks, for sure.

This holding would be huge, if upheld. If it is, expect a wave of challenges to other parts of the tax law covering all sorts of items that weren't thought of in 1913, from original issue discount to gain on stock option excercise. It will be a golden era for tax litigators and a nightmare for Congress and the Treasury.

Cite: Murphy, No. 05-5139 (CA-DC)

UPDATE: After thinking about it during the lunch hour, the obvious occurred to me: this thing is going to trigger lots of refund claims in all sorts of areas starting right now. A great many corporations extend their return, and their 2002 statute of limitations expires September 15. Let the gold rush begin.

The TaxProf now has a post up on Murphy, including this from UCLA lawprof Steve Bank:

More importantly, during this period, the definition of income was far from settled. The income tax was only five years old and Congress was borrowing from economic definitions, legal definitions, and popular definitions. The economic understanding of the term “income” at the time was arguably evenly split between those advocating an accretion tax notion of income (e.g., Haig) and those advocating a consumption tax notion of income (e.g., Fisher). The latter would not have supported a tax on capital gains, although the Supreme Court held that it was permissible in a 1921 decision. As I have argued in the context of tax-free reorganizations, the provisions adopted in 1918 were an attempt to compromise between these conflicting definitions of income so as to assure a proper revenue to pay for war expenses while still maintaining the appearance of fairness and responding to heavy lobbying from business and the wealthy. The notion of taxing people who recovered damages during this war period may have violated our sense of fair play when war profiteers were seeking to avoid paying tax on their bounty.

This from the Appellate Law and Practice blog: "And so the misguided fires of tax protesters are stoked once again."

"How Appealing" also weighs in.

Also a good comment thread has started at the Volokh (Orin Kerr) post listed above.

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