Murphy and the Sixteenth Amendment in Relation to the Taxation of Non-Excludable Personal Injury Awards

Abstract

A recent panel decision of the U. S. Court of Appeals for the District of Columbia, Murphy v. Internal Revenue Service, shocked the tax community by holding that Internal Revenue Code section 104(a)(2) was unconstitutional by failing to exclude from gross income revenue (damages for emotional distress and injury to professional reputation) that is not “income” under the Sixteenth Amendment to the U.S. Constitution.
A petition for rehearing en banc was filed, but, in a highly unusual move, the D.C. Circuit panel that decided the case, on its own motion, vacated its judgment and set the case for re-argument.
Before 1996, section 104(a)(2) had excluded from gross income compensatory damages on account of personal injuries, including non-physical personal injuries of the type suffered by plaintiff Murphy. In 1996, Congress narrowed the exclusion so that it only applied to damages on account of physical personal injuries, thereby removing the exclusion for non-physical injuries. The panel stated its constitutional holding as follows:
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.
Part I contains a brief description of the federal constitutional provisions concerning taxation and how they are related to each other. Part II discusses the issue of how to interpret the Sixteenth Amendment. Part III considers the on-the-merits exclusionary theories offered by the Murphy panel.