Taxability of Damage Awards

The D.C. Circuit Court of Appeals has released an en banc  opinion in Murphy v. Internal  Revenue Service,  No. 05-5139 (July 3, 2007).

The summary of the opinion as prepared by the Court:  "Marrita Murphy brought this suit to recover income taxes she paid on the compensatory damages for emotional distress and loss of reputation  she was awarded inan administrative action she brought against her former employer. Murphy contends that under § 104(a)(2) of the Internal Revenue Code (IRC), 26 U.S.C. § 104(a)(2), her award should have been excluded from her gross income because it was compensation received “on account of personal physical injuries or physical sickness.” She also maintains that, in any event, her award is not part of her gross income as defined by § 61 of the IRC, 26 U.S.C. § 61. Finally, she argues that taxing her award subjects her to an unapportioned direct tax in violation of Article I, Section 9 of the Constitution of the United States.

We reject Murphy’s argument in all aspects. We hold, first, that Murphy’s compensation was not “received … on account of personal physical injuries” excludable from gross income under §104(a)(2). Second, we conclude gross income as defined by § 61 includes compensatory damages  for non-physical injuries. Third, we hold that a tax upon such damages is within the
Congress’s power to tax."

Read the entire opinion here.