Sylvius von Saucken, a partner in the Garretson firm, has written this analysis of the opinion in Murphy v. United States, released by D.C. Court of Appeals on July 3, 2007. The case addresses the taxability of damage awards in cases alleging emotional distress.
Here, in bold, is his analysis of the decision:
On July 3, 2007 the highly anticipated Murphy decision was handed down following its rehearing on April 23, 2007. The original three judge panel (for the D.C. Court of Appeals) reheard the case following the Government’s Petition for a Rehearing En Banc. This case has a rather unusual procedural history because it is atypical for a court to vacate its own opinion, which in turn renders an existing Petition for a Rehearing en banc moot, and then rehear the case. The court’s impetus for doing so remained a mystery up until Tuesday. In the recent decision the court explained its actions. In its Petition for a rehearing the Government raised a new constitutional issue, as the Government argued “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.” This issue apparently triggered the court to vacate its earlier opinion and effectively gave the Government another try.
The initial opinion, issued last August was decided in favor of Murphy, but this time the same court’s three-judge panel turned about-face and held:
1. Murphy’s compensatory award was not received on account of personal physical injuries, it was for non-physical emotional distress, with the physical manifestations (bruxism, etc.) being used to prove those emotional injuries, therefore is not exempt from taxation pursuant to §104(a)(2) of the IRC;
2. The award is a part of her “gross income,” as defined by § 61 of the IRC; regardless of whether the award was an accession to wealth.
3. The tax upon the award is an excise and not a direct tax subject to the apportionment requirement of Article I, Section 9 of the Constitution.”
The court agreed with the Government’s argument that the most important language of §104(a)(2) is the phrase “on account of” and not the portion “personal injuries or sickness” as argued by Murphy.4* In so holding, the court clarified that damage awards are now taxable unless they are “on account of “personal physical injury, or physical sickness.”” The court based its decision on the Administrative Law Judge’s (ALJ) classification of damages from the prior administrative hearing. In that hearing the damages awarded to Murphy were on account of non-physical injuries, notwithstanding the physical symptoms or sickness evidence used to prove those non-physical injuries. The court found the ALJ’s classification sufficient to void the applicability of §104(a)(2).
Next, the court clarified that in order to give effect to the 1996 Amendment to §104(a)(2), that code section must be read in conjunction with §61. If the sections are mutually exclusive the amendments would have no “real [or] substantial effect.” Therefore, the court presumed that Congress intended §61 to include non-physical injuries in the definition of gross income.
Perhaps the most intriguing argument Murphy raised before the court the first time was that the award is a restoration of her human capital, and as such, is not an accession (increase) to wealth, thus is not taxable. This argument, if successful, had the potential to judicially expand the category of damages exempt from taxation. In the first round, the court gave merit to this argument (p.17 slip opinion). This time, however, the court rejected this theory.
The court noted Murphy’s and the Government’s arguments but focused on the “heart of the matter” – whether the award is properly included in the definition of gross income within §61(a).
The court first looked to the statute but saw no implication that “all income from whatever source derived” included Murphy’s award. Murphy argued that emotional distress damages are not listed in the examples of §61, and ambiguities in revenue raising statutes should be resolved in favor of the taxpayer. The court addressed this argument by reading §61 in conjunction (in pari materia) with §104(a)(2) – to get the complete picture.
In the court’s view, the picture became so clear that the use of statutory interpretation techniques were not necessary. The court focused on the 1996 Amendment to §104(a)(2), reasoning that if damages received from emotional distress were not intended to be taxed under §61(a), that would render the 1996 Amendment meaningless, as it explicitly provided emotional distress damages are not personal injuries or sickness, thus clarifying that an award received on account of emotional distress damages is not excluded from gross income under §104(a)(2). To render the Amendment effective, the court reasoned that the 1996 Amendment of §104(a)(2) “strongly suggests” §61 should be read to include an award for damages from non-physical harms.”
As a result, the court held that §61(a) includes an award for non-physical damages such as Murphy received, regardless of whether the award is an accession to wealth.
Simply put, this decision further underscores the importance of damage classifications and evidentiary proof of damages. Such classifications must be established from either the outset of a case or through a stipulation, the failure to do so can have devastating tax implications on our clients.
Ms. Murphy will likely continue her fight and we will, therefore, keep you apprised of any subsequent news or decisions impacting the way personal injury judgments or settlements are taxed in the future.
The Murphy docket number is No. 03cv024114; read the entire opinion for yourself here.