Reaction to Murphy vs IRS ruling.
Sunday, August 27, 2006 at 12:45PM As you might expect, the reaction in the tax and legal community to the Murphy vs IRS decision, ( also listed by some commentators as Murphy vs United States) has been been one of "shock and awe".
Most of the tax and legal community, not to mention industry lobbyists, were caught by surprise when this ruling came down last week, essentially declaring pain and suffering, mental anguish and other previously taxable elements of certain types of personal injury cases as having been unconstitutionally taxed and in violation of the 16th amendment. Certainly amazing stuff.
Since then there has been some instant analysis, some of it provided by our own commentators here on The Settlement Channel, such as the podcasts provided by national expert Attorney Robert Wood. Those podcasts are available by clicking here for part one, and clicking here for part two.
However, we don't have a corner on commentary and i've collected a few links i've found by cruising on Taxprof Blog, Google and other sites dedicated to tax policy.
Among them are some of the more powerful critiques as to why this is Bad Law, which I don't agree with but think you need to hear both sides on this. Also, a highly recommended academic paper by Georgetown Professor Stephen Cohen in which he had prior to Murphy argued against the status of taxing non-personal injury damages differently then physical injury cases. I don't usually get into reading about "human capital" and tax policy but I put this down as recommended reading.
Summary of blog commentary is available here on TaxProf Blog/
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Reader Comments (4)
It's not necessarily bad law, it's how they arrived at the solution. To say that non-physical injuries shouldn't be taxed is the way to go (like 104a2 was prior to 1996). It has always bothered me that a wrongful imprisonment case or sexual harassment case was taxable but a bruised toe was. Try to tell a victim of molestation that they weren't really injured by IRS standards, that it's really income.
Now, to say that Congress can't tax things that aren't income is just too radical. What about gift taxes? Or disability payments? Those get taxed but aren't income. We know that the IRS isn't going to sit back on this one.
Do you think this attention focused on 104a2 is a good or bad thing for our industry? Could we see the pendulum swing the other way and find physical injury cases under attack by the IRS?
Jack
To your first point, I agree, the taxation of non-physical damages was fundamentally unfair, with it further compounded by the fact that the attorney fee wasn't/isn't deductible on taxable cases as well. You had the perversity of people actually owing money to the government after some awards and how is that making anyone whole?
I think some of the commentary on this being an attack on Congressional power to impose income taxes under the 16th ammendment is a bit over blown. What Ginsburg appears to be saying is there are limits as to what Congress can define as income/earnings and just their saying it's so, doesn't make it so. This is what the judiciary is about, the protection of the citizen against the excesses of the government, and if you read his opinion it really smacks of a conservative judge saying, ok, this is the line in the sand, enough now. Go back and give a valid reason why it's income, why the government is entitled to taxing it and lets try this again.
I expect there will be an appeal to the US District Court in DC to reconsider, but i'm not all that sure there will be an appeal to the Supreme Court by the IRS. Rob Wood makes the point in our podcast that the risk of losing at the Supreme Court might be greater then we realize, and a ruling at the Supreme Court level affirming Murphy could really throw a lot of issues into the air. They might choose to simply let sleeping dogs lie knowing the ruling only applies to that district.
Finally, I'm not at all convinced that attention focused on 104a2 is a bad thing. We seem to have this industry posture of hoping no one notices us and that we can keep this tax break going. Most commentators, liberal, conservative and liberatarian all seem to be in solid agreement that 104a2 is equitable and just and I don't see much writing where it is under attack by anyone. I'd be suprised if this led to a wholesale review of tax equity and 104a2.
Any Settlement for physical and/or emotional abuse should not be taxable, because Section 104(a) (2) excludes from gross income “the amount of any damages (other than punitive damages) received (whether by suit or agreement and whether as a lump sum or as periodic payments) on account of personal physical injuries or physical sickness.
Section 104(a)(2) is premised on the assumption that physical and nonphysical injuries should be compensated (and taxed) differently. Scientifically, the distinction between the mind and the body is a false perception, and making a “distinction between physical and nonphysical harm for the purposes of tax law is a destructive dualism that has the effect of discriminating against women and minorities.” (Laura Spitz – “I Think, Therefore I Am; I Feel, Therefore I am Taxed: Descartes, Tort Reform, and Civil Rights Tax Relief Act). It is not within the IRS’s scope of practice to make such profound philosophical and scientific distinctions.
Settlements for damages for emotional harm should compensate plaintifs for both physical and psychiatric injuries, which are not distinguishable. Physical illness has a psychiatric component, just as psychiatric illness has a physical component and the concept that there can be a division between mind and body is as ignorant of medicine and science as contending that the Earth is at the center of the Universe. Migraine Headaches, Insomnia, and GI Disturbance are physical injuries. PTSD is a Psychiatric Diagnosis with a syndrome of physically manifested illnesses including, but not limited to hyperlipidemia, cardiovascular disease, endocrine disorders, sleep disorders, eating disorders, headaches, and so forth, some manifestations of which do not present immediately. The Veterans Health Administration will give 100% Service-Connected Disability for Veterans who suffer from PTSD.
For these reasons, the damages award victims of sexual molestation receive are, in fact, received on account of personal physical injuries and are not taxable under Code section 104(a)(2).
2. Unfair and Excessive Taxation of Civil Rights Settlements is Unconstitutional as it is a FIRST AMENDMENT VIOLATION
Although I agree with Murphy, I am not arguing that what I perceive to be unfair taxation of Civil Rights Taxation as it pertains to the Sixteenth Amendment. I am arguing that unfair taxation of Civil Rights Cases by IRS is a First Amendment Violation and is therefore unconstitutional and discriminatory.
On February 18, 2003, in Coszalter v. City of Salem, the Court of Appeals for the Ninth Circuit held that “in a First Amendment retaliation case, an adverse employment action is an act that is reasonably likely to deter employees from engaging in constitutionally protected speech.” The court also held that “when adverse employment actions are taken between three and eight months after the plaintiffs’ protected speech, a reasonable jury could infer that retaliation is a substantial or motivating factor.”
Unfair and excessive tax treatment by the IRS of settlements and awards in employment Civil Rights cases is REASONABLY LIKELY TO DETER employees from engaging in protected constitutionally protected speech. In fact, such excessive and unfair taxes can be considered retaliatory and an attempt to deter employees from filing Civil Rights Cases and attorneys from representing employees whose Civil Rights have been violated. The IRS should not be entitled to retaliate against certain groups of tax payers who speak up against Civil Rights Violations (Sexual Harassment, Whistle Blowing, and Racial Discrimination) and should be held to the same or higher standard as government and other employers. (Coszalter v. City of Salem, Court of Appeals for the Ninth Circuit).
In Coszalter, the court correctly held that defendants’ actions were adverse employment actions. In making its determination, the court correctly emphasized the fact that a government employer (and I would extend this to the IRS or any other government agency) cannot abuse its position and interfere with the constitutional right to exercise freedom of expression guaranteed to employees under the First Amendment. I would ask the court to extend this ruling to the IRS, a Government Agency that is abusing its position in order to discriminate against citizens who speak up against unlawful employment discrimination, whistle blowing – often against government employers, and sexual harassment by creating arbitrary tax laws. Ironically, the IRS is discriminating against those who file unlawful discrimination cases.
Prior to the amending Section 62 (a) of the American Job Creations Act of 2004 (“Act”) on October 22, 2004, those who received settlements for unlawful discrimination cases could not deduct attorneys’ fees and were taxed on the total settlement. Potentially, a victim of such discriminatory tax laws could spend years fighting a case and end up receiving nothing, and in fact, owing the IRS taxes due to the taxation of attorneys’ fees. This obviously unfair and excessive tax injustice has finally been resolved.
Today, there remain two major sources of excessive and unfair taxes in such cases:
1. Taxation of damages for noneconomic harm that employees suffer as a result of egregious, intentional harassment, retaliation, or similar workplace wrongs; and
2. Taxation of lump-sum settlements or awards that compensate for lost back pay over a period of years at the artificially high marginal tax rates of the year of receipt.
These taxes drive up the cost of settlement of workplace-related cases for America’s businesses, while at the same time reducing recoveries for victims of discrimination. They also create unfair and arbitrary distinctions among taxpayers. (National Employment Lawyers Association – NELA)
Unfair and excessive taxation of Civil Rights Settlements by the IRS would appear to be intentional and outrageous and done for the purpose of causing government employees who exercise their First Amendment Rights and speak up against racial discrimination, sexual harassment, and threats to Public Health and Public Safety to suffer further insult and financial injury. These unfair tax laws were and continue to be enforced with reckless disregard of the consequences to those seeking relief for the actions of their employers. In imposing excessive and unfair taxation on unlawful discrimination, whistle blower, and sexual harassment settlements, I believe it is done by the IRS for the purpose of making an example of those who settle or litigate their cases to other government employees not to comment on or criticize the practices related to their employer.
“Often the very act of whistle blowing indicates that governmental regulation has been inadequate to protect the public; it represents a breakdown of systems whose very goal is to make sure that misconduct does not occur in the first place.” Winters v. Houston Chronicle Publ’g Co., 795 S.W.2d 723, 729 (Tex. 1990)).
"In a dynamic society where breakdowns of systems are inevitable, the whistleblowing employee provides the public some assurance that the government is functioning properly, especially in the areas of safety and health. In this case, plaintiffs Coszalter,
Jones, and Johnson were punished for speaking out against their employers regarding safety and health violations. However, the Ninth Circuit protected these plaintiffs from their employer’s adverse employment actions. In so doing, the Ninth Circuit has provided the necessary protections to future employees who are faced with similar circumstances as the plaintiffs faced in this case" (David Uchida∗)
The Civil Rights Tax Relief Act provides the same necessary protections to employees who finally receive settlements by protecting the employee from unfair taxation and further retaliation by another government agency. (IRS) Unfair taxation of Civil Rights Cases is egregious and flies in the face of the whistle blower protection act.
The decision to uphold the Civil Rights Tax Relief Act solidifies the concept that when a government employer attempts to retaliate against a whistleblowing employee for speaking up about workplace violations, misuse of Taxpayers money, and threats to Public Health and Public Safety, the First Amendment will rightfully protect the outspoken employee from retaliation both from his employer and from the IRS.
Any Settlement for physical and/or emotional abuse should not be taxable, because Section 104(a) (2) excludes from gross income “the amount of any damages (other than punitive damages) received (whether by suit or agreement and whether as a lump sum or as periodic payments) on account of personal physical injuries or physical sickness.
Section 104(a)(2) is premised on the assumption that physical and nonphysical injuries should be compensated (and taxed) differently. Scientifically, the distinction between the mind and the body is a false perception, and making a “distinction between physical and nonphysical harm for the purposes of tax law is a destructive dualism that has the effect of discriminating against women and minorities.” (Laura Spitz – “I Think, Therefore I Am; I Feel, Therefore I am Taxed: Descartes, Tort Reform, and Civil Rights Tax Relief Act). It is not within the IRS’s scope of practice to make such profound philosophical and scientific distinctions.
Settlements for damages for emotional harm should compensate plaintifs for both physical and psychiatric injuries, which are not distinguishable. Physical illness has a psychiatric component, just as psychiatric illness has a physical component and the concept that there can be a division between mind and body is as ignorant of medicine and science as contending that the Earth is at the center of the Universe. Migraine Headaches, Insomnia, and GI Disturbance are physical injuries. PTSD is a Psychiatric Diagnosis with a syndrome of physically manifested illnesses including, but not limited to hyperlipidemia, cardiovascular disease, endocrine disorders, sleep disorders, eating disorders, headaches, and so forth, some manifestations of which do not present immediately. The Veterans Health Administration will give 100% Service-Connected Disability for Veterans who suffer from PTSD.
For these reasons, the damages award victims of sexual molestation receive are, in fact, received on account of personal physical injuries and are not taxable under Code section 104(a)(2).
2. Unfair and Excessive Taxation of Civil Rights Settlements is Unconstitutional as it is a FIRST AMENDMENT VIOLATION
Although I agree with Murphy, I am not arguing that what I perceive to be unfair taxation of Civil Rights Taxation as it pertains to the Sixteenth Amendment. I am arguing that unfair taxation of Civil Rights Cases by IRS is a First Amendment Violation and is therefore unconstitutional and discriminatory.
On February 18, 2003, in Coszalter v. City of Salem, the Court of Appeals for the Ninth Circuit held that “in a First Amendment retaliation case, an adverse employment action is an act that is reasonably likely to deter employees from engaging in constitutionally protected speech.” The court also held that “when adverse employment actions are taken between three and eight months after the plaintiffs’ protected speech, a reasonable jury could infer that retaliation is a substantial or motivating factor.”
Unfair and excessive tax treatment by the IRS of settlements and awards in employment Civil Rights cases is REASONABLY LIKELY TO DETER employees from engaging in protected constitutionally protected speech. In fact, such excessive and unfair taxes can be considered retaliatory and an attempt to deter employees from filing Civil Rights Cases and attorneys from representing employees whose Civil Rights have been violated. The IRS should not be entitled to retaliate against certain groups of tax payers who speak up against Civil Rights Violations (Sexual Harassment, Whistle Blowing, and Racial Discrimination) and should be held to the same or higher standard as government and other employers. (Coszalter v. City of Salem, Court of Appeals for the Ninth Circuit).
In Coszalter, the court correctly held that defendants’ actions were adverse employment actions. In making its determination, the court correctly emphasized the fact that a government employer (and I would extend this to the IRS or any other government agency) cannot abuse its position and interfere with the constitutional right to exercise freedom of expression guaranteed to employees under the First Amendment. I would ask the court to extend this ruling to the IRS, a Government Agency that is abusing its position in order to discriminate against citizens who speak up against unlawful employment discrimination, whistle blowing – often against government employers, and sexual harassment by creating arbitrary tax laws. Ironically, the IRS is discriminating against those who file unlawful discrimination cases.
Prior to the amending Section 62 (a) of the American Job Creations Act of 2004 (“Act”) on October 22, 2004, those who received settlements for unlawful discrimination cases could not deduct attorneys’ fees and were taxed on the total settlement. Potentially, a victim of such discriminatory tax laws could spend years fighting a case and end up receiving nothing, and in fact, owing the IRS taxes due to the taxation of attorneys’ fees. This obviously unfair and excessive tax injustice has finally been resolved.
Today, there remain two major sources of excessive and unfair taxes in such cases:
1. Taxation of damages for noneconomic harm that employees suffer as a result of egregious, intentional harassment, retaliation, or similar workplace wrongs; and
2. Taxation of lump-sum settlements or awards that compensate for lost back pay over a period of years at the artificially high marginal tax rates of the year of receipt.
These taxes drive up the cost of settlement of workplace-related cases for America’s businesses, while at the same time reducing recoveries for victims of discrimination. They also create unfair and arbitrary distinctions among taxpayers. (National Employment Lawyers Association – NELA)
Unfair and excessive taxation of Civil Rights Settlements by the IRS would appear to be intentional and outrageous and done for the purpose of causing government employees who exercise their First Amendment Rights and speak up against racial discrimination, sexual harassment, and threats to Public Health and Public Safety to suffer further insult and financial injury. These unfair tax laws were and continue to be enforced with reckless disregard of the consequences to those seeking relief for the actions of their employers. In imposing excessive and unfair taxation on unlawful discrimination, whistle blower, and sexual harassment settlements, I believe it is done by the IRS for the purpose of making an example of those who settle or litigate their cases to other government employees not to comment on or criticize the practices related to their employer.
“Often the very act of whistle blowing indicates that governmental regulation has been inadequate to protect the public; it represents a breakdown of systems whose very goal is to make sure that misconduct does not occur in the first place.” Winters v. Houston Chronicle Publ’g Co., 795 S.W.2d 723, 729 (Tex. 1990)).
"In a dynamic society where breakdowns of systems are inevitable, the whistleblowing employee provides the public some assurance that the government is functioning properly, especially in the areas of safety and health. In this case, plaintiffs Coszalter,
Jones, and Johnson were punished for speaking out against their employers regarding safety and health violations. However, the Ninth Circuit protected these plaintiffs from their employer’s adverse employment actions. In so doing, the Ninth Circuit has provided the necessary protections to future employees who are faced with similar circumstances as the plaintiffs faced in this case" (David Uchida∗)
The Civil Rights Tax Relief Act provides the same necessary protections to employees who finally receive settlements by protecting the employee from unfair taxation and further retaliation by another government agency. (IRS) Unfair taxation of Civil Rights Cases is egregious and flies in the face of the whistle blower protection act.
The decision to uphold the Civil Rights Tax Relief Act solidifies the concept that when a government employer attempts to retaliate against a whistleblowing employee for speaking up about workplace violations, misuse of Taxpayers money, and threats to Public Health and Public Safety, the First Amendment will rightfully protect the outspoken employee from retaliation both from his employer and from the IRS.