The Goal Is Freedom: "Congressional Generosity" and the Power to Tax

January 19, 2007

by Sheldon Richman

Every now and then we get a glimpse into what government officials really think about our rights to life, liberty, and property. The U.S. Justice Department recently provided such a glimpse in a controversial tax case, Murphy v. IRS.

How revealing it is! Did you know that if the government abstains from taxing all your income, you should be grateful for this "congressional generosity"?

To recap the case, Marrita Murphy was awarded $70,000 in compensatory damages for the mental distress and loss of reputation she claimed to have suffered after she acted as a whistleblower against her employer, the New York Air National Guard. She paid about $20,000 in federal income taxes on that money, but later asked for a refund on grounds that the damage award should have been excluded from her gross income under §104(a)(2) of the Internal Revenue Code (Title 26 of the U.S. Code), which states:

gross income does not include --

. . . (2) the amount of any damages (other than punitive damages) received (whether by suit or agreement and whether as lump sums or as periodic payments) on account of personal physical injuries or physical sickness . . . .

The IRS rejected the request for a refund because her injuries were nonphysical and the section specifies "physical injuries." When she sued in federal district court she lost.

Murphy appealed to the U.S. Court of Appeals for the District of Columbia Circuit. She argued that the compensation was covered by §104(a)(2) but if not, then the section is unconstitutional because it would permit the taxation of money that is not included in the constitutional and statutory meaning of "income."

The government rebutted that Murphy's injuries were nonphysical -- and hence not included in §104(a)(2) -- and that IRS policy was consistent with the concept of "income" as used since the Sixteenth Amendment was ratified in 1913.

In August a three-judge panel stunned the government by ruling in Murphy's favor that §104(a)(2) is unconstitutional: "[T]he framers of the Sixteenth Amendment would not have understood compensation for a personal injury -- including a nonphysical injury -- to be income." (The opinion is here [pdf]. Point of historical fact: the Amendment did not delegate to the government the power to tax wages and other income. According to the courts, it always had that power. See "Is the Income Tax Unconstitutional?")

Before anyone could recover from the shock of having part of the tax code declared unconstitutional, the judges shook the tax world again. In October the Bush administration's Department of Justice petitioned to have the case heard by the circuit court's entire complement of judges (en banc). However, before the court could rule on the petition, the original three judges announced they would rehear the case themselves. Tax watchers couldn't remember when this kind of thing last happened and speculated that the panel realized it had erred and wanted to reverse itself rather than be reversed.

The case will be reheard in April. The glimpse into the Justice Department's thinking is provided by its 19-page petition (pdf) for rehearing, which details its grounds for believing the court wrongly decided the case. The petition is revealing and chilling.


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