Court Reverses Itself on Key Tax Case

Published on July 03, 2007

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Court Reverses Itself on Key Tax Case

New decision setback for whistleblowers and civil rights victims.

Washing, D.C. – July 3, 2007. The U.S. Court of Appeals for the District of Columbia Circuit reversed itself on a key civil rights tax case and held that the IRS can tax damage awards based solely on compensating victims who suffer emotional injuries. On August 22, 2006 the same court held that such taxes were unconstitutional, as compensation for a documented “loss” was not “income” subject to the tax code.

In a major reversal, the Court held that compensation for personal injuries are taxable.

The case arose as a result of the Department of Labor ruling in the whistleblower case of Marrita Murphy. In that case, the Labor Department held that Ms. Murphy suffered substantial damages to her health and reputation, and awarded her $70,000 in compensatory damages strictly related to her losses.

The IRS taxed Ms. Murphy’s damages and she asked for a refund of the tax on the grounds that her damages were not income.

I an August 22, 2006 decision, the U.S. Court of Appeals for the D.C. Circuit agreed with Ms. Murphy, and found that compensation limited to making a human being whole for actual documented losses to physical or mental health were not subject to an income tax. The IRS forcibly appealed that decision and the Appeals Court agreed to vacate its original decision and hear reargument on the case.

On rehearing the IRS urged the Court to treat damages to people differently from damages to property. The IRS contended that compensation awarded to a person for the loss of an arm or a leg was not payment to make a person “whole,” but was payment obtained as part of a “forced sale.” In other words, if a person suffered a mental breakdown after witnessing her/his child being murdered, payment for that mental breakdown was taxable – as the victim (according to the IRS) simply was “forced” to sell his or her mental health, and obtained “income” based on the forced sale theory.

In a remarkable reversal of its prior decision, the Court adopted this baseless argument. The Court held as follows:

Murphy’s situation seems akin to an involuntary conversion of assets; she was forced to surrender some part of her mental health and reputation in return for monetary damages.

Murphy v. IRS, p. 2.

“The Court’s reversal stands reality on its head,” said David K. Colapinto, who argued on behalf of Ms. Murphy. “When whistleblowers suffer retaliation, they do not ‘sell’ their mental health. If people are injured in a car accident, they do not ‘sell’ their arms and legs. These are real human losses, and compensation to restore that human loss was never intended to be ‘income’ under our Constitution or the tax code.”

Stephen M. Kohn, the President of the National Whistleblowers Center and co-counsel for Ms. Murphy, stated: “This decision is a terrible setback for all victims of civil rights abuses. it permits Congress to enact retaliatory taxes, stripping people from the Constitutional protections afforded property. Damages to whistleblowers are not part of a business transaction – forced or otherwise. They are part of harm caused by illegal conduct. This decision threatens fundamental human rights.”

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