Whistleblower Wins Major Tax Ruling

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Whistleblower Wins Major Tax Ruling

IRS taxing of non-wage damages is “unconstitutional”

August 22, 2006, Washington, D.C. —  The U.S. Court of Appeals for the District of Columbia Circuit issued a landmark ruling today holding that wrongfully fired whistleblowers do not have to pay taxes on “make whole” non-wage damage awards for loss of reputation and emotional distress.   Chief Judge Douglas H. Ginsburg, writing for a unanimous three-judge panel of the D.C. Circuit, decided in Murphy v. IRS, that the Sixteenth Amendment of the U.S. Constitution limits Congress’s taxing authority to “income,” thus making damages awarded for emotional distress and reputational harm not “income” under the federal tax code.

The sole issue, decided by the court, was whether or not non-wage damages for injuries to emotional distress and damage to reputation were taxable as income. The case did not involve the taxing of any wages or other income.

Since 1996, when Congress, for the first time, changed the law to tax such emotional distress and reputational harm damages awarded in civil suits, hundreds of whistleblowers and other victims of discrimination have been forced to pay taxes on “make whole” remedies – regardless of the extent of the harm.

In today’s opinion, the court ruled as follows:

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 in an 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.’  In the alternative, she maintains § 104(a)(2) is unconstitutional insofar as it fails to exclude from gross income revenue that is not ‘income’ within the meaning of the Sixteenth Amendment to the Constitution of the United States.

We hold, first, that Murphy’s compensation was not ‘received … on account of personal physical injuries’ excludable from gross income under § 104(a)(2). We agree with the taxpayer, however, that § 104(a)(2) is unconstitutional as applied to her award because compensation for a non-physical personal injury is not income under the Sixteenth Amendment if, as here, it is unrelated to lost wages or earnings.

Murphy v. IRS, Slip Op. at 2 (emphasis added).

The court also held:

Murphy’s compensatory award in particular was not received “in lieu of” something normally taxed as income; nor is it within the meaning of the term “incomes” as used in the Sixteenth Amendment.  Therefore, insofar as § 104(a)(2) permits the taxation of compensation for a personal injury, which compensation is unrelated to lost wages or earnings, that provision is unconstitutional.

Murphy v. IRS, Slip Op. at 24 (emphasis added).

David K. Colapinto, who successfully argued the case, said, “The government had the audacity to argue that non-wage compensatory damages for emotional distress and loss of reputation can be taxed as income because the economic value of human life is zero. The taxing of non-wage damages is highly destructive and punishes whistleblowers and other civil rights plaintiffs for prevailing in their cases. Hopefully, today’s ruling will stop this arcane and regressive policy.”

Stephen M. Kohn, the Chairperson of the National Whistleblowers Center, also said the following:

For over four years the Center has supported Ms. Murphy’s challenge to the cruel and discriminatory practices of the IRS.  By taxing their “make whole” remedies, the IRS ensured that no whistleblower could ever receive justice.  Instead of limiting tax liability of prevailing whistleblowers to wage claims, the IRS – with wanton disregard to the U.S. Constitution – imposed taxes on whistleblowers for their non-wage, emotional distress and reputational harm damages.   These actions resulted in numerous injustices and undermined Congress’s intent to ensure that whistleblowers – and other victims of intentional discrimination, were made whole.

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