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Sunday, September 03, 2006


While taxpayers may often assert constitutional arguments against the enforcement of the Internal Revenue Code, the actual finding of a provision to be unconstitutional is an extremely rare event. Subject to possible review by the U.S. Supreme Court, the U.S. Circuit Court of Appeals for the District of Columbia circuit did just that in the recent case of Murphy v. United States, No. 05-5139.

For the nonlawyers, a little constitutional background is helpful. Until the 16th Amendment to the U.S. Constitution was enacted, an income tax was not allowed. The 16h Amendment allows a tax on income, and Section 61 of the Internal Revenue Code imposes such a tax on "gross income." The U.S. Supreme Court in Helvering v. Clifford has found these provisions coextensive. It has further found that "income" means "gain derived from capital, from labor, or from both combined" (Eisner v. Macomber), and further includes all "accessions to wealth" (Commissioner v. Glenshaw Glass).

The issue in the instant case was whether a damage award for mental distress is "income" when not arising from a physical injury or physical sickness. Section 104(a) of the Code provides that gross income does NOT include the amount of damages (other than punitive damages) received on account of physical injury or physical sickness. In 1996, Congress amended the Section to further provide that "emotional distress shall not be treated as a physical injury or physical sickness" - so that mere emotional distress would not fall within the Section 104(a) exclusion from gross income.

The taxpayer challenged the 1996 amendment, claiming that the new provision is unconstitutional since by treating emotional distress damages as income, Congress is including as income something that is not income under the 16th Amendment authorizing a tax on income. The Circuit Court noted that Congress does not have the power to declare any economic benefit as income, but is bound by what was intended to be included as income under the 16th Amendment. After reviewing interpretations of the term "income" from around the time of the enactment of the 16th Amendment in 1913, and that damages for emotional distress are similar to physical damages in that they are a return of damaged "human capital" and not an asccession to wealth, the Circuit Court held that Section 104(a) is unconstitutional to the extent "it permits the taxation of an award of damages for mental distress and loss of reputation."

This finding has far reaching consequences in the area of employment law, where damages often relate to mental distress without any physical sickness or illness.

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