A federal appeals court ruled this week that awards for nonphysical injuries (emotional distress, for example) are taxable as income under the Constitution.
That makes sense, right?
It would – except that the same court ruled exactly the opposite about a year ago. Damages for personal injuries have been tax exempt for purposes of federal income tax since 1996. However, money received for emotional distress and other intangible injuries has been taxable until the ruling last year. At the time, I thought the ruling was a bit maverick, predicting that, if the ruling stood it would make it all of the way to the Supreme Court.
It didn’t stand. The court has now ruled that taxing awards for nonphysical damages does not violate the Constitution. The ruling came about in response to a claim by the IRS that Marrita Murphy owed $20,665 in taxes as a result of her $70,000 award in a whistle-blower suit. The award was for nonphysical injuries, and the court agreed last year that it was exempt from taxation. After arguments from the government, the court reversed itself.
Such reversals are unusual. This one was criticized by – you guessed it – Mrs. Murphy and her lawyers.
While I feel for Ms. Murphy (I don’t even want to think what her legal bills are like), I believe that this is the correct ruling. Awards in these kinds of cases (in this instance, it was a whistle-blower matter) are meant to punish the defendant – not give the plaintiff a windfall. In contrast, awards for personal injury are not (in theory) meant to punish the defendant but make the plaintiff whole. Those are different results and should be taxed differently.
Everyone should pay their fair share, right?
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The facts are wrong in your report. Awards in these kinds of cases (in this instance, it was a whistle-blower matter) are NOT meant to punish the defendant – RATHER Ms. Murphy’s compensatory damages award, which is based on tort-like remedies, are designed to make the plaintiff whole. The court ruled that all awards for personal injury are now taxable. While you are correct that personal injury awards should be taxed differently because they are “make whole” relief, you missed the entire point of the court’s decision. This court is ruling that “make whole” personal injury awards are taxable.
Editor’s note: the commenter above, David Colapinto, is the attorney in the case who represented Ms. Murphy.
Please correct the mis-information and factual errors reported about Ms. Murphy’s award that you posted on your blog. As previously pointed out in my earlier comment, Ms. Murphy did not receive damages to punish the employer and she only received “make whole” tort-type damages to restore her personal injury losses. This point is crucial to your analysis which is wrong because you assumed Ms. Murphy did not receive tort-type “make whole” damages. Please correct your blog immediately because your factual errors are being reported on other blogs. See, http://wanderingtaxpro.blogspot.com/2007/07/murphys-law.html
Thank you.
David K. Colapinto, attorney for Ms. Murphy
Who exactly is this taxpayer? Is she famous?
What is your opinion on Offer In Compromises and the IRS? What do you think the chances are receiving an OIC
The taxpayer isn’t famous. She’s a whistle-blower who received a jury award and the subsequent tax consequences have led to a number of cases (due to the appeals).
Diane, I could write several posts on OICs these days. Here’s my short answer… Despite TV commercials that promise “pennies on the dollar”, it is much more difficult (and expensive) to get an OIC in the current economy. I have been advised by agents that there is tremendous pressure to turn down Offers – and the Service is even turning down its own Offers (http://www.taxgirl.com/are-irs-employees-actually-responsible-for-anything/)
All of that said, it really depends on personal circumstances – how much is owed, the assets owned and income stream. But the IRS is really making it tougher than ever before.