US Appeal Court Asked To Reverse Whistleblower Tax Ruling

by Leroy Baker, Tax-News.com, New York 22 August 2007

The full US Court of Appeals for the District of Columbia Circuit has been asked to reconsider last month’s decision by a three-judge panel that reversed itself on a key civil rights tax case.

On July 3, 2007, the panel held that the IRS can tax damage awards based solely on compensating victims who suffer personal injuries. However, on August 22, 2006, the same panel in the same case 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 three-judge panel, (Chief Judge Douglas H. Ginsburg, and Judges Judith W. Rogers and Janice Rogers Brown), held that 'make whole' compensation to restore personal injuries losses 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.

In an August 22, 2006 decision, Judge Ginsburg, writing for the 3-judge panel, agreed with Ms. Murphy, and found that compensation for actual documented personal injury losses were not subject to an income tax. The IRS argued that the decision was wrong, and the panel agreed to vacate its original decision and rehear the case to consider issues that were never timely raised on appeal by the IRS.

Rather than overrule its prior decision (Murphy v. IRS, Aug. 22, 2006) holding that taxing Murphy’s damages was unconstitutional, the panel simply held that Congress intended to amend the tax code “by implication” to tax personal injury damages under its authority to create an excise tax on people who use the courts to vindicate their rights. No court in the history of the United States has ever upheld such an implied tax.

In a remarkable ruling, the Court held that compensation for damages for emotional distress suffered by a whistleblower were not paid to make the employee “whole,” but were instead paid as part of a “forced sale” which Congress could tax under its excise tax authority.

Read the rest Here