Tax Law

Tax on Emotional Damages Upheld

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A federal appeals panel has reversed course and upheld the power of the federal government to tax an award for emotional distress.

The U.S. Court of Appeals for the D.C. Circuit ruled today that Congress has the power to impose the tax under Article 1, Section 8 of the Constitution. The decision by the three-judge panel came in a rehearing of the case.

Tax experts were surprised when a three-judge D.C. Circuit panel ruled last August that damage awards for emotional distress unrelated to lost wages or earnings were not taxable. The court said in the earlier opinion that the awards were not income within the meaning of the 16th Amendment, which permits an income tax.

In today’s ruling, the court said it granted a rehearing based on a new government argument that the tax is indirect and uniform, and thus permitted under Article 1, Section 8.

“The government petitioned for rehearing en banc, arguing for the first time that, even if Murphy’s award is not income, there is no constitutional impediment to taxing it because a tax on the award is not a direct tax and is imposed uniformly,” the court explained. “In view of the importance of the issue thus belatedly raised, the panel sua sponte vacated its judgment and reheard the case.”

A hat tip to How Appealing, which posted a PDF of the ruling, Murphy v. Internal Revenue Service, No. 03cv0241.

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