This morning the D.C. Circuit decided a fascinating case holding that the Constitution does not permit the federal government to collect income taxes on compensation for a non-physical work-related injury not related to wages or earnings.

  In Murphy v. IRS, Murphy received $70,000 from the state of New York for anxiety suffered and injury to her reputation for being unlawfully "blacklisted" after becoming a whistleblower aaginst her former employer, the New York Air National Guard. The government wanted to tax the $70,000 as income, but Murphy claimed that it was not taxable either because it was excludable as compensation for "personal physical injuries" or because the Internal Revenue Code is unconstitutional for trying to tax such earnings as income.

  Murphy drew a very favorable panel for this sort of claim -- Chief Judge Douglas Ginsburg, Judge Judith Rogers, and Judge Janice Rogers Brown -- and the panel held, in an opinion by Ginsburg, that the text of the Internal Revenue Code does not exclude such compensation but is unconstitutional for not doing so. The basic argument: When the Sixteenth Amendment was passed in 1913 and permitted the federal income tax, the framers of the amendment did not have this broad an understanding of "income." Here's an excerpt:

The Sixteenth Amendment simply does not authorize the Congress to tax as "incomes" every sort of revenue a taxpayer may receive. As the Supreme Court noted long ago, the "Congress cannot make a thing income which is not so in fact." Burk-Waggoner Oil Ass’n v. Hopkins, 269 U.S. 110, 114 (1925). Indeed, because the "the power to tax involves the power to destroy," McCulloch v. Maryland, 17 U.S. (4 Wheat.) 316, 431 (1819), it would not be consistent with our constitutional government, and the sanctity of property in our system, merely to rely upon the legislature to decide what constitutes income.

* * * [T]he term "incomes," as understood in 1913, clearly did not include damages received in compensation for a physical personal injury, we infer that it likewise did not include damages received for a nonphysical injury and unrelated to lost wages or earning capacity.

In sum, every indication is that damages received solely in compensation for a personal injury are not income within the meaning of that term in the Sixteenth Amendment. First, as compensation for the loss of a personal attribute, such as wellbeing or a good reputation, the damages are not received in lieu of income. Second, the framers of the Sixteenth Amendment would not have understood compensation for a personal injury -- including a nonphysical injury -- to be income. Therefore, we hold § 104(a)(2) unconstitutional insofar as it permits the taxation of an award of damages for mental distress and loss of reputation.

  I know essentially nothing about the Sixteenth Amendment, but it will be interesting to see if the SG petitions for certiorari in this case (assuming it doesn't go en banc). I suspect the Supreme Court would take the case.

  Thanks to How Appealing for the link.