The Volokh Conspiracy -

Income Tax and Sanctity of Property in Our Constitutional System:

As Orin points out, the D.C. Circuit has just held that a small part of the federal tax code exceeds Congress's power to lay income taxes under the Sixteenth Amendment. The tax code, the court held, does tax as income compensatory damages for emotional distress and loss of reputation. But such damages aren't "income" for purposes of the Sixteenth Amendment ("The Congress shall have power to lay and collect taxes on incomes, from whatever source derived, without apportionment among the several States, and without regard to any census or enumeration"), because they are not a gain but merely a compensation for loss; therefore, the court held, they can't constitutionally be subjected to the income tax.

I don't have much to say about the opinion but one thing did strike me. The court writes:

The Sixteenth Amendment simply does not authorize the Congress to tax as "incomes" every sort of revenue a taxpayer may receive.... [B]ecause the "the power to tax involves the power to destroy," 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.

Yet "the sanctity of property in our system" does not generally protect people from taxes on their capital. Not only may the federal government impose taxes on transactions involving property (such as importation, gift, or disposition on death), but state governments are free to tax property in a wide range of ways, including by imposing a percentage tax on all possessed property.

The state may, for instance, impose a percentage tax on all real estate; it may do the same for personal property, though my understanding is that administrative (and political) problems usually prevent that from happening; and I think it would be quite free to impose a tax on compensatory damage awards as well. States have long taxes real estate, to my knowledge from before the Constitution, though a property tax is often thought of as a quintessential direct non-income tax that the federal government may not impose. There's just nothing in the federal Constitution, or to my knowledge in most state constitutions, that prohibits states from laying taxes either on capital or on compensation for loss. Our system just doesn't view such taxes on property as inconsistent with "the sanctity of property."

Rather, the limits on the federal income tax are limits specific to the federal government — limits that originated in the Direct Tax Clause and were then made much looser by the Sixteenth Amendment. They stem from concerns about federal power, not about government power more generally. And they thus have to do not with "the sanctity of property" as such, but rather with what only states and not the federal government should be able to do as to that property.

	[Orin Kerr, August 22, 2006 at 11:50am] Trackbacks Constitutional Limits on the Power to Tax: 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. Related Posts (on one page): Income Tax and Sanctity of Property in Our Constitutional System: Constitutional Limits on the Power to Tax: Comments [Eugene Volokh, August 22, 2006 at 5:51pm] Trackbacks Income Tax and Sanctity of Property in Our Constitutional System: As Orin points out, the D.C. Circuit has just held that a small part of the federal tax code exceeds Congress's power to lay income taxes under the Sixteenth Amendment. The tax code, the court held, does tax as income compensatory damages for emotional distress and loss of reputation. But such damages aren't "income" for purposes of the Sixteenth Amendment ("The Congress shall have power to lay and collect taxes on incomes, from whatever source derived, without apportionment among the several States, and without regard to any census or enumeration"), because they are not a gain but merely a compensation for loss; therefore, the court held, they can't constitutionally be subjected to the income tax. I don't have much to say about the opinion but one thing did strike me. The court writes: The Sixteenth Amendment simply does not authorize the Congress to tax as "incomes" every sort of revenue a taxpayer may receive.... [B]ecause the "the power to tax involves the power to destroy," 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. Yet "the sanctity of property in our system" does not generally protect people from taxes on their capital. Not only may the federal government impose taxes on transactions involving property (such as importation, gift, or disposition on death), but state governments are free to tax property in a wide range of ways, including by imposing a percentage tax on all possessed property. The state may, for instance, impose a percentage tax on all real estate; it may do the same for personal property, though my understanding is that administrative (and political) problems usually prevent that from happening; and I think it would be quite free to impose a tax on compensatory damage awards as well. States have long taxes real estate, to my knowledge from before the Constitution, though a property tax is often thought of as a quintessential direct non-income tax that the federal government may not impose. There's just nothing in the federal Constitution, or to my knowledge in most state constitutions, that prohibits states from laying taxes either on capital or on compensation for loss. Our system just doesn't view such taxes on property as inconsistent with "the sanctity of property." Rather, the limits on the federal income tax are limits specific to the federal government — limits that originated in the Direct Tax Clause and were then made much looser by the Sixteenth Amendment. They stem from concerns about federal power, not about government power more generally. And they thus have to do not with "the sanctity of property" as such, but rather with what only states and not the federal government should be able to do as to that property. Related Posts (on one page): Income Tax and Sanctity of Property in Our Constitutional System: Constitutional Limits on the Power to Tax: Comments