NEWS AND ANALYSIS The standard amount set by the IRS is likely to Experts Ponder Murphy fully compensate taxpayers with just landlines, (C) Tax Analysts 2006. All rights reserved. does not claim copyright in any public domain or third party content. according to several tax lawyers contacted by Tax Decision’s Many Flaws Analysts, but households with landlines and cell- phones could find themselves shortchanged. By Sheryl Stratton — [email protected] ‘‘Based on the [Federal Communication Commis- sion’s] estimated per household [spending] on It is not often that an appeals court invalidates a long-distance and wireless service, the proposed federal tax statute, and it is even rarer that consti- $30 to $60 refunds are not unreasonable,’’ said Steve tutional law scholars join the tax bar in taking Rosen of Levine, Blaszack, Block & Boothby in potshots at a circuit court chief judge’s ruling. Washington. But Rosen, who represented taxpayers On August 22 the D.C. Circuit held that a com- in four of the five circuit court cases in which the tax pensatory award for emotional and professional was ruled invalid and who is cocounsel in Sloan v. reputation damages is excluded from gross income, United States, a class-action suit in D.C. district court finding that section 104(a)(2) is unconstitutional challenging the refund procedures, said a house- insofar as it allows taxation on compensation unre- hold’s adjusted gross income is probably a better lated to lost wages or earnings. indication of the amount of telephone excise tax paid than family size. (For the amended complaint The ruling is startling, misguided, and in Sloan v. United States, No. 1:06cv00483, see Doc wrong, Wolfman said. 2006-13066 or 2006 TNT 132-15.) Tom Sykes of McDermott Will & Emery LLP in Chicago said he thought the standard amount out- In a unanimous opinion, Chief Judge Douglas lined in last week’s IRS announcement might be Ginsburg determined that Marrita Murphy’s com- overly generous to a residential subscriber who had pensatory award was effectively for a loss of a a landline but not a cellphone throughout the personal attribute and not to compensate her for 41-month period. But adding in taxes paid on lost wages or other income. Judge Ginsburg also cellphone service for just one line might bring the determined that, based on the history of ‘‘personal amount of tax paid over the past three years to over injury compensation’’ and the definition of income, $70. the framers of the Sixteenth Amendment would not A family with multiple cellphones could have have considered damages for nonphysical injuries paid upwards of $150 in telephone excise taxes over to be included in income. (For the D.C. Circuit’s the past three years, according to Sykes, who gave opinion in Marrita Murphy v. IRS, No. 05-5139 (D.C. as an example a family with five cellphones — one Cir. Aug. 22, 2006), see Doc 2006-15916 or 2006 TNT for each parent and two children, plus an additional 163-6. For related news analysis, see p. 825.) cell line for a grandparent — that might find it paid $180 or more since March 2003. General Dismay Although the standard refund set by the IRS The ruling is startling, misguided, and wrong, contains a marriage penalty, it also provides a little said Bernard Wolfman, a professor at Harvard Law perk for new parents: Since the refund amount is School. linked to the number of exemptions on a taxpayer’s The decision is an embarrassment to the D.C. 2006 return, new moms and dads will get an extra Circuit, said George Yin, the former head of the $10 per child, even for those born in the last few Joint Committee on Taxation, now a professor at the months of 2006 and for those too young to talk. University of Virginia School of Law. Rosen pointed out that although the IRS has said It strikes Michael Graetz, a professor at Yale Law it will work to address the problems of small School, as ‘‘odd that judges who claim to be con- businesses and nonprofits, taxpayers who are not servative, and supposedly want to defer to the required to file tax returns — a class that includes legislative branch, can be so ready to strike down many seniors — are still disadvantaged under the this kind of statute,’’ which Congress enacted only IRS refund procedures that require a return to be after a great deal of confusion and after many filed. decisions by the Supreme Court on the treatment of damages. It is a horrible decision for a more fundamental reason than what the tax people are worried about, said Martin S. Lederman, a visiting constitutional law professor at Georgetown University Law Cen- ter. The appeals court’s opinion is woefully incom- plete, he said, because it failed to perform a full constitutional analysis. 822 TAX NOTES, September 4, 2006 NEWS AND ANALYSIS Indeed, tax and constitutional law professors are Camp said the opinion’s essential logic is that having a field day with the decision. The TaxProf- Murphy’s emotional well-being and reputation (C) Tax Analysts 2006. All rights reserved. does not claim copyright in any public domain or third party content. Blog (http://taxprof.typepad.com) has been track- were not taxable items in and of themselves, both ing media coverage of the case and keeping a were diminished by the tort, and, therefore, the running commentary for anyone who cares to share money paid to Murphy to make her emotional state an opinion. and reputation ‘‘whole’’ should not be taxed be- When not joking about how to convert their cause it was ‘‘in lieu of’’ the diminution of a capital partnership incomes into personal injury claims, tax asset. practitioners are mystified by the decision. The reaction among members of the tax bar has been uniform incredulity, said Pamela Olson, Saying it is possible the Supreme former Treasury assistant secretary for tax policy, Court will reverse the decision, now at Skadden, Arps, Slate, Meagher & Flom LLP Kirsner said he is recommending to in Washington. At the same time, tax advisers must clients that they file refund claims figure out what to tell clients whose claims are ‘since the appeal process could take potentially affected by the decision, she said. ‘‘I a year or two.’ suspect most will make clients aware of it but advise them not to bank anything on it, but there Assuming the vitality of the opinion’s ‘‘human are likely to be quite a few advisers who accept the capital’’ concept, Murphy’s damages are excluded decision and try to apply it or use it to their clients’ from income only if Murphy’s basis in her reputa- advantage.’’ tion and emotional well-being was equal to or Nixon Peabody has posted an employment law greater than the damages awarded, Camp said. But alert on its Web site calling the decision ‘‘extraordi- until this opinion, it has been widely accepted that nary’’ and saying that it has the potential to com- taxpayers have no basis in their labor — their pletely change the taxation of many employment ‘‘human capital,’’ Camp said. That lack of basis is judgments and settlements. The most widespread why taxpayers cannot take a deduction under sec- effect in the short run will be that recipients of tion 170 for a donation of services, Camp said. damages would be advised to file claims for re- Yin also took exception to the court’s analysis of funds to protect their rights, said Thomas J. McCord what the taxpayer was receiving recovery for as of the firm’s Boston office. means of determining whether it was taxable. The Acknowledging that it is very possible that the theory is that the recovery is taxable if it is made in Supreme Court will reverse the decision, Marvin lieu of something that would otherwise be taxable, Kirsner of Greenberg Traurig said he is now recom- Yin said. When taken to its logical conclusion, that mending to clients that they file refund claims analysis would result in not treating wages as ‘‘since the appeal process could take a year or two.’’ income, he said, because people work for pay in Technical Tax Points lieu of having leisure time. (For related coverage of ‘‘We law professors must not be doing our jobs Murphy’s effect on tax protestor arguments, see p. right if three federal judges and their clerks can 832.) reach a conclusion like this one,’’ Yin said. Further, the court holds unconstitutional section Yin has identified several flaws in the court’s 104(a)(2), which provides that some recoveries are technical analysis. The first is that the court was not not income. In striking down an exclusionary pro- familiar with the concept of basis. The court’s vision, it does not follow that there is no income, opinion reads as if recovery is made to make a Yin said. taxpayer whole, he said. The logic of comparing the Indeed, Martin McMahon, a professor at the value of what is lost to the value of what is received University of Florida College of Law, said that to determine whether there is an accession to exclusions from an exclusion provision fall back wealth would lead to virtually any exchange as not into section 61. To reach their decision and properly creating income, he said. apply the statute, McMahon wrote on the TaxProf- Basis is one of the toughest ideas to teach first- Blog, the circuit court judges should have held that year tax students, said Bryan Camp, a professor at section 61, as applied to the damages in question, as Texas Tech University School of Law.