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Murphy V. Internal Revenue Service, the Meaning of Income, and Sky-Is-Falling Tax Commentary

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Murphy V. Internal Revenue Service, the Meaning of Income, and Sky-Is-Falling Tax Commentary Case Western Reserve Law Review Volume 60 Issue 3 Article 17 2010 Murphy v. Internal Revenue Service, the Meaning of Income, and Sky-is-Falling Tax Commentary Erik M. Jensen Follow this and additional works at: https://scholarlycommons.law.case.edu/caselrev Part of the Law Commons Recommended Citation Erik M. Jensen, Murphy v. Internal Revenue Service, the Meaning of Income, and Sky-is-Falling Tax Commentary, 60 Case W. Rsrv. L. Rev. 751 (2010) Available at: https://scholarlycommons.law.case.edu/caselrev/vol60/iss3/17 This Article is brought to you for free and open access by the Student Journals at Case Western Reserve University School of Law Scholarly Commons. It has been accepted for inclusion in Case Western Reserve Law Review by an authorized administrator of Case Western Reserve University School of Law Scholarly Commons. MURPHY V. INTERNAL REVENUE SERVICE, THE MEANING OF "INCOME," AND SKY-Is-FALLING TAx COMMENTARY Erik M. Jensent I. INTRODUCTION ...................................... 752 A. Murphy I and the Hyperventilating Blogosphere ....... 753 B. The Plan of Attack.......................... 758 II. MURPHY 1: THE BASICS ............................ 759 III. THE HOWLERS IN MURPHY I ............ ......... 761 IV. DIRECT TAXES AND THE SIXTEENTH AMENDMENT .......... 765 A. The ConstitutionalStructure .................. 765 B. Does Any of This Matter Anymore? ............. 771 C. What Is a Direct Tax? .............. .......... 776 1. Direct Taxes Are (Would You Believe It?) Not Indirect Taxes......................... 776 2. Pollock and a Tax on Earned Income Only ........... 779 D. The Constitution Matters in Murphy-and in Taxation Generally ................................ 783 V. SECTION 104(A)(2) AND NONPHYSICAL PERSONAL INJURIES ............................................ 783 A. The 1996 Amendment to Section 104(a)(2) ................ 784 B. Why Automatic Taxability Makes No Sense ............... 789 1. Basis-Recovery Cases..................... 789 2. Cash Recoveries Outside the Clear Recovery-of-Basis Context............................... 793 a. Alienation of Affections and Similar (Silly?) Torts .................... ...........793 b. More Tax-Free Recoveries for Losses of "Personal Rights " ..................... ........ 797 i. Recoveries by Victims of Persecution........... 797 David L. Brennan Professor of Law, Case Western Reserve University. 751 752 CASE WESTERN RESERVE LAW REVIEW [Vol. 60:3 ii. Revocation of Acquiescences in Old Cases... 801 3. How Common Is Recovery of Basis?............. 804 4. Gotcher: "Gross Income" Is Not All-Encompassing............... .............. 811 C. Analyzing a Recovery for a Personal Injury: The "In Lieu of" Test ............... ............. 815 D. The Bottom Line: Not All "Nonphysical" Recoveries Are Taxable ........................ ...... 821 VI. WHY THE RESULT INMURPHY I WAS NOT CRAZY ........... 821 A. The "In Lieu of" Test Applied to Murphy.................. 822 B. Return of Capital Ideas... ................... 823 C. What Did "Income" Mean in 1913?... .......... 825 D. Involuntariness and "Personal"Rights..................... 832 E. Wages and Recoveries for Emotional Distress........... 835 1. The Limits of Logic.......... .............. 836 2. Evolving Conceptions of "Income ... ........ 837 VII. MURPHY II: THE DO-OVER ............... ........ 840 A. Was the Tax Direct?. ........................ 842 B. Was Murphy's Recovery Includable in Gross Income? .................... ............. 845 C. Can "Gross Income" Be Broader Than "Incomes"?. 846 VIII. CONCLUSION........................... 849 I. INTRODUCTION Politics constrains the federal taxing power, of course: a candidate's promise to raise taxes across the board is generally thought to be political suicide, as is breaching a promise not to raise taxes. The conventional wisdom, however, is that the Constitution imposes no significant legal limitations on the taxing power.' If Congress is willing to take the political flack, it can do what it wants, or so it is assumed. Similarly, in construing what Congress has done on a tax issue, a court can usually proceed without meaningful references to the Constitution. I The Constitution imposes real restrictions in special situations. For example, the Export Clause provides that "No Tax or Duty shall be laid on Articles exported from any State," U.S. CONST. art. I, § 9, cl. 5, and that Clause has been enforced. See United States v. U.S. Shoe Corp., 523 U.S. 360, 366-70 (1998) (holding that the Harbor Maintenance Tax, which obligates exporters to pay a percentage of the value of cargo shipped, was a tax on exports and therefore unconstitutional); United States v. Int'l Bus. Machs. Corp., 517 U.S. 843, 861-62 (1996) (holding that the Export Clause categorically bars Congress from imposing any tax on exports); see also Erik M. Jensen, The Export Clause, 6 FLA. TAX REV. 1 (2003) (detailing the historical importance of the Export Clause and observing that, although the Export Clause is enforced by modem courts, its effect is largely invisible in the lives of ordinary Americans). 2010]1 MURPHY V. INTERNAL REVENUE SERVICE 753 In the widely noted case of Murphy v. Internal Revenue Service,2 a panel of the United States Court of Appeals for the District of Columbia Circuit ultimately reached a result consistent with conventional wisdom, concluding that a whistleblower's recovery for emotional distress was properly includable in the income-tax base.3 But the court followed a torturous path to get there, and Murphy provides an opportunity to revisit some basics of taxation. At bottom one of the questions in Murphy was "What is income?" and you cannot get more basic than that. A. Murphy I and the Hyperventilating Blogosphere Chief Judge Douglas Ginsburg's opinion on Murphy's first go-round in August 2006 (Murphy 1), which unanimously concluded that the emotional-distress recovery was not income within the meaning of the Sixteenth Amendment and, as a result, could not be reached by the federal income tax,4 characterized the government's arguments as resting on a "breathtakingly expansive claim of congressional power."5 Although the panel must have known that striking down an exercise of the taxing power would be noteworthy, it apparently did not realize how controversial its conclusion would be. Murphy I did not have a long shelf life; the negative reaction was immediate-the decision "shocked the tax community" 6-and effective. Tax professors generally were appalled (some refusing to read the opinion, or so they said, because the result was so bizarre), and cries were heard that the decision was not only dumb but also catastrophic.7 If an emotional-distress recovery were not income, then logically, it was argued, wages were not either. Remove compensation for services from the income-tax base, and the base would be gutted. 2 493 F.3d 170 (D.C. Cir. 2007), cert. denied, 553 U.S. 1004 (2008). 3 Id. at 17 1. 4 Murphy v. IRS (Murphy 1), 60 F.3d 79 (D.C. Cir.), vacated, No. 05-5139, 2006 WL 4005276 (D.C. Cit. Dec. 22, 2006). The panel included two Republican appointees and one Democratic. If this decision had partisan political overtones, they were not obvious. 5 Id. at 87. The breathtaking claim was that any receipt of value could be reached: '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."' Id. (quoting Burk-Waggoner Oil Ass'n v. Hopkins, 269 U.S. 110, 114 (1925)). 6 Joseph M. Dodge, Murphy and the Sixteenth Amendment in Relation to the Taxation of Non-Excludable PersonalInjury Awards, 8 FLA. TAX REv. 369, 370 (2007) [hereinafter Dodge, Murphy and the Sixteenth Amendment]. 7 See, e.g., Marcia Coyle, Full Court May Weigh Taxation of Damages, NAT'L L.J., Oct. 30, 2006, at I (quoting officials and commentators, one of whom called Murphy I "outrageous"). 754 CASE WESTERN RESERVE LAW REVIEW [Vol. 60:3 Obviously embarrassed by the reaction-according to Professor Paul Caron, the court was "prodded by the tax blogosphere"' 8-the panel on its own motion vacated its judgment in December 2006.9 New briefs were filed, the case was reargued, and in June 2007 the same panel unanimously held, on the basis of an issue "belatedly raised" and "newly argued"-the court was covering its backside- that the recovery had been properly taxed.' 0 The panel's abrupt turnaround left rubber on the road. With the decision in Murphy II, most of the tax professoriate and the tax bar gave a sigh of relief. And when the Supreme Court denied certiorari in April 2008," the Republic appeared safe. Or maybe not. Not all critics were mollified. For example, Professor Caron has written that "the panel could not unring the bell and undo much of the damage caused by its original decision."12 By ignoring the Supreme Court's good sense in Commissioner v. Glenshaw Glass Co. 13-which, half a century earlier, had "appeared to establish the term 'gross income' as a catch-all phrase reaching all accessions to wealth, regardless of source"14-the panel "turned what should have been a run of the mill tax dispute ... into a threat to the very survival of the income tax."15 Strong stuff. Murphy I might have no legal effect, but Caron and others worried that it encouraged tax protesters.16 Moreover, since the opinion had been printed in the 8 Paul L. Caron, The Story of Murphy: A New Front in the War on the Income Tax, in TAX STORIES 55, 91 (Paul L. Caron ed., 2d ed. 2009). Caron presents instant analysis from the post-Murphy I period, see id. at 70-71, and makes the case for blogs' centrality in modem tax policy. See id. at 90-91. 9 See Murphy v. IRS, No. 05-5139, 2006 WL 4005276, at *1 (D.C. Cir. Dec. 22, 2006). A petition for rehearing en banc had been filed. The panel vacated the judgment before the petition was acted upon, but the panel relied in part on the argument in the petition.
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