Don't Mess With Taxes

Last August, a D.C. federal appellate panel ruled that the IRS cannot collect taxes on money awarded as compensation for emotional distress and other intangible injuries. 

In the original ruling, Marritta Murphy was awarded damages for emotional distress and loss of reputation after she blew the whistle in 1994 on environmental hazards at a New York Air National Guard base.

The three-member D.C. appellate panel said Murphy should get a tax refund of $20,665, plus interest, on her $70,000 judgment from the Department of Labor Administrative Review Board because it was "compensation for the loss of a personal attribute," not income. Under that interpretation, the compensation was similar to awards for physical injuries, which are tax exempt.

The ruling also raised the wider issue of the constitutionality of a tax code provision that permits taxation of damage awards for injuries such as those in Murphy's case. And it set off widespread debate and judicial second-guessing, as recounted in this blog post.

Now that same group of jurists has reversed itself, saying that Murphy's money is taxable.

Specifically, the panel found that Murphy's compensatory award was not for personal physical injuries, and therefore is not tax-free. The panel also determined the award was part of her gross income.

"Murphy no doubt suffered from certain physical manifestations of emotional distress,'' wrote Douglas Ginsburg, the appeals court's chief judge. But the money awarded her was for mental pain and anguish and for injury to professional reputation, according to the revisited ruling.

TaxProf has compiled a nice list of links to press coverage and blogosphere commentary on the reversal.

Now all that remains is the answer to the question, what's the tax on the misery caused by judicial whiplash?