Constitutionality of Damages Awards (Murphy case)

Current status and outlook

Posted January 13, 2008

Supreme Court unlikely to review this case.

Use this page to keep on top of developments concerning the Murphy case, in which an appeals court issued a surprising decision holding that it was unconstitutional to apply the income tax to certain awards of damages for personal injury, but later reversed its own decision.

The issue
Who's affected
Recent events
Current status
What's next

The issue

You don't have to pay tax when you receive a damages award for a physical injury, for example when you recover for damages in an auto accident. This exclusion doesn't apply to non-physical injuries, however. The law says you have to pay tax when you're compensated for emotional distress, damage to your reputation, or similar non-physical injuries. A bizarre decision issued in August 2006 held that the law imposing income tax on certain damage awards for non-physical injuries was unconstitutional. The decision unleashed a storm of criticism (and a blizzard of cliches about storms of criticism) as scholars from the worlds of tax law and constitutional law pondered the implications. As noted below, the court that made this strange ruling later reversed its own decision.

Who's affected

It seems unlikely that anyone will end up being affected by this decision because the court has reversed its own ruling. However, anyone receiving a damages award for non-physical injuries may want to continue tracking this issue.

If you paid tax on such an award in a past year that is about to be closed by the statute of limitations, you may want to consult with a tax professional to determine whether it makes sense to file a protective claim for refund. This is a refund claim that becomes active only upon the occurrence of a stated event. Your claim would say it is conditioned on a Supreme Court ruling favorable to the taxpayer in the Murphy case.

Recent events

The court that issued the original ruling in the Murphy case granted a rehearing and, in July 2007, reversed its own decision. The taxpayer has filed a motion asking the Supreme Court to review the case.

Current status

There is no longer any judicial decision supporting the notion that Congress cannot tax awards for non-physical injuries. It's possible, but seems unlikely, that the Supreme Court will decide to review the case.

What's next

As of this writing, the Department of Justice is preparing a response to the petition for a writ of certiorari (the request for the Supreme Court to review this case). If, as expected, the Supreme Court declines to review the case, the decision in favor of the government will become final.