UPDATE Tuesday a.m. Dec. 18: The case has now been docketed as 07-802.  The response is due Jan. 16, unless the government obtains an extension of time to file it.  It is doubtful that the case would be granted in time for a decision during the current Term, unless significantly expedited.

Lawyers for a woman who was awarded $70,000 to compensate for personal injuries –  damage to reputation, emotional distress, and physical problems resulting from mental stress — on Thursday asked the Supreme Court to rule that the money is not subject to federal tax.  The case of Murphy v. Internal Revenue Service (a docket number has not yet been assigned) raises an issue that tax professionals say has been lingering for close to 90 years. The Murphy case has become a celebrated one because a panel of the D.C. Cicuit Court ruled on it twice, first finding that the compensatory damages award was not income subject to tax, then ruling that it was, in fact, subject to an excise tax.

The petition for certiorari, and the texts of the lower court rulings, can be downloaded here.  (Thanks to Professor Paul Caron of Taxprof Blog for the heads-up on this appeal.)

The appeal argues: “For more than a decade, since the personal injury exemption was amended in 1996, taxpayers, employers and employees, have struggled with the taxability of compensatory damages for emotional distress, physical injuries related to emotional distress, and loss of reputation.”

In enacting the 1996 amendment, the petition says, Congress did not include or further define the scope of gross income under the tax levying statute, and IRS regulations “do not require physical injury or physical sickness to qualify for the personal injury exemption, thus causing widespread confusion, uncertainty and litigation.”  The plain meaning of the law, it asserts, “excludes from gross income any damages received on account of ‘physical injuries or physical sickness’ regardless of what caused the injury or sickness.”

The case involves Marrita Murphy, who won the $70,000 in a Labor Department proceeding against her former employer, the New York Air National Guard.  She contended that, after she had complained about environmental hazards at an Air National Guard base, her former employer “blacklisted” her with other potential employers, causing her significant emotional stress and resulting physical injuries. The whistleblower laws under which she complained provided for compensatory damages for violations.  Murphy listed the award on her federal tax return, but later sought a refund of $20,665 in taxes on the award, contending that the award was not taxable.  IRS denied a refund, and she sued for it.

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