Murphy vs IRS, analysis of the decision.

Later this evening and early tomorrow morning we will be posting a two part podcast with nationally respected tax attorney Robert Wood of Wood & Porter, SF, CA. In a wide ranging discussion we reviewed the Murphy vs IRS ruling handed down by the US District Court in Washington, DC and was authored by Chief Judge Douglas Ginsburg. These are somewhat longer then our typical 12 minute podcast but I think the subject is of sufficient importance that you won't mind listening a bit longer.

The ruling, in what I can only describe as a masterful argument against overly broad definitions by the government as to what is taxable income, strikes down on constitutional grounds key elements of IRC section 104(a)(2) as it relates to issues such as emotional distress, mental anguish, defamation, slander, wrongful imprisonment, etc. This goes back to the 1996 law which amended the section of the code that drew a firm distinction between physical injury and or sickness, and other injury that was not physical in nature. Yesterday's ruling struck down that distinction as unconstitutional, but did it in such a stunning and sweeping fashion that many commentators feel it will spawn a flurry of similar suits and arguments about what is income, and what is a return of "human capital".

I have to admit, I don't usually get all worked up over tax policy and issues, which is probably a result of starting out way back when at my alma mater, Bentley College, with a desire to be an accountant, and realized I had neither the aptitude or temperament to handle the excitement of a career in accounting. That said, yesterdays ruling was positively Libertarian in nature in that it spoke to the issue of how broadly the government is able to sweep economic activity into the definition of "taxable income" and what sort of transactions and events are rightly defined as a return of capital or making someone whole. I don't usually recommend reading tax court opinions but this is one of the most fascinating philosophical discussions as to what is income that I've seen, and it resides in the body of a courts decision. As any reader of my blogs know, I have always contested the tortured logic of taxing a molestation victim on the full amount of their award, but then allowing a car accident victim to receive tax free income under the code. It was fundamentally unfair, and the court in deciding for the tax payer in the Murphy case, came to the same conclusion, and to some degree rebuked the IRS for failing to issue more specific guidance on this topic, despite having 10 years to do so.

Lest anyone think this was a liberal decision, two of the three judges are either Reagan or Bush appointees, with the author, Chief Judge Ginsburg, being President Reagan's first choice after Robert Bork to sit on the Supreme Court. I must admit, as a conservative, that I take great delight in the commentary and comments being offered by former IRS commissioners, law professors and others, that find this to be a dangerous ruling and expect the full Supreme Court to hear and reverse it. Few if any of them are use to seeing the governments over reaching, tax collection arm struck down on such a fundamental basis as this was, and I'm not at all sure the current Supreme Court will reverse it once they look at the facts. At least I hope they don't.

There is a fundamentally just aspect to this ruling when it argues that not all economic rewards or transaction are necessarily income, and therefore should be beyond the reach of the government to tax as they see fit. For now, even though it puts my own business and industry into a bit of turmoil, I'm happy to see a pro-taxpayer decision on this grand a scale, and hope that given there was no dissent on the DC Circuit that the next destination will be the Supreme Court.

Podcasts posting by 7 am EST time tomorrow.  


Posted on August 23, 2006 .