Murphy vs IRS, decision vacated, but is this the end or the begining?

In a somewhat less publicized opinion released at the very end of the year on December 27, 2006 during the Christmas Holiday, the D.C. Circuit court vacated the Murphy vs. IRS ruling that turned the taxation of damages rules on their heads, by declaring them largely non-taxable.

There was a quick and powerful storm of commentary against the decision by tax professionals, law school professors and others who were stunned by the original decision, which in essence ruled that it was unconstitutional for the IRS to tax the money plaintiffs had received as compensation for emotional distress and other non-income related, or intangible, injuries. The readers of The Settlement Channel were on this quickly as the number of downloads of our podcast commentary with Attorney Robert Wood topped any download we'd ever had to that date.

However, while many people are assuming that the three judge panel, led by Judge Ginsburg, will rehear their case and do a "never mind we were only kidding" type mea culpa, the more appellate and inside tax people I speak with the more convinced I am that we still might see this ruling be narrowed a bit to address the panic expressed by the IRS and others that this would open the door for the income tax crazies to declare the entire income tax unconstitutional. In short, the court might tighten up and clarify elements tied to section 61 of the tax code which defines taxable income, and instead again strongly focus on the issue of income of a type that is currently taxed, that they feel should not be taxed.

I have a very hard time believing that Judge Ginsberg and the rest of the three person panel that authored this wonderfully libertarian decision were ignorant of the fact that it would cause a fire storm, so I have a tough time imagining them sitting down together and saying they blew it and come out with a reversal of their own decision so quickly. I think, and in fact I hope, we will be getting a decision in which section 104 is broadened a bit by the court to include the very cases the Judge felt should be tax free, as the single biggest injustice in personal injury cases is how this class of plaintiffs is abused by the tax code.

My question now, and something I intend to address in future posts, is why is the settlement industry so terrified of this decision instead of forcefully supporting it and advocating legislatively a broadening of the types of cases that fall under section 104? For that matter, where is ATLA, or what ever they call themselves now, on this topic? This is a situation that corrects a massive inequity in the tax code and penalizes plaintiffs and injured parties looking for justice, but if the trial lawyer organizations at the state or national level have addressed this I've sure missed it. What accounts for the general climate of fear about this issue? 

Posted on March 1, 2007 .