Are Emotional Injury Recoveries Tax Exempt? An Appeals Court Dumps Its Own Opinion
Cross-posted from NY Personal Injury Law Blog
It's odd to see an appeals court vacate its own decision, without anyone having asked, but that is what happened here. It's all about the power of the government to tax personal injury awards.
Congress has the power to tax income, but not recoveries for personal injury. Its power comes from the Sixteenth Amendment, which gives it the "power to lay and collect taxes on incomes, from whatever source derived..."
Since a personal injury award, either by settlement or verdict/judgment, is compensation for that which was lost, it is not income. The injured person is simply made whole.
But what of the psychological injury or loss to reputation? In Murphy v. IRS, a three judge panel of the U.S. Court of Appeals for the District of Columbia held last year that this was not income, and therefore not taxable. Therefore the provision of the Internal Revenue Code that tried to tax the money was held to be unconstitutional as it contravened the Sixteenth Amendment. Much was written on the subject, which I will not repeat, some of which can be found at this link to the TaxProf Blog. (keep reading)