Murphy v. Internal Revenue Service

United States Court of Appeals

FOR THE DISTRICT OF COLUMBIA CIRCUIT

Argued February 24, 2006 Decided August 22, 2006

No. 05-5139

MARRITA MURPHY AND

DANIEL J. LEVEILLE,

APPELLANTS

v.

INTERNAL REVENUE SERVICE AND

UNITED STATES OF AMERICA ,

APPELLEES

Appeal from the United States District Court

for the District of Columbia

(No. 03cv02414)

David K. Colapinto argued the cause for appellants. With

him on the briefs was Stephen M. Kohn.

Colin M. Dunham was on the brief for amicus curiae No

Fear Coalition in support of appellant.

John A. Nolet, Attorney, U.S. Department of Justice, argued

the cause for appellees. With him on the brief were Kenneth L.

Wainstein, U.S. Attorney, and Kenneth L. Greene, Attorney.

Bridget M. Rowan, Attorney, entered an appearance.

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Before: GINSBURG , Chief Judge, and ROGERS and BROWN ,

Circuit Judges.

Opinion for the Court filed by Chief Judge GINSBURG .

GINSBURG , Chief Judge: Marrita Murphy brought this suit

to recover income taxes she paid on the compensatory damages

for emotional distress and loss of reputation she was awarded in

an adminstrative action she brought against her former

employer. Murphy contends that under § 104(a)(2) of the

Internal Revenue Code (IRC), 26 U.S.C. § 104(a)(2), her award

should have been excluded from her gross income because it

was compensation received “on account of personal physical

injuries or physical sickness.” In the alternative, she maintains

§ 104(a)(2) is unconstitutional insofar as it fails to exclude from

gross income revenue that is not “income” within the meaning

of the Sixteenth Amendment to the Constitution of the United

States.

We hold, first, that Murphy’s compensation was not

“received ... on account of personal physical injuries”

excludable from gross income under § 104(a)(2). We agree with

the taxpayer, however, that § 104(a)(2) is unconstitutional as

applied to her award because compensation for a non-physical

personal injury is not income under the Sixteenth Amendment

if, as here, it is unrelated to lost wages or earnings.

I. Background

In 1994 Marrita Leveille (now Murphy) filed a complaint

with the Department of Labor alleging that her former employer,

the New York Air National Guard (NYANG), in violation of

various whistle-blower statutes, had “blacklisted” her and

provided unfavorable references to potential employers after she

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had complained to state authorities of environmental hazards on

a NYANG airbase. The Secretary of Labor determined the

NYANG had unlawfully discriminated and retaliated against

Murphy, ordered that any adverse employment references to the

taxpayer in Office of Personnel Management files be withdrawn,

and remanded her case to an Administrative Law Judge “for

findings on compensatory damages.”

On remand Murphy submitted evidence that she had

suffered both mental and physical injuries as a result of the

NYANG’s blacklisting her. A physician testified Murphy had

sustained “somatic” and “emotional” injuries. One such injury

was “bruxism,” or teeth grinding often associated with stress,

which may cause permanent tooth damage. Upon finding

Murphy had also suffered from other “physical manifestations

of stress” including “anxiety attacks, shortness of breath, and

dizziness,” the ALJ recommended compensatory damages

totaling $70,000, of which $45,000 was for “emotional distress

or mental anguish,” and $25,000 was for “injury to professional

reputation” from having been blacklisted. None of the award

was for lost wages or diminished earning capacity.

In 1999 the Department of Labor Administrative Review

Board affirmed the ALJ’s findings and recommendations. See

Leveille v. N.Y. Air Nat’l Guard, 1999 WL 966951, at *2-*4

(Oct. 25, 1999). On her tax return for 2000, Murphy included

the $70,000 award in her “gross income” pursuant to § 61 of the

IRC. See 26 U.S.C. § 61(a) (“[G]ross income means all income

from whatever source derived”). As a result, she paid $20,665

in taxes on the award.

Murphy later filed an amended return in which she sought

a refund of the $20,665 based upon § 104(a)(2) of the IRC,

which provides that “gross income does not include ... damages

... received ... on account of personal physical injuries or

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physical sickness.” In support of her amended return, Murphy

submitted copies of her dental and medical records. Upon

deciding Murphy had failed to demonstrate the compensatory

damages were attributable to “physical injury” or “physical

sickness,” the Internal Revenue Service denied her request for

a refund. Murphy thereafter sued the IRS and the United States

in the district court.

In her complaint Murphy sought a refund of the $20,665,

plus applicable interest, pursuant to the Sixteenth Amendment,

along with declaratory and injunctive relief against the IRS

pursuant to the Adminstrative Procedure Act and the Due

Process Clause of the Fifth Amendment to the Constitution of

the United States. She argued her compensatory award was in

fact for “physical personal injuries” and therefore excluded from

gross income under § 104(a)(2). In the alternative Murphy

asserted § 104(a)(2) as applied to her award was

unconstitutional because the award was not “income” within the

meaning of the Sixteenth Amendment. The Government moved

to dismiss Murphy’s suit as to the IRS, contending the Service

was not a proper defendant, and for summary judgment on all

claims.

The district court denied the Government’s motion to

dismiss, holding that Murphy had the right to bring an “action[]

for declaratory judgments or ... [a] mandatory injunction”

against an “agency by its official title,” pursuant to § 703 of the

APA, 5 U.S.C. § 703. Murphy v. IRS, 362 F. Supp. 2d 206, 211-

12, 218 (2005). The court then rejected all Murphy’s claims on

the merits and granted summary judgment for the Government

and the IRS. Id. at 218. Murphy now appeals the judgment of

the district court with respect to her claims under § 104(a)(2)

and the Sixteenth Amendment.

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II. Analysis

We review the district court’s grant of summary judgment

de novo, Flynn v. R.C. Tile, 353 F.3d 953, 957 (2004), bearing

in mind that summary judgment is appropriate only “if there is

no genuine issue as to any material fact and if the moving party

is entitled to judgment as a matter of law,” Anderson v. Liberty

Lobby, Inc., 477 U.S. 242, 250 (1986). Before addressing

Murphy’s claims on their merits, however, we must determine

whether the district court erred in holding the IRS was a proper

defendant.

A. The IRS as a Defendant

The Government contends the courts lack jurisdiction over

Murphy’s claims against the IRS because the Congress has not

waived that agency’s immunity from declaratory and injunction

actions pursuant to 28 U.S.C. § 2201(a) (Courts may grant

declaratory relief “except with respect to Federal taxes”) and 26

U.S.C. § 7421(a) (“no suit for the purpose of restraining the

assessment or collection of any tax shall be maintained in any

court by any person”); and insofar as the Government has

waived immunity for civil actions seeking tax refunds under 28

U.S.C § 1346(a)(1), that provision on its face applies to “civil

action[s] against the United States,” not against the IRS. In

reply Murphy argues only that the Government forfeited the

issue of sovereign immunity because it did not cross-appeal the

district court’s denial of its motion to dismiss. See Fed. R. App.

P. 4(a)(3). Notwithstanding the Government’s failure to cross-

appeal, however, the court must address a question concerning

its jurisdiction. See Occidental Petroleum Corp. v. SEC, 873

F.2d 325, 328 (D.C. Cir. 1989) (“As a preliminary matter ... we

must address the question of our jurisdiction to hear this

appeal”).

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Murphy and the district court are correct that § 703 of the

APA does create a right of action for equitable relief against a

federal agency but, as the Government correctly points out, the

Congress has preserved the immunity of the United States from

declaratory and injunctive relief with respect to all tax

controversies except those pertaining to the classification of

organizations under § 501(c) of the IRC. See 28 U.S.C. §

2201(a); 26 U.S.C. § 7421(a). As an agency of the Government,

of course, the IRS shares in that immunity. See Settles v. U.S.

Parole Comm’n, 429 F.3d 1098, 1106 (D.C. Cir. 2005) (agency

“retains the immunity it is due as an arm of the federal

sovereign”). Insofar as the Congress has waived sovereign

immunity with respect to suits for tax refunds under 28 U.S.C.

§ 1346(a)(1), that provision specifically contemplates only

actions against the “United States.” Therefore, we hold the IRS,

unlike the United States, may not be sued eo nomine in this case.

B. Section 104(a)(2) of the IRC

Section 104(a) (“Compensation for injuries or sickness”)

provides that “gross income [under § 61 of the IRC] does not

include the amount of any damages (other than punitive

damages) received ... on account of personal physical injuries or

physical sickness.” 26 U.S.C. § 104(a)(2). Since 1996 it has

further provided that, for purposes of this exclusion, “emotional

distress shall not be treated as a physical injury or physical

sickness.” Id. § 104(a). The version of § 104(a)(2) in effect

prior to 1996 had excluded from gross income monies received

in compensation for “personal injuries or sickness,” which

included both physical and nonphysical injuries such as

emotional distress. Id. § 104(a)(2) (1995); see United States v.

Burke, 504 U.S. 229, 235 n.6 (1992) (Ҥ 104(a)(2) in fact

encompasses a broad range of physical and nonphysical injuries

to personal interests”). In Commissioner v. Schleier, 515 U.S.

323 (1995), the Supreme Court held that before a taxpayer may

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exclude compensatory damages from gross income pursuant to

§ 104(a)(2), he must first demonstrate that “the underlying cause

of action giving rise to the recovery [was] ‘based upon tort or

tort type rights.’” Id. at 337. The taxpayer has the same burden

under the statute as amended. See, e.g., Chamberlain v. United

States, 401 F.3d 335, 341 (5th Cir. 2005).

Murphy contends § 104(a)(2), even as amended, excludes

her particular award from gross income. First, she asserts her

award was “based upon ... tort type rights” in the whistle-blower

statutes the NYANG violated -- a position the Government does

not challenge. Second, she claims she was compensated for

“physical” injuries, which claim the Government does dispute.

Murphy points both to her physician’s testimony that she

had experienced “somatic” and “body” injuries “as a result of

NYANG’s blacklisting [her],” and to the American Heritage

Dictionary, which defines “somatic” as “relating to, or affecting

the body, especially as distinguished from a body part, the mind,

or the environment.” Murphy further argues the dental records

she submitted to the IRS proved she has suffered permanent

damage to her teeth. Citing Walters v. Mintec/International, 758

F.2d 73, 78 (3d Cir. 1985), and Payne v. General Motors Corp.,

731 F. Supp. 1465, 1474-75 (D. Kan. 1990), Murphy contends

that “substantial physical problems caused by emotional distress

are considered physical injuries or physical sickness.”

Murphy further contends that neither § 104 of the IRC nor

the regulation issued thereunder “limits the physical disability

exclusion to a physical stimulus.” In fact, as Murphy points out,

the applicable regulation, which provides that § 104(a)(2)

“excludes from gross income the amount of any damages

received (whether by suit or agreement) on account of personal

injuries or sickness,” 26 C.F.R. § 1.104-1(c), does not

distinguish between physical injuries stemming from physical

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stimuli and those arising from emotional trauma; rather, it tracks

the pre-1996 text of § 104(a)(2), which the IRS agrees excluded

from gross income compensation both for physical and for

nonphysical injuries.

For its part, the Government argues Murphy’s exclusive

focus upon the word “physical” in § 104(a)(2) is misplaced;

more important is the phrase “on account of.” In O’Gilvie v.

United States, 519 U.S. 79 (1996), the Supreme Court read that

phrase to require a “strong[] causal connection,” thereby making

§ 104(a)(2) “applicable only to those personal injury lawsuit

damages that were awarded by reason of, or because of, the

personal injuries.” Id. at 83. The Court specifically rejected a

“but-for” formulation in favor of a “stronger causal connection.”

Id. at 82-83. The Government therefore concludes Murphy must

demonstrate she was awarded damages “because of” her

physical injuries, which the Government claims she has failed

to do.

Indeed, as the Government points out, the ALJ expressly

recommended, and the Board expressly awarded, compensatory

damages “because of” Murphy’s nonphysical injuries. The

Board analyzed the ALJ’s recommendation under the headings

“Compensatory damage for emotional distress or mental

anguish” and “Compensatory damage award for injury to

professional reputation.” In describing the ALJ’s proposed

award as “reasonable,” the Board stated Murphy was to receive

“$45,000 for mental pain and anguish” and “$25,000 for injury

to professional reputation.” That Murphy suffered from bruxism

or other physical symptoms of stress is of no moment, the

Government argues, because “the Board awarded her damages,

not to compensate [her for that] particular injur[y], but explicitly

with respect to nonphysical injuries.”

In reply Murphy merely reiterates that she suffered

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“physical” injuries. She does not address the Government’s

point that she received her award “on account of” her mental

distress and reputational loss, not her bruxism or other physical

symptoms.

Murphy’s failure to address the Government’s position is

telling. Although the pre-1996 version of § 104(a)(2) was at

issue in O’Gilvie, the Court’s analysis of the phrase “on account

of,” which phrase was unchanged by the 1996 Amendments,

remains controlling here. Murphy no doubt suffered from

certain physical manifestations of emotional distress, but the

record clearly indicates the Board awarded her compensation

only “for mental pain and anguish” and “for injury to

professional reputation.” Leveille, 1999 WL 966951, at *5. The

Board thus having left no room for doubt about the grounds for

her award, we conclude Murphy’s damages were not “awarded

by reason of, or because of, ... [physical] personal injuries,”

O’Gilvie, 519 U.S. at 83. Therefore, § 104(a)(2) does not permit

Murphy to exclude her award from gross income.* But is that

constitutional?

C. The Sixteenth Amendment

The Government of the United States is a government of

limited powers: “Every law enacted by Congress must be based

on one or more of its powers enumerated in the Constitution.”

United States v. Morrison, 529 U.S. 598, 607 (2000). The

*Insofar as compensation for nonphysical personal injuries appears to

be excludable from gross income under 26 C.F.R. § 1.104-1, the

regulation conflicts with the plain text of § 104(a)(2); in these

circumstances the statute clearly controls. See Brown v. Gardner, 513

U.S. 115, 122 (1994) (finding “no antidote to [a regulation’s] clear

inconsistency with a statute”).

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constitutional power of the Congress to tax income is provided

in the Sixteenth Amendment, ratified in 1913:

The Congress shall have power to lay and collect taxes on

incomes, from whatever source derived, without

apportionment among the several States, and without regard

to any census or enumeration.

The Supreme Court has held the word “incomes” in the

Amendment and the phrase “gross income” in § 61(a) of the

IRC are coextensive. See Helvering v. Clifford, 309 U.S. 331,

334 (1940) (§ 61 represents the “full measure of [the

Congress’s] taxing power”). When it first construed those terms

in Eisner v. Macomber, 252 U.S. 189, 207 (1920), the Supreme

Court held the taxing power extended to any “gain derived from

capital, from labor, or from both combined.” Later, after

explaining that Eisner was not “meant to provide a touchstone

to all future gross income questions,” the Court added that under

the IRC -- and, by implication, under the Sixteenth Amendment

-- the Congress may “tax all gains” or “accessions to wealth.”

Commissioner v. Glenshaw Glass Co., 348 U.S. 426, 430-31

(1955).

Murphy argues that, being neither a gain nor an accession

to wealth, her award is not income and § 104(a)(2) is therefore

unconstitutional insofar as it would make the award taxable as

income. Broad though the power granted in the Sixteenth

Amendment is, the Supreme Court, as Murphy points out, has

long recognized “the principle that a restoration of capital [i]s

not income; hence it [falls] outside the definition of ‘income’

upon which the law impose[s] a tax.” O’Gilvie, 519 U.S. at 84;

see, e.g., Doyle v. Mitchell Bros. Co., 247 U.S. 179, 187-88

(1918); S. Pac. Co. v. Lowe, 247 U.S. 330, 335 (1918) (return of

capital not income under IRC or Sixteenth Amendment). By

analogy, Murphy contends a damage award for personal injuries

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-- including nonphysical injuries -- is not income but simply a

return of capital -- “human capital,” as it were. See Gary S.

Becker, Human Capital (1st ed. 1964); Gary S. Becker, “The

Economic Way of Looking at Life,” 43-45 (Nobel Lecture, Dec.

9, 1992).

According to Murphy, the Supreme Court read the concept

of “human capital” into the IRC in Glenshaw Glass. There, in

holding that punitive damages for personal injury were “gross

income” under the predecessor to § 61, the Court stated:

The long history of ... holding personal injury recoveries

nontaxable on the theory that they roughly correspond to a

return of capital cannot support exemption of punitive

damages following injury to property .... Damages for

personal injury are by definition compensatory only.

Punitive damages, on the other hand, cannot be considered

a restoration of capital for taxation purposes.

348 U.S. at 432 n.8. In Murphy’s view, the Court thereby made

clear that the recovery of compensatory damages for a “personal

injury” -- of whatever type -- is analogous to a “return of

capital” and therefore is not income under the IRC or the

Sixteenth Amendment.

In support of her reading of the caselaw, Murphy contends

the IRC, as drafted shortly after “passage of the [Sixteenth]

Amendment demonstrates that compensatory damages designed

to make a person whole are excluded from the definition of

‘income.’” She focuses upon the three sources the Supreme

Court quoted in O’Gilvie, 519 U.S. 84-87, to wit, an Opinion of

the Attorney General, a Decision of the Department of the

Treasury, and a Report issued by the Ways and Means

Committee of the House of Representatives -- each of which

predates the first version of § 104(a)(2), namely, § 213(b)(6) of

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the Revenue Act of 1918. See 40 Stat. 1057, 1066 (1919).

In an opinion rendered to the Secretary of the Treasury on

the question whether proceeds from an accident insurance policy

were income under the IRC as it stood prior to the 1918 Act, the

Attorney General stated:

Without affirming that the human body is in a technical

sense the “capital” invested in an accident policy, in a

broad, natural sense the proceeds of the policy do but

substitute, so far as they go, capital which is the source of

future periodical income. They merely take the place of

capital in human ability which was destroyed by the

accident. They are therefore “capital” as distinguished from

“income” receipts.

31 Op. Att’y. Gen. 304, 308 (1918). In a revenue ruling, the

Department of the Treasury then reasoned that

upon similar principles ... an amount received by an

individual as the result of a suit or compromise for personal

injuries sustained ... through accident is not income [that is]

taxable.

T.D. 2747, 20 Treas. Dec. Int. Rev. 457 (1918).

As for the House Report on the bill that became the

Revenue Act of 1918, it states:

Under the present law it is doubtful whether amounts

received through accident or health insurance, or under

workmen’s compensation acts, as compensation for

personal injury or sickness, and damages received on

account of such injuries or sickness, are required to be

included in gross income.

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H.R. Rep. No. 65-767, at 9-10 (1918). Thereafter, the Congress

passed the Act, § 213(b)(6) of which excluded from gross

income “[a]mounts received, through accident or health

insurance or under workman’s compensation acts, as

compensation for personal injuries or sickness, plus the amount

of any damages received whether by suit or agreement on

account of such injuries or sickness.” 40 Stat. 1057, 1066

(1919).

Because the 1918 Act followed soon after ratification of the

Sixteenth Amendment, Murphy contends that the statute reflects

the meaning of the Amendment as it would have been

understood by those who framed, adopted, and ratified it. She

observes that in Dotson v. United States, 87 F.3d 682 (5th Cir.

1996), the court concluded upon the basis of the House Report

that the “Congress first enacted the personal injury

compensation exclusion ... when such payments were considered

the return of human capital, and thus not constitutionally taxable

‘income’ under the 16th amendment.” Id. at 685.

The Government attacks Murphy’s constitutional argument

on all fronts. First, invoking the presumption that the Congress

enacts laws within its constitutional limits, see Rust v. Sullivan,

500 U.S. 173, 191 (1991), the Government asserts at the outset

that § 104(a)(2) is constitutional even if, as amended in 1996, it

does permit the taxation of compensatory damages. Indeed, the

Government goes further, contending the Congress could,

consistent with the Sixteenth Amendment, repeal § 104(a)(2)

altogether and tax compensation even for physical injuries.

Noting that the power of the Congress to tax income

“extends broadly to all economic gains,” Commissioner v.

Banks, 543 U.S. 426, 433 (2005), the Government next

maintains that compensatory damages “plainly constitute

economic gain, for the taxpayer unquestionably has more money

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after receiving the damages than she had prior to receipt of the

award.” On that basis, the Government contends Murphy’s

reliance upon footnote eight of Glenshaw Glass is misplaced;

merely because the Congress “has historically excluded personal

injury recoveries from gross income, based on the make-whole

or restoration-of-human-capital theory, does not mean that such

an exclusion is mandated by the Sixteenth Amendment.”

Because the Supreme Court in Glenshaw Glass was construing

“gross income” with reference only to the IRC, the Government

argues footnote eight addresses only a now abandoned

congressional policy, not the outer limit of the Sixteenth

Amendment.

According to the Government, the same is true of the 1918

Act and the interpretive rulings that preceded it. Although the

Government acknowledges that the dictum in Dotson, 87 F.3d

at 685, accords with Murphy’s position, the Government notes

the court there relied solely upon the House Report. Because the

House Report merely states “it is doubtful whether ...

compensation for personal injury or sickness ... [is] required to

be included in gross income,” H.R. Rep. No. 65-767, at 9-10

(1918), the Government observes that the “report simply does

not establish that Congress believed taxing compensatory

personal injury damages would be unconstitutional.”

In addition, the Government challenges the coherence of

Murphy’s analogy between a return of “human capital or well-

being” and a return of “financial capital,” the latter of which it

acknowledges does not constitute income under the Sixteenth

Amendment. See Doyle, 247 U.S. at 187; S. Pac. Co., 247 U.S.

at 335. The Government first observes that financial capital,

like all property, has a “basis,” defined by the IRC as “the cost

of such property,” 26 U.S.C. § 1012, adjusted “for expenditures,

receipts, losses, or other items, properly chargeable to [a] capital

account,” id. § 1016(a)(1); thus, when a taxpayer sells property,

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his income is “the excess of the amount realized therefrom over

the adjusted basis.” Id. § 1001(a). The Government then

observes that “[b]ecause people do not pay cash or its equivalent

to acquire their well-being, they have no basis in it for purposes

of measuring a gain (or loss) upon the realization of

compensatory damages.” Nor is there any corresponding theory

of “human depreciation,” which would permit “an offsetting

deduction for the exhaustion of the taxpayer’s physical prowess

and mental agility.” Boris I. Bittker & Lawrence Lokken,

Federal Taxation of Income, Estates, and Gifts ¶ 5.6 (2003).

Finally, the Government points to the Ninth Circuit’s dictum in

Roemer v. Commissioner, 716 F.2d 693 (1983), suggesting that

“[s]ince there is no tax basis in a person’s health and other

personal interests, money received as compensation for an injury

to those interests might be considered a realized accession to

wealth.” Id. at 696 n.2.

At the outset, we reject the Government’s breathtakingly

expansive claim of congressional power under the Sixteenth

Amendment -- upon which it founds the more far-reaching

arguments it advances here. The Sixteenth Amendment simply

does not authorize the Congress to tax as “incomes” every sort

of revenue a taxpayer may receive. As the Supreme Court noted

long ago, the “Congress cannot make a thing income which is

not so in fact.” Burk-Waggoner Oil Ass’n v. Hopkins, 269 U.S.

110, 114 (1925). Indeed, because the “the power to tax involves

the power to destroy,” McCulloch v. Maryland, 17 U.S. (4

Wheat.) 316, 431 (1819), it would not be consistent with our

constitutional government, and the sanctity of property in our

system, merely to rely upon the legislature to decide what

constitutes income.

Fortunately, we need not rely solely upon the wisdom and

beneficence of the Congress for, when the Sixteenth

Amendment was drafted, the word “incomes” had well

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understood limits. To be sure, the Supreme Court has broadly

construed the phrase “gross income” in the IRC and, by

implication, the word “incomes” in the Sixteenth Amendment,

but it also has made plain that the power to tax income extends

only to “gain[s]” or “accessions to wealth.” Glenshaw Glass,

348 U.S. at 430-31. That is why, as noted above, the Supreme

Court has held a “return of capital” is not income. Doyle, 247

U.S. at 187; S. Pac. Co., 247 U.S. at 335. The question in this

case is not, however, about a return of capital -- except insofar

as Murphy analogizes human capital to physical or financial

capital; the question is whether the compensation she received

for her injuries is income.*

To determine whether Murphy’s compensation is income

under the Sixteenth Amendment, we are instructed by the

Supreme Court first to consider whether the taxpayer’s award of

compensatory damages is “a substitute for [a] normally untaxed

personal ... quality, good, or ‘asset.’” O’Gilvie, 519 U.S. at 86.

Accordingly, we join our sister circuits by asking: “In lieu of

what were the damages awarded”? Raytheon Prod. Corp. v.

Commissioner, 144 F.2d 110, 113 (1st Cir. 1944); see Francisco

v. United States, 267 F.3d 303, 319 (3d Cir. 2001) (treating

* In any event, the Government’s quarrel with Murphy’s analogy,

based upon Glenshaw Glass, of “human capital” to financial or

physical capital is not persuasive. To be sure, the analogy is

incomplete; personal injuries do not entail an adjustment to any basis,

nor are human resources, such as reputation, depreciable for tax

purposes. But nothing in Murphy’s argument implies a need to

account for the basis in or to depreciate anything. Her point, rather,

is that as with compensation for a harm to one’s financial or physical

capital, the payment of compensation for the diminution of a personal

attribute, such as reputation, is but a restoration of the status quo ante,

analogous to a “restoration of capital,” Glenshaw Glass, 348 U.S. at

432 n.8; in neither context does the payment result in a “gain” or

“accession[] to wealth,” id. at 430-31.

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Raytheon’s “in lieu of” test as authoritative); Tribune Publ’g Co.

v. United States, 836 F.2d 1176, 1178 (9th Cir. 1988) (applying

“in lieu of” test to determine whether settlement proceeds were

income); Gilbertz v. United States, 808 F.2d 1374, 1378 (10th

Cir. 1987) (adopting “in lieu of” test to determine whether

compensatory damages were income). Here, if the $70,000

Murphy received was “in lieu of” something “normally

untaxed,” O’Gilvie, 519 U.S. at 86, then her compensation is not

income under the Sixteenth Amendment; it is neither a “gain”

nor an “accession[] to wealth.” Glenshaw Glass, 348 U.S. at

430-31.

As we have seen, it is clear from the record that the

damages were awarded to make Murphy emotionally and

reputationally “whole” and not to compensate her for lost wages

or taxable earnings of any kind. The emotional well-being and

good reputation she enjoyed before they were diminished by her

former employer were not taxable as income. Under this

analysis, therefore, the compensation she received in lieu of

what she lost cannot be considered income and, hence, it would

appear the Sixteenth Amendment does not empower the

Congress to tax her award.

Our conclusion at this point is tentative because the

Supreme Court has also instructed that, in defining “incomes,”

we should rely upon “the commonly understood meaning of the

term which must have been in the minds of the people when

they adopted the Sixteenth Amendment.” Merchants’ Loan &

Trust Co. v. Smietanka, 255 U.S. 509, 519 (1921). And, to

discern the original understanding of a provision of the

Constitution, we must examine any contemporaneous

implementing legislation. See Myers v. United States, 272 U.S.

52, 175 (1926) (“This court has repeatedly laid down the

principle that a contemporaneous legislative exposition of the

Constitution ..., acquiesced in for a long term of years, fixes the

18

construction to be given its provisions”); see Macomber, 252

U.S. at 202 (district judge correctly treated “construction of the

[Revenue Act of 1913] as inseparable from the interpretation of

the Sixteenth Amendment”). Therefore, we must inquire

whether “the people when they adopted the Sixteenth

Amendment,” or the Congress when it implemented the

Amendment, would have understood compensatory damages for

a nonphysical injury to be “income.”

In the years immediately following ratification of the

Sixteenth Amendment, the Congress created and then thrice

revised the IRC. See Revenue Act of 1913, ch. 16, 38 Stat. 114

(1913); Revenue Act of 1916, ch. 463, 39 Stat. 756 (1916);

Revenue Act of 1917, ch. 63, 40 Stat. 300 (1917); Revenue Act

of 1918, ch. 18, 40 Stat. 1057 (1919). Of the four enactments,

that of 1918 was the first to address the tax treatment of

compensatory damages for personal injuries, and it did so

without distinguishing between physical and nonphysical

injuries. We agree with the Government that the House Report

on the 1918 Act is ambiguous and therefore unhelpful on the

question before us. We concur in Murphy’s view, however, that

the Attorney General’s 1918 opinion and the Treasury

Department’s ruling of the same year strongly suggest that the

term “incomes” as used in the Sixteenth Amendment does not

extend to monies received solely in compensation for a personal

injury and unrelated to lost wages or earnings.

That emotional distress and loss of reputation were both

actionable in tort when the Sixteenth Amendment was adopted

supports the view that compensation for these nonphysical

injuries was not regarded differently than was compensation for

physical injuries and, therefore, was not considered income by

the framers of the Amendment and the state legislatures that

ratified it. By 1913, in at least 39 of the then-48 states and in the

District of Columbia, the law made compensatory damages for

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“mental suffering” recoverable in the same matter as

compensatory damages for physical harms; indeed, in 34 of

those states, there are reported cases involving defamation and

other reputational injuries* -- the

* See, e.g., Garrison v. Sun Printing & Publ’g Ass’n, 207 N.Y. 1, 6,

100 N.E. 430, 431 (1912) (plaintiffs are “entitled to recover

compensatory damages for mental distress resulting from the

publication of defamatory words actionable in themselves”); Guisti v.

Galveston Tribune, 105 Tex. 497, 504-05 150 S.W. 874, 877 (1912)

(holding statute afforded “right to maintain an action for a publication

not libelous per se [without having] to allege or prove special damages

.... for mental anguish”); Fields v. Bynum, 72 S.E. 449, 451

(1911)(general damages in defamation actions “include injury to the

feelings, and mental suffering endured in consequence”); Comer v.

Advertiser Co., 172 Ala. 613, 55 So. 195, 198 (1911) (in libel actions

“damages for mental pain and suffering ... must in all cases be fixed

by the jury, in view of all the facts and circumstances surrounding any

particular case”); Miller v. Dorsey, 149 Mo. App. 24, 129 S.W. 66, 69

(1910) (upholding jury award of damages in action for slander “to

compensate [plaintiff] for the mortification and shame he might have

suffered, and the disgrace and dishonor attempted to be cast upon him,

and all damages done to his reputation”); Jozsa v. Moroney, 125 La.

813, 821, 51 So. 908, 911 (1910) (in libel action “damages for mental

suffering alone can be recovered, although the party may have

suffered no other loss”); Moore v. Maxey, 152 Ill. App. 647, 1910 WL

1686, at *2 (1910) (“Where words spoken are actionable per se ....

there need be no direct evidence of mental suffering to enable the jury

to consider it in their estimate of damages”); Davis v. Mohn, 145 Iowa

417, 124 N.W. 206, 207 (1910) (holding mental “pain and suffering

may be considered by the jury in determining the amount of damages

in cases where the words spoken are actionable [as slander] per se”);

Henry v. Cherry & Webb, 30 R.I. 13, 73 A. 97, 102 (1909) (noting that

“mental suffering alone [will] sustain a right of action” if “the words

spoken or pictures published are of such a nature that the court can

conclude, as a matter of law, that they will tend to degrade the person,

or hold him up to public hatred, contempt, or ridicule, or cause him to

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be shunned and avoided”); Neafie v. Hoboken Printing & Publ’g Co.,

75 N.J.L. 564, 566, 68 A. 146, 147 (1907) (rejecting view that “mental

anguish cannot be considered in estimating compensatory damages in

an action of libel”); McArthur v. Sault News Printing Co., 148 Mich.

556, 558, 112 N.W. 126, 127 (1907) (“A woman might have a bad

reputation and a bad character, neither of which would be changed by

such a [libelous] publication, and yet be entitled to substantial

damages for injuries to her feelings resulting from the publication”);

Todd v. Every Evening Printing Co., 22 Del. 233, 66 A. 97, 99 (1907)

(“amount to be awarded to the plaintiff should be such as would

reasonably compensate him for any wrong done to his reputation,

good name, or fame, and for any mental suffering caused thereby as

shown by the evidence”); Gendron v. St. Pierre, 73 N.H. 419, 62 A.

966, 969 (1905) (“amount of the damages” in slander action “depends

in part upon the effect of the malice upon the plaintiff’s mind”); Ott

v. Press Pub. Co., 40 Wash. 308, 310, 82 P. 403, 404 (1905) (“upon

a proper showing damages for mental pain and suffering may be

recovered” in libel action); Wash. Times Co. v. Downey, 26 App. D.C.

258, 1905 WL 17653, at *4 (1905) (holding “plaintiff is ... entitled to

recover as general damages for injury to her feelings and the mental

suffering which she endured as a natural result of the [libelous]

publication”); Hanson v. Krehbiel, 68 Kan. 670, 75 P. 1041, 1042

(1904) (noting that general damages for libel and slander actions are

“designed to compensate for that large and substantial class of injuries

arising from injured feelings, mental suffering and anguish, and

personal and public humiliation”); Finger v. Pollack, 188 Mass. 208,

209, 74 N.E. 317, 318 (1905) (“In an action for slander one of the

elements of damage is mental suffering”); Davis v. Starrett, 97 Me.

568, 55 A. 516, 519 (1903) (“plaintiff is entitled to recover

compensation [for] slander, such as injury to the feelings and injury to

the reputation”); Bedtkey v. Bedtkey, 15 S.D. 310, 89 N.W. 479, 480

(1902) (holding “evidence of injury to feelings having been admitted

without objection, damages therefore are recoverable”); Kidder v.

Bacon, 74 Vt. 263, 52 A. 322, 324 (1902) (“It is well settled that when

the words spoken are actionable the jury have a right to consider the

mental suffering which may have been occasioned to a party by the

publication of the slanderous words, and to allow damages therefor”);

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Hacker v. Heiney, 111 Wis. 313, 87 N.W. 249, 251 (1901) (rejecting

contention that “no recovery can be had for injury to feelings” in

action for slander); McCarty v. Kinsey, 154 Ind. 447, 57 N.E. 108, 108

(1900) (holding it was “proper for the jury to consider” slanderous

words used in course of an assault and battery “with all the

circumstances in evidence, and the humiliation, degradation, shame,

and loss of honor, and mental anguish, if any, caused thereby, in

determining the amount of damages”); Gray v. Times Newspaper Co.,

78 Minn. 323, 324, 81 N.W. 7, 7 (1899) (plaintiff “was entitled to

some damages for injury to his feelings, shame, and loss of the good

opinion of his fellows, and injury to his standing in the community”);

Louisville Press Co. v. Tennelly, 105 Ky. 365, 49 S.W. 15, 17 (1899)

(“the rule is well settled that the publication of a libel exposes the

publisher, not only to compensatory damages for the loss of business,

but also to a judgment for the mental suffering that the libel or slander

inflicts upon the plaintiff”); Cole v. Atlanta & W.P.R. Co., 102 Ga.

474, 31 S.E. 107, 108 (1897) (permitting action by plaintiff passenger

against railroad for its employee’s slander, which caused plaintiff “to

undergo the pain and mortification of being publicly denounced”); Fry

v. McCord, 95 Tenn. 678, 33 S.W. 568, 571 (1895) (damages for

slander per se may include “pain, mental anxiety, or general loss of

reputation”); Taylor v. Hearst, 170 Cal. 262, 270, 40 P. 392, 393-94

(1895) (“actual damages embraces recovery for loss of reputation,

shame, mortification, injury to feelings, etc.; and while special

damages must be alleged and proven, general damages for outrage to

feelings and loss of reputation need not be alleged in detail”); Taylor

v. Dominick, 36 S.C. 368, 15 S.E. 591, 593-94 (1892) (“the elements

of damages in the action for malicious prosecution are the injury to the

reputation or character, feelings, health, mind, and person, as well as

expenses incurred in defending the prosecution”); Stallings v.

Whittaker, 55 Ark. 494, 18 S.W. 829, 831 (1892) (damages in slander

action may compensate for “mental suffering and mortification”);

Republican Pub. Co. v. Mosman, 15 Colo. 399, 410, 24 P. 1051, 1055

(1890) (“in cases of written slander where the defamatory matter is

libelous per se, the mental suffering of the plaintiff, occasioned by the

false publication, may be taken into consideration, in awarding general

compensatory damages”); Commercial Gazette Co. v. Grooms, 10

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very sort of injury Murphy suffered -- and at least five more

states allowed an action for alienation of affections, also a

nonphysical injury.* As a result, we see no meaningful

distinction between Murphy’s award and the kinds of damages

recoverable for personal injury when the Sixteenth Amendment

was adopted. Because, as we have seen, the term “incomes,” as

understood in 1913, clearly did not include damages received in

compensation for a physical personal injury, we infer that it

likewise did not include damages received for a nonphysical

Ohio Dec. Reprint 489, 1889 WL 346, at *4 (1889) (“The most natural

result from an injury to reputation is mental suffering and it is a proper

element to be considered in estimating damages in a libel suit”); Boldt

v. Budwig, 19 Neb. 739, 28 N.W. 280, 283 (1886) (“jury should

consider the damage to her character, as well as her mental suffering

caused [by the slander]”); Riddle v. McGinnis, 22 W.Va. 253, 1883

WL 3242, at *15 (1883)(“in ... actions for wilful and wanton injuries

done to the person and reputation ... the plaintiff is entitled to recover

damages ... for his mental anguish”); Swift v. Dickerman, 31 Conn.

285, 1863 WL 763, at *7 (1863) (holding “anxiety and suffering [due

to slander] were proper subjects for compensation to the plaintiff, and

ought to be atoned for by the defendant”); Beehler v. Steever, 1 Miles

146, 1837 WL 3209, at *6 (1837) (noting in syllabus that “[o]utrage

to the plaintiff’s feelings and peace of mind may be considered” by the

jury in awarding damages for slander).

* See, e.g., Greuneich v. Greuneich, 23 N.D. 368, 137 N.W. 415 (N.D.

1912); Hillers v. Taylor, 116 Md. 165, 81 A. 286 (Md. 1911); Seed v.

Jennings, 47 Or. 464, 83 P. 872 (Or. 1905); Tucker v. Tucker, 74 Miss.

93, 19 So. 955 (Miss. 1896); Samuel v. Marshall, 30 Va. 567, 1832

WL 1822 (Va. 1832). An action for “alienation of affection” enabled

the plaintiff to recover damages for mental suffering and reputational

damage arising from the defendant’s interference in the relationship

between the plaintiff and his or her spouse. See generally

R ESTATEMENT (S ECOND ) OF T ORTS § 683 cmt. f (1977) (“It is

unnecessary for recovery that the acts of the defendant cause any

financial loss to the injured spouse”).

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injury and unrelated to lost wages or earning capacity.

The IRS itself reached the same conclusion when it first

addressed the question, expressly affirming that personal injuries

included nonphysical personal injuries:

[T]here is no gain, and therefore no income, derived from

the receipt of damages for alienation of affections or

defamation of personal character .... If an individual is

possessed of a personal right that is not assignable and not

susceptible of any appraisal in relation to market values,

and thereafter receives either damages or payment in

compromise for an invasion of that right, it can not be held

that he thereby derives any gain or profit.

Sol. Op. 132, I-1 C.B. 92, 93 (1922); see also Hawkins v.

Commissioner, 6 B.T.A. 1023, 1024-25 (U.S. Bd. of Tax App.

1927) (holding “compensation for injury to [plaintiff’s] personal

reputation for integrity and fair dealing” was not income

because it was “an attempt to make the plaintiff whole as before

the injury”). Note that the Service regarded such compensation

not merely as excludable under the IRC, but more fundamentally

as not being income at all.

In sum, every indication is that damages received solely in

compensation for a personal injury are not income within the

meaning of that term in the Sixteenth Amendment. First, as

compensation for the loss of a personal attribute, such as well-

being or a good reputation, the damages are not received in lieu

of income. Second, the framers of the Sixteenth Amendment

would not have understood compensation for a personal injury --

including a nonphysical injury -- to be income. Therefore, we

hold § 104(a)(2) unconstitutional insofar as it permits the

taxation of an award of damages for mental distress and loss of

reputation.

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III. Conclusion

Albert Einstein may have been correct that “[t]he hardest

thing in the world to understand is the income tax,” The

Macmillan Book of Business and Economic Quotations 195

(Michael Jackman ed., 1984), but it is not hard to understand

that not all receipts of money are income. Murphy’s

compensatory award in particular was not received “in lieu of”

something normally taxed as income; nor is it within the

meaning of the term “incomes” as used in the Sixteenth

Amendment. Therefore, insofar as § 104(a)(2) permits the

taxation of compensation for a personal injury, which

compensation is unrelated to lost wages or earnings, that

provision is unconstitutional. Accordingly, we remand this case

to the district court to enter an order and judgment instructing

the Government to refund the taxes Murphy paid on her award

plus applicable interest.

So ordered.