I’m no tax law expert, but I’ve been fascinated with the reaction to last week’s big DC Circuit tax case, Murphy v. IRS. The Tax Prof Blog has naturally been all over this. You can get the basics here. The opinion is here (24-page pdf). Prof. Caron sums it up more concisely than I ever could: The court held “that § 104(a)(2) is unconstitutional under the 16th Amendment as applied to a recovery for a non-physical personal injury (emotional distress and loss of reputation) unrelated to lost wages or earnings.” Section 104(a)(2) excludes from gross income “damages…received…on account of personal physical injuries or physical sickness.”
First, a few more links. The Tax Prof Blog has good posts here and here, with more here and here and here and here. Prof. Lederman has a very good post at Balkinization, but there are tons of links to other good posts at Tax Prof Blog.
I had two thoughts about Murphy. First, I’m very intrigued by the court’s adoption of a theory that these damage awards are just a restoration of the taxpayers’ basis in “human capital.” As Professor Bryan Camp said in this Tax Prof Blog post:
For the opinion to make any sense, then, it must assume that Murphy’s basis in her reputation and emotional well-being was equal to or greater than her recovery. The court must assume that some dollars Murphy spent at some point in time gave her a basis in her “human capital.” That unstated assumption has huge consequences. For example, if Murphy has a basis in her “human capital” then some portion of wages would also represent a recovery of the capital. Or if Murphy donates her services to a section 501(c)(3) organization, then she should get to take a charitable deduction. Of course, the case law has long held that people cannot take a charitable deduction for the donation of services. That is because it has, until this opinion, been widely accepted that taxpayers have no basis in their labor, their human capital. Karl Marx would undoubtedly give basis to labor, but this county generally has not adopted his economic theories. This opinion moves us in that direction.
I’m sure the DC Circuit panel loves being compared to Karl Marx. People more learned in tax than I am will have lots more to say about the basis basis of Murphy, but I think that aspect of the opinion is even more interesting than the constitutional arguments. And, under the avoidance doctrine, wouldn’t it be a lot easier and smarter for a court (assuming it was inclined to reverse the panel) to declare the recovery to be income, and therefore taxable because of this basis argument, and not get to the constitutional issue at all?
Also, like a lot of the commentators, I am curious to see what tax protesters do with this opinion, especially the restoration-of-human-capital idea. (See these links for lots of fun stuff about tax protester arguments — constitutional, statutory, and conspiratorial.) I think they’re likely to be buoyed by a couple of lines in the opinion. I expect to see these quotes taken out of context in scores of protester filings in the near future: (1) “[W]e reject the Government’s breathtakingly expansive claim of congressional power under the Sixteenth Amendment….The Sixteenth Amendment simply does not authorize the Congress to tax as ‘incomes’ every sort of revenue a taxpayer may receive.” (page 15 of the pdf) (alterations mine) (2) “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.’” (page 10 of the pdf) (alterations in the opinion) I expect these quotes, and other similar lines from the panel opinion, to join the pantheon of misapplied legal statements, such as the famous line in Flora v. United States that “[o]ur system of taxation is based upon voluntary assessment and payment, not upon distraint.” 362 U.S. 145, 176 (1960) (Warren, C.J.).
So, with tax protesters on the brain, I turned to Judge Easterbrook’s opinion in a Seventh Circuit tax protester case, Szopa v. United States (5-page pdf) (link via Howard Bashman). The Murphy case wasn’t a classic tax protester case, even if it will be misused in that context. Szopa was a tax protester. In fact, the Seventh Circuit had previously decided to impose sanctions on her for frivolous filings. The panel hesitated over the Justice Department Tax Division’s arguments for a specific dollar amount presumptive sanction based on their hours logged in the average protester case. This opinion, issued a day before Murphy, is the follow-up, where Judge Easterbrook essentially says the government attorneys have been overdoing it in the time they spend responding to tax protester arguments. The panel set the presumptive sanctions at a level higher than they were before, but lower than the government asked for.
I have mixed feelings about this one. On the one hand, a lot of the government briefs in these cases are certainly boilerplate, and usually short to boot. After all, there’s no need to reinvent the wheel here. But on the other hand, as the government attorneys argued, a lot of these filings are gibberish, and the government attorneys have to sift through the junk to present the court with something resembling coherence. I’ve had to do that kind of thing a lot, especially with prisoner litigation, and I can attest that sometimes the “easy” cases take longer, and require more work, than the “hard” cases. That’s because (a) hard cases tend to be briefed well (not coincidentally, usually by counsel as opposed to the frivolous pro se cases) or at least present the issues in a way the reader can grasp. Even if the answer isn’t obvious, the question usually is, whereas in frivolous cases the questions are often unclear. And, (b), sometimes a case you know is frivolous is hard to get rid of because it’s so out-there that there isn’t a lot of precedent on the question — you know it’s ridiculous, but you can’t point to a case saying so.
Now, I grant Judge Easterbrook’s point that Szopa’s case didn’t require a lot of original thought. So maybe it wasn’t the case for the government to fight this battle over. But, in a half-hearted defense of the government attorneys here, I don’t think it’s crazy that they might be putting in a lot more work than you might think is necessary in some of these “frivolous” cases. Judge Easterbrook says that the government can seek higher sanctions “when the case is especially complex or the tax protester’s argument is especially long and opaque.” I wonder if, after Murphy, the government will be seeing those kind of filings more and more.