Set forth below are summaries of two recent court decisions. Copies of the decisions are attached below. If you have any questions, comments, or additional cases or materials that you would like us to consider, please feel free to send us a reply.
Richard v. R & Q Reinsurance Company, et al., No. 4:07-CV-022-A, 2007 WL 1119212, 2007 U.S. Dist. LEXIS 27987 (N.D. Tex. April 13, 2007); 2007 WL 1406481, 2007 U.S. Dist. LEXIS 34751 (N.D. Tex. May 10, 2007)
This action arose out of the argument of plaintiff Diana Richard (“Richard”) that the structured settlement agreement she entered into more than 20 years ago should have included monthly life-contingent payments, although neither the agreement nor the resulting annuity provided for any such life-contingent payments. Richard supported her claim with correspondence from the annuity issuer that referenced life-contingent payments. Richard’s amended complaint included legal malpractice claims against her attorney in the underlying lawsuit, and fraud and negligence claims against counsel for the defendants and their fi rms. The claims against the attorneys and their fi rms were dismissed on the basis that the court lacked personal jurisdiction.
Richard also alleged, inter alia, fraud, negligent misrepresentation, violations of the Texas Deceptive Trade Practices – Consumer Protection Act and the Texas Insurance Code, and breach of contract against the underlying insurer, annuity issuer and annuity owner. All defendants fi led motions to dismiss under Rule 12(b)(6) and Rule 9(b) of the Federal Rules of Civil Procedure. The court granted Richard leave to fi le a second amended complaint after advising her counsel as to his Rule 11 obligations. Richard’s second amended complaint named only the annuity issuer as a defendant. The annuity owner was represented by Stephen Harris and Michael Bootier of Drinker Biddle & Reath LLP.
Murphy v. Internal Revenue Service, et al., No. 05- 5139, 2007 WL 1892238 (D.C. Cir. July 3, 2007)
As a result of an administrative action that she brought against her former employer, Marrita Murphy (“Murphy”) was awarded compensatory damages for “emotional distress” and “injury to professional reputation” unrelated to lost wages or earnings. Murphy included those damages as gross income in her federal tax return, but later fi led an amended return seeking a refund for the taxes paid on those damages. The IRS denied her request. Murphy then fi led suit against the IRS and the U.S. Government in the U.S. District Court for the District of Columbia, arguing that her compensatory award was in fact for “physical personal injuries” and therefore excluded from gross income under IRC § 104(a)(2). Alternatively, Murphy argued that taxing her award was unconstitutional because the award was not “income” within the meaning of the Sixteenth Amendment. The district court rejected Murphy’s arguments and granted summary judgment in favor of the IRS and the Government. Murphy appealed to the U.S. Court of Appeals for the District of Columbia Circuit.
In a decision entered on August 22, 2006, the court of appeals reversed the district court. See Murphy v. IRS, 460 F.3d 79 (D.C. Cir. 2006). The court of appeals fi rst held that Murphy’s award was taxable under Section 104(a)(2) because her damages were not on account of “personal physical injuries or physical sickness” as is required for exclusion under Section 104(a)(2). Rather, her damages were on account of emotional distress, which type of damages is expressly excluded from Section 104(a)(2). However, the court of appeals also held that Section 104(a)(2) was unconstitutional insofar as it permitted the taxation of compensatory damages for non-physical personal injuries, because such damages are not “income” within the meaning of the Sixteenth Amendment. The court of appeals reasoned that, since the emotional well-being and good reputation that the taxpayer previously enjoyed were not taxable, the compensation for the loss of same could not be considered income. The court of appeals further opined that the framers of the Sixteenth Amendment would not have understood such compensation to be “income” or taxable.
The IRS and the Government petitioned for rehearing en banc. Then, by order dated December 22, 2006, the court of appeals – on its own motion – vacated its August 22 order, and decided to rehear the case. In a decision entered on July 3, 2007, the court of appeals reversed itself and ruled that taxing awards for non-physical personal injuries does not violate the Constitution. In doing so, the court of appeals relied in part on the argument – advanced for the fi rst time in the petition for rehearing en banc – that even if Murphy’s award was not income, there was no constitutional impediment to taxing it, because a tax on the award is not a direct tax and is imposed uniformly.
Specifically, the court of appeals held that: (1) Murphy’s damages were not “awarded by reason of, or because of,… [physical] personal injuries,” and were therefore not excluded from income by Section 104(a)(2) of the IRC; (2) gross income under Section 61 of the IRC includes compensatory damages for non-physical personal injuries1; (3) the income tax imposed on an award for non-physical personal injuries is an excise and not a direct tax and does not violate the constitutional requirement of Article I, Section 9, that capitations or other direct taxes be laid among the states only in proportion to the population; and (4) the income tax imposed on an award for non-physical personal injuries does not violate the constitutional requirement of Article I, Section 8, that all duties, imposts and excises be imposed uniformly throughout the United States. In so holding, the court of appeals opined that “[a]lthough the Congress cannot make a thing income which is not so in fact, [...] it can label a thing income and tax it, so long as it acts within its constitutional authority, which includes not only the Sixteenth Amendment but also Article I, Sections 8 and 9” (emphasis in original). Thus, the court of appeals concluded that, even if an award for non-physical personal injuries was not income within the meaning of the Sixteenth Amendment, it was still “within the reach of the congressional power to tax,” and Murphy’s award therefore was taxable.2