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.
 2

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
 3

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
 4

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.
 5

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”).
 6

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
 7

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
 8

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
 9

“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”).
 10

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
 11

-- 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
 12

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.
 13

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
 14

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,
 15

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
 16

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.
 17

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
 19

“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
 20

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”);
 21

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
 22

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”).
 23

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.
 24

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.