Murphy and the Evolution of Basis

Abstract

Marrita Murphy received compensatory damages of 45,000 for emotional distress or mental anguish and $25,000 for injury to professional reputation after bringing a complaint with the Department of Labor under various whistle-blower statutes. A three-judge panel of the U.S. Court of Appeals for the D.C. Circuit unanimously held, in an opinion written by Chief Judge Douglas Ginsburg, that Murphy's damages were not due to physical injury and thus could not be excluded under the authority of section 104(a)(2) of the Internal Revenue Code but that the government nevertheless could not, under the Constitution, tax those damages as income. The government has now asked the full D.C. Circuit to hear the case en banc and reverse.

While there are many interesting aspects of the case, I focus on what I think to be the key that underlies the panel's conclusion and that should result in its reversal. Stripped to its bare essentials, the panel opinion appears to hold that our understanding of the core concept of tax basis (or capital) must be frozen as of 1913, when the Sixteenth Amendment was adopted and the first tax on income was enacted under it. I think that this holding is not only unwise but inconsistent with prior Supreme Court precedent in Taft v. Bowers.

Keywords: Murphy, 104(a)(2), basis, capital, Sixteenth Amendment

JEL Classification: E62, H20, H24