The recent ruling holds the IRS can continue to tax compensatory damages awarded to victims of whistleblower retaliation and other civil rights violations. These damage awards, which are intended to make the victim whole again, include payments for loss of reputation and emotional distress.
The case was brought by Marrita Murphy, an environmental whistleblower who won her case before the Department of Labor, and was awarded compensatory damages to vindicate her rights under six federal environmental whistleblower statutes. Murphy filed suit when the IRS demanded that she pay taxes on the make-whole award as if it were income. After having her case dismissed, Murphy filed an appeal.
After full briefing and oral argument, the Appeals court initially held that Murphy's award was not income and the tax on her damages violated the U.S. Constitution. Then, under pressure from the Bush Administration, the judges decided to rehear the case. In this ruling, Murphy II, the D.C. Circuit reversed its own previous decision, declaring that non-physical compensatory damages are taxable as gross income. The Supreme Court recently declined to hear this case.