Opinion ID: 186753
Heading Depth: 2
Heading Rank: 3

Heading: The Sixteenth Amendment

Text: 20 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, 120 S.Ct. 1740, 146 L.Ed.2d 658 (2000). The 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. 21 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, 60 S.Ct. 554, 84 L.Ed. 788 (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, 40 S.Ct. 189, 64 L.Ed. 521 (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, 75 S.Ct. 473, 99 L.Ed. 483 (1955). 22 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, 117 S.Ct. 452; see, e.g., Doyle v. Mitchell Bros. Co., 247 U.S. 179, 187-88, 38 S.Ct. 467, 62 L.Ed. 1054 (1918); S. Pac. Co. v. Lowe, 247 U.S. 330, 335, 38 S.Ct. 540, 62 L.Ed. 1142 (1918) (return of capital not income under IRC or Sixteenth Amendment). By analogy, Murphy contends a damage award for personal injuries—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). 23 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: 24 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. 25 348 U.S. at 432 n. 8, 75 S.Ct. 473. 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. 26 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. at 84-87, 117 S.Ct. 452, 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 the Revenue Act of 1918. See 40 Stat. 1057, 1066 (1919). 27 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: 28 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. 29 31 Op. Att'y. Gen. 304, 308 (1918). In a revenue ruling, the Department of the Treasury then reasoned that 30 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. 31 T.D. 2747, 20 Treas. Dec. Int. Rev. 457 (1918). 32 As for the House Report on the bill that became the Revenue Act of 1918, it states: 33 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. 34 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). 35 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. 36 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, 111 S.Ct. 1759, 114 L.Ed.2d 233 (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. 37 Noting that the power of the Congress to tax income extends broadly to all economic gains, Commissioner v. Banks, 543 U.S. 426, 433, 125 S.Ct. 826, 160 L.Ed.2d 859 (2005), the Government next maintains that compensatory damages plainly constitute economic gain, for the taxpayer unquestionably has more money 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. 38 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. 39 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, 38 S.Ct. 467; S. Pac. Co., 247 U.S. at 335, 38 S.Ct. 540. 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, 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. 40 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, 46 S.Ct. 48, 70 L.Ed. 183 (1925). Indeed, because the the power to tax involves the power to destroy, McCulloch v. Maryland, 17 U.S. (4 Wheat.) 316, 431, 4 L.Ed. 579 (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. 41 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 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, 75 S.Ct. 473. That is why, as noted above, the Supreme Court has held a return of capital is not income. Doyle, 247 U.S. at 187, 38 S.Ct. 467; S. Pac. Co., 247 U.S. at 335, 38 S.Ct. 540. 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.  42 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, 117 S.Ct. 452. 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 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, 117 S.Ct. 452, 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, 75 S.Ct. 473. 43 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. 44 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, 41 S.Ct. 386, 65 L.Ed. 751 (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, 47 S.Ct. 21, 71 L.Ed. 160 (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 construction to be given its provisions); see Macomber, 252 U.S. at 202, 40 S.Ct. 189 (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. 45 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. 46 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 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 very sort of injury Murphy suffered PAGE CONTAINED FOOTNOTES —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 injury and unrelated to lost wages or earning capacity. 47 The IRS itself reached the same conclusion when it first addressed the question, expressly affirming that personal injuries included nonphysical personal injuries: 48 [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. 49 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. 50 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.