Whistleblower Lawyer & Attorney : National Whistleblower Legal Defense and Education Fund : Whistlebower Protection, Fraud Claims : Washington DC

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NATIONAL WHISTLEBLOWER CENTER

FOR IMMEDIATE RELEASE
APRIL 21, 2008

U.S. Supreme Court Refuses to Hear Murphy v. IRS
Advocates To Continue Pressing for Changes in Civil Rights Tax Law

WASHINGTON, DC -- Today, the United States Supreme Court announced its decision not to grant certiorari in the case of Murphy v. IRS. The order, posted on the Court's website this morning, means that the IRS can continue to tax non-pecuniary 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 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.

National Whistleblower Center General Counsel David K Colapinto, who represents Ms. Murphy, released the following statements regarding the Court's decision

"The DC Circuit's decision was contradictory and wrong. It will have a tragic impact on thousands of whistleblowers and victims of discrimination. We are not surprised though, that the Supreme Court declined to hear the case, as there was not a traditional "split in the circuits," as the DC Circuit was the first court to take this issue on. Given the DC Circuit's difficulty in dealing with this issue, I expect that it will be taken up in other courts across the country."

"It is unfair and unconstitutional to tax victims of discrimination and retaliation when the awards were simply compensation to make them whole again. The money is to restore a loss for personal injury; it is not income."

Unfortunately, as a result of the Court's decision not to hear the Murphy case, whistleblowers and other civil rights victims whose make whole compensatory damages awards are taxed will have to continue to fight the IRS through the courts. The only alternative to continued litigation is for Congress to change the tax code.

Currently pending before Congress is the Civil Rights Tax Relief Act of 2007 ("CRTRA"), H.R. 1540, which would end unfair taxation of noneconomic damages received by those who have suffered unlawful discrimination in the workplace or other violations of their employment rights.

The CRTRA was introduced in the House by Representative John Lewis (D-GA), who was joined by a bipartisan group of original CRTRA cosponsors, including Representatives Deborah Pryce (R-OH), Sander Levin (D-MI), Jim Ramstad (R-MN), Xavier Becerra (D-CA), and Phil English (R-PA). The Senate companion bill was introduced by Senators Jeff Bingaman (D-NM) and Susan Collins (R-ME).

The CRTRA has broad bi-partisan support. It is supported by employer and employee advocacy groups alike because both business and employee organizations recognize that taxing non-economic make whole compensatory damages makes settlement more difficult and results in protracted litigation in employment disputes.

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The case was brought by Marrita Murphy, an environmental whistleblowerwho won before the Department of Labor, and was awarded only compensatory damages to vindicate her rights under six federal environmental whistleblower statutes, and none of her damages were for lost wages. Murphy filed a tax refund suit when the IRS demanded that she pay taxes on the "make-whole" award.

The ruling in Murphy v. IRS will affect thousands of past and future victims of civil rights violations and whistleblower retaliation who are awarded compensatory damages for personal injuries. The following summarizes the arguments made on behalf of Ms. Murphy in the reply brief.

In her reply brief, Murphy argues that the D.C. Circuit’s final decision in Murphy v. IRS violates the “accession to wealth” test, which specifies that in order for damages to be within the scope of the “gross income” statute, 26 U.S.C. § 61(a), there must be some “accession” to the taxpayer’s wealth. Commissioner v. Glenshaw Glass Co., 348 U.S. 426, 430 (1955). The D.C. Circuit’s final decision conflicts with this controlling precedent and a long line of authorities holding that damages awarded to make a person “whole” or to restore a personal loss are not “income” or an “accession to wealth.”

Since the enactment of the modern tax code between 1913 and 1918, numerous court and administrative rulings held that personal injury damages, including compensatory damages for non-physical personal injury losses, are not “income.” The scope of the “gross income” statute (codified at 26 U.S.C. § 61(a)) and the subsequent versions of the personal injury statutory exclusions were expressly based on the limitations set forth in the Sixteenth Amendment. Any tax on damages that are not income is not a tax within the scope of those statutes and the Sixteenth Amendment.

Notably, the D.C. Circuit never held that the compensatory damages awarded to Murphy for emotional distress and loss of reputation are “income” under the controlling “accession to wealth” test under Glenshaw Glass. Instead, the court of appeals initially held in Murphy I that Murphy’s damages did not meet this test and were not “income,” but after vacating that decision, the D.C. Circuit decided that 26 U.S.C. § 61(a) was amended “by implication” to include this type of non-physical personal injury damages as “gross income” without deciding the “accession to wealth” test required by Glenshaw Glass. Simply put, gross income under Section 61(a) cannot include damages for non-physical injuries without satisfying the “accession to wealth” test.

The court of appeals in Murphy II, invented the fiction of an excise tax in this case, in an attempt to avoid the required “accession to wealth” test. After holding that Congress amended Section 61(a) “by implication” when it amended Section 104(a)(2) in 1996, the Murphy II court went on to uphold this imagined tax under Article I of the U.S. Constitution. In continuing its fiction of a judicially created excise tax, the court of appeals held that the excise was imposed on the “privilege” of using the “legal system” to “vindicate a statutory right.” To be sure, this is the first case in which any court has judicially created an excise tax on the right to use the legal system to vindicate a federal statutory right. However, the very troubling implications of such a tax on civil rights plaintiffs, whistleblowers and tort victims are so enormous as to warrant review by the Supreme Court.

A straightforward application of Glenshaw Glass shows that Murphy’s damages are not income because they were awarded to make her “whole” and to restore a personal injury or human capital loss. Murphy was not enriched by receiving “make whole” compensatory damages.

Murphy also argues that Supreme Court review is warranted to address important questions of federal law resulting from the 1996 amendments to the personal injury exclusion, 26 U.S.C. § 104(a)(2). The type of compensatory personal injury damages at issue here are commonly awarded under numerous federal anti-discrimination and anti-retaliation statutes, as well as in state tort actions. If these damages are taxed the government not only deprives the plaintiff of a “make whole” remedy to compensate for personal injury losses, such as emotional distress and damage to reputation, but there exists confusion about the applicability of the personal injury exemption in cases where the plaintiff also suffers a physical injury of physical sickness as well as emotional distress.

Unquestionably, the D.C. Circuit decided an important question of federal law in a manner that calls for this Court’s review. The taxing of personal injury damages in light of the 1996 amendments to Section 104(a)(2) affects not only the tax bar, but impacts employment law, torts, whistleblower law, and civil rights. Review by the Supreme Court is needed to resolve whether “make whole” personal injury damages are not income and not taxable.

• Click here to view the brief (PDF)
• Click here for more articles on Murphy v. IRS

Prepared Statement of Senator Chuck Grassley of Iowa

Senate Committee on the Judiciary

Department of Justice Oversight Hearing

Attorney General Michael Mukasey

Wednesday, January 30, 2008

Chairman Leahy, thank you for calling this hearing today on Department
of Justice oversight.  It has only been three months since Attorney
General Mukasey was last here for his confirmation hearings, but it is
always good to hold oversight hearings and check in on the
administration.

As a senior member of the Senate, I've always held great respect for the
oversight function of Congress.  The Constitution placed great power in
the Legislative Branch and that is not limited to just writing laws.
Instead, the Constitution requires that we ask tough questions of the
Executive Branch.  We need to make sure they are being faithful stewards
of taxpayer dollars and that they are enforcing and implementing the
laws as Congress intended.  That said, I want to ask the Attorney
General a number of questions today and follow-up on some responses he
submitted following his confirmation hearing back in October.

One topic I'd like to discuss with the Attorney General is a letter he
signed regarding the Federal Employee Protection Act (S.274).  This bill
provides some necessary revisions in the Whistleblower Protection Act
and unanimously passed the Senate back in December.  This legislation
will ensure that whistleblowers are protected and not subject to
retaliation.  I have some concerns with the letter signed by the
Attorney General and want to hear his rationale for raising objections
to S.274.

Next, I have some follow-up questions related to oversight of the
Federal Bureau of Investigation (FBI).  These questions relate to the
Counterterrorism Division of the FBI and allegations that have been made
public by employees within the FBI.  I also have questions regarding the
FBI's use of "exigent letters" in relation to the investigation
conducted by the Department of Justice Office of Inspector General on
the FBI's use of National Security Letters.  These questions are vitally
important to ensuring that efforts to protect our homeland are accurate
and in accordance with the law.  I've been asking questions for some
time and look forward to further dialogue and, more importantly, some
answers on these matters.

I also would like to work with the Attorney General in the second
session of the 110th Congress on two very important legislative
initiatives, S.2041 the False Claims Act Correction Act of 2007, and
S.473, the Combating Money Laundering and Terrorist Financing Act of
2007.

The False Claims Act Correction Act will clarify negative court
interpretations of the False Claims Act which I amended in 1986.  The
FCA is the premier tool in the Government's toolbox for combating fraud.
Since the 1986 amendments were signed into law by President Reagan, it
has helped the government recover over $20 billion that would otherwise
be lost to fraud, waste, or abuse.  However, 20 years later the law
needs a few tweaks to deal with court decisions that run contrary to the
spirit and intent of the 1986 amendments.  I look forward to working
with the Justice Department to ensure that the FCA will continue to work
as intended for the next 20 years.

The Combat Money Laundering and Terrorist Financing Act is an important
bill that will ensure that our laws are up to date in combating the
laundering of terrorist and criminal proceeds.  I've long believed that
to effectively combat terrorists and criminal organizations, we need to
hit them where it hurts, right in the pocketbook.  However, as the fight
against terrorism continues, we need to make sure that our laws against
money laundering keep pace with technological advances, such as the use
of prepaid debit cards.  In fact, there are additional loopholes in the
law that have been pointed out that I also intend to address in this
legislation.  This is a testament to the ever-evolving world of money
laundering, and we need to ensure that our laws are not outpaced by the
creativity and unrelenting nature of terrorist and criminals around the
world.

I hope the Attorney General, and members of this Committee, will work
with me on these two legislative initiatives in the near future. 

Prepared Questions from Senator Chuck Grassley

(1) Oversight and Timeliness of Document Requests:

During your confirmation hearing you assured us that you would assist my
congressional oversight efforts with the Department.  I appreciate your
cooperation and will hold you to your word.

I'd like you to know that prior to this hearing the Department provided
responses to requests, dating back to March 2007.  Unfortunately, we
received these responses on Friday and have had four days to digest
nearly 250 pages of answers.

Buried in the responses from the FBI was a response to questions 64
through 83 that said answers are "provided separately", but they were
not.  

Attorney General Mukasey, I am troubled when I get responses stating one
thing but then you do another.  When can I expect this response from the
FBI I've been waiting for since March of 2007?  Can I expect these
answers before a full year has passed?

(2) Whistleblowers

At your confirmation hearing you testified about whistleblowers at the
FBI and said "people ought to be encouraged to come forward...and that
they should be protected."

The FBI and Justice Department have not always had a culture that
supported whistleblowers.  Instead the culture usually worked to prevent
whistleblowing through intimidation and retaliation.

One of the most difficult issues in whistleblowing is that of national
security whistleblowers.  These individuals have security clearances
that prevent the disclosure of our Nation's closest held secrets.  I
understand that a security clearance is a privilege and not a right.

However, individuals with security clearances who witness wrongdoing
often face a catch-22.  They can either report the wrongdoing to
supervisors who may retaliate against them, or they can sit silent and
let the wrongdoing continue.  Either situation is unacceptable.

As a solution, the Senate unanimously passed S.274, the Federal Employee
Protection Act of 2007.  This bill attempts to strike a balance.  It
allows individuals who know of wrongdoing in classified matters to come
forward and report that wrongdoing to Congress.  BUT, it only allows
disclosure to specific persons cleared to hear classified information.

This bi-partisan legislation would ensure that national security
information remains secret, while allowing Congress to conduct oversight
required under the Constitution.

On January 22, 2008, you along with Director of National Intelligence
McConnell, Secretary Gates, and Secretary Chertoff, signed a letter
objecting to S.274.  I am concerned by statements in this letter which
claim that secure reporting mechanisms for whistleblowers are somehow
unconstitutional or jeopardize national security.  While I agree that
this information needs to be secure, Congress must be able to conduct
oversight of the Executive Branch on matters involving National
Security. 

Further, I find it difficult to reconcile this letter with statements
made at your confirmation hearings.

Now, I'm not for a blanket privilege allowing whistleblowers to release
classified information at will.  That is not practical or safe.
However, we need a secure mechanism to allow whistleblowers to make
protected disclosures to Congress.

Why doesn't Congress have a right to classified information when
providing that information is necessary to report wrongdoing?

Why isn't it enough to require that whistleblowers report classified
information to those with the necessary security clearances?

(3) Bassem Youssef

As you know, in the 1990s whistleblowers exposed major problems with the
FBI crime lab. Dr. Frederic Whitehurst, testified before you when you
were a judge in New York, raised concerns about the lack of expertise in
the FBI crime lab.  In response, the former Attorney General recruited
five outside forensic experts to carefully review the work of the crime
lab and all of Dr. Whitehurst's concerns and to make recommendations.

One of the changes was to ensure that the FBI placed scientists in
charge of the lab.  In other words, the FBI put people with expertise in
leadership positions.  Now, there is another FBI whistleblower named
Bassem Youssef who is prepared to testify about major problems with the
FBI's counterterrorism operations.  The FBI has taken the position that
neither Arabic skills nor expertise with Middle Eastern counterterrorism
are required for management positions in its counterterrorism programs.
This sounds too much like the days when the FBI didn't think it needed a
scientist to run the crime lab.

After your confirmation hearing, I asked you about these issues and
whether you would consider appointing an independent panel of experts to
give them serious consideration.  In your written answers, which we just
received, you said you were unfamiliar with the problems outlined by
Youssef, but that it would be among your "highest priorities" to
familiarize yourself with the Bureau's counterterrorism efforts.

Special Agent Youssef, through his counsel, provided my office with a
copy of a ten page letter (dated October 11, 2007) filed with your
office detailing threats to our nation's security caused by the failure
of the FBI to hire and promote subject matter experts within the FBI's
counterterrorism division. The examples set forth in that letter are
extremely troubling.  [Mr. Chairman, I ask that the letter be placed in
the record.]

What action has your office taken to investigate the issues and concerns
raised in Mr. Youssef's October 11, 2007 letter?

Do you plan to seek an independent review of Youssef's allegations about
how lack of expertise among FBI managers is hindering its
counterterrorism efforts?  Why or why not?

(4) Exigent Letters:

Youssef is also a central figure in the controversy over so-called
"exigent letters" issued by the FBI.  These letters obtained phone
records by falsely claiming an emergency and promising that a grand jury
subpoena would be issued later.  According to Youssef, he helped the FBI
identify and fix the problems with these letters.

The FBI General Counsel recently briefed Committee staff and claimed
that her office did not know of the letters "at the time."  However,
according to page 93 of the Inspector General's report, interviews and a
review of email indicates that a division of the General Counsel's
Office did know "at the time," about the exigent letters as early as
2004, long before the FBI stopped sending them.

We should not have to rely on misleading statements from FBI officials
when there is evidence available that would clarify exactly how this
mess happened.  The Committee requested all of the emails related to
exigent letters last year, DOJ promised them to us, but we have received
only one small batch of heavily redacted documents.

When are these documents coming-it has been almost a full year since we
first asked?