Tax on emotional damages held unconstitutional: how to protect clients in the short term

Since 1996, Sec. 104(a)(2) has specifically excluded awards for personal physical injuries or physical sickness from taxation. Accordingly, awards for emotional distress, mental anguish or loss of reputation have been firmly recognized as taxable income. In Murphy, DC Cir., 8/22/06, the court held that the taxation of nonphysical injury awards is unconstitutional, as it taxes receipt of money that is not "income" under the 16th Amendment. Practitioners should advise taxpayers immediately to file refund claims or protective refund claims to protect their rights under Sec. 6511. It is advantageous to pay the taxes first and then seek a refund; this avoids incurring interest on taxes owed should Sec. 104(a) be upheld. Additionally, there is no risk the money will be spent by the taxpayer should it eventually have to be paid to Treasury.