Murphy & the
Sixteenth Amendment

Wednesday, September 13, 2006

By Phil Hart

On August 22, 2006, the United States Court of Appeals for the District of Columbia decided the appeal of Ms. Marrita Murphy in her case against the IRS. For the first time in a long time the court took a serious look at the definition of the word “income” as it is used in the Sixteenth Amendment. The case centered on whether or not an award of $70,000 received by Murphy for damages she experienced was taxable. Murphy had been retaliated against because she had been a whistleblower, and the award was to “make her whole.” An administrative law judge awarded the monies for "compensatory damages..., of which $45,000 was for 'emotional distress or mental anguish', and $25,000 was for 'injury to professional reputation'".

Murphy had reported some environmental problems at the New York Air National Guard. Her whistleblower actions got her not only fired, but blacklisted too. The entire ordeal was stressful for Murphy and she sued her former employer. The National Whistleblower Center lawyers successfully prosecuted the case, as they are an organization specializing in whistleblower cases.

The IRS wanted a cut of the award, but Murphy believed the award was nontaxable. Murphy, who must have developed faith in her whistleblower lawyers, retained them to litigate the tax case against the IRS, even though, as a firm, they had no experience in tax litigation. What was at issue was whether or not the $70,000 Murphy received for these damages was taxable. The federal District Court said, “yes,” but the Appeals Court said, “no.” The Appeals Court remanded the case back to the District Court "instructing that the Government refund the taxes Murphy paid on her award plus applicable interest."

The Appellate Court ruled that the monies received by Murphy were taxable under 26 USC 104 (a), but that this section of the United States Code was unconstitutional on the grounds that the monies received by Murphy were not "income" within the meaning of the Sixteenth Amendment.

Section 104(a) of title 26, the Internal Revenue Code provides that "gross income does not include the amount of any damages received... on account of personal physical injuries or physical sickness." The Government claimed that because the administrative law judge did not specifically identify any physical injury of Murphy, none of the monies awarded Murphy were exempt from taxation.

The National Whistleblower Center’s lack of experience in tax litigation worked in their favor. They were not biased to the status quo, and instead took a fresh look at the issue.

The National Whistleblower Center started at the beginning of the issue. They researched the legislative history of 26 USC 104 (a). They had to as they knew nothing about tax law. Most tax attorneys do not do original research as that would take too much time, and they might log some hours that they couldn't bill for. However, lawyers from public interest law firms are often different. Most of them have a passion for their causes, and they apply themselves more seriously to their work. This is evidently the case at the National Whistleblower Center.

Murphy’s lawyers put their legal training to good use: they questioned everything including the meaning of the word "income" as it was used in the Sixteenth Amendment. Not only did her lawyers do so, but so did the panel of three appellate judges. Since these judges normally don’t handle tax cases, they were likely more open minded and not biased by the tax mantra of today.

What does the word "income" mean as it is used in the Sixteenth Amendment? Let us start with what the District of Columbia Appeals Court said; as for this narrow decision, they got it right.

The Court started at the beginning by determining what the framers of the Sixteenth Amendment intended the word "income" to mean. The Appeals Court quoted the Supreme Court, "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 and Trust, Co. v. Smietanka, 255 U.S. 509, 519 (1921).” The Appeals Court also said "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 (1925).”

The Appeals Court was correct on all fronts. Congress derives its powers from the Constitution, as authorized by We the People. If Congress could change the meaning of words in the Constitution, then the whole principle of "limited government" would fly out the window. The Appeals Court got it right too when they stated "The Government of the United States is a government of limited powers: 'Every law enacted by Congress must be based on one or more powers enumerated in the Constitution.' United States v. Morrison, 529 U.S. 598, 607 (2000)."

Of the definition of the word "income" the Supreme Court said long ago, "Congress cannot by any definition it may adopt conclude the matter, since it cannot by legislation alter the Constitution, from which alone it derives its power to legislate and within whose limitations alone that power can be lawfully exercised." Eisner v. Macomber, 252 U.S. 189, 206 (1919). And the Appeals Court said, "...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."

The lawyers for Murphy also started at the beginning. They researched the legislative history of 26 USC 104 (a) and the meaning of the word "income" as it was used by the framers of the Sixteenth Amendment.

They discovered that back in the 1913 period, when the Sixteenth Amendment was purportedly ratified, awards for personal injury type damages were considered a "return of capital" and an attempt to make the injured party "whole." In making the injured party "whole," such an award was thought to only be returning something that was earlier lost. Murphy's lawyers discovered that the history of this area of law was rich with examples of both state and federal cases.

The analogy was made that the injury depleted Murphy's "human capital" just as an injury to say a building (by fire, lighting strike or some act of negligence) would diminish the building's value. The cost of bringing the building back up to its condition before the injury would be restoring the building's capital in the same way as Murphy's award was restoring her human capital. The Appeals Court agreed.

The entire case turned on whether or not Murphy's award represented a return of diminished capital, or an economic gain? The entire Murphy Case was about setting the boundary line between direct taxes and indirect taxes. Direct taxes are taxes on capital, indirect taxes are taxes on gains. This lack of experience of Murphy’s lawyers and the three-judge panel allowed them to do their legal research and analysis with an open mind. And these open minds, aided by their legal training, caused them to arrive at the correct interpretation of the intent of the Sixteenth Amendment as it relates to this narrow issue.

The odd man out was the government. This is not surprising when one realizes that the main source of all the confusion over the Sixteenth Amendment is the government, aided by Congress, who writes these confusing taxing statutes. The more confusing the tax code is, the more money that can be collected. That this is the source of the confusion is confirmed by the "follow the money" principle.

The Sixteenth Amendment provided for an income tax that was to be an "excise tax," a species of an "indirect tax." In an 1895 decision that angered the American People, the Supreme Court called an income tax on the net income from investment a direct tax in the Pollock Case. The genesis of the Sixteenth Amendment was to nullify the theory upon which the Pollock Court declared the income tax to be a direct tax; that being the idea that an income tax on net income was the same as a tax on the underlying source of the income. In other words, it was a tax on the underlying asset; so said the Pollock Court. With the ratification of the Sixteenth Amendment, the Pollock Theory died.

With the Pollock Theory gone, the Sixteenth Amendment returned us to the criteria for determining what constitutes a direct tax and an indirect tax as laid down by the man who gave us those terms, Adam Smith. Adam Smith's book, Wealth of Nations, was the economic bible in the hands of every one of the framers of the Constitution. The meaning of these terms can be found in a 1909 quote from Utah Senator Sutherland as he debated the Sixteenth Amendment.

“The most generally received opinion, however, is that by direct taxes in the Constitution are those meant which are raised on the capital or revenue of the people; by indirect, such as are raised on their expense... it will not be improper to corroborate it by quoting the author from whom the idea seems to have been borrowed. (Naming Doctor Smith's Wealth of Nations)" 44 Congressional Record 2094 (1909).

Murphy’s attorneys argued that her award constituted only monies that “made her whole.” The award was a return of her “human capital.” Murphy’s attorney, David K. Colapinto, who successfully argued the case, said of the government’s position, “The government had the audacity to argue that non-wage compensatory damages for emotional distress and loss of reputation can be taxed as income because the economic value of human life is zero. The taxing of non-wage damages is highly destructive and punishes whistleblowers and other civil rights plaintiffs for prevailing in their cases. Hopefully, today’s ruling will stop this arcane and regressive policy.” See, www.whistleblowers.org

Colapinto’s position is further buttressed by what some of the leading supporters of the Sixteenth Amendment had to say, in 1909, about the income tax while it was being debated in Congress. Senator Bailey of Texas said,

“I believe that in earning an income by personal service every man consumes a part of his principal, and that fact ought always to be taken in to consideration. The man who has his fortune invested in securities may find in a hundred years, if he spent his income, that fortune still intact, but the lawyer or the physician or the man engaged in other personal employment is spending his principal in earning his income. That fact ought under every just system of income taxation to be recognized and provided against.” 44 Congressional Record, 4007 (1909).

Senator Bailey also said,

“I have no hesitation in declaring that a tax on any useful occupation can not be defended in any forum of conscience or of common sense. To tax a man for trying to make a living for his family is such a patent and gross injustice that it should deter any legislature from perpetrating it.” 44 Congressional Record, 1702 (1909).

The author of the Sixteenth Amendment, Senator Brown from Nebraska, had this to say about the object of the income tax: “It is the theory of the friends of the of the income-tax proposition that [income from] property should be taxed and not individuals.” 44 Congressional Record 1570 (1909).

The three-judge panel was correct it its determination that it was not the framers of the Sixteenth Amendment intent to tax “human capital.” Such a tax on the “human capital” of Murphy would be a direct tax. The Supreme Court has already ruled that the Sixteenth Amendment only authorizes an excise tax, a species of an indirect tax.

In the first modern tax case to be litigated after the Sixteenth Amendment was purportedly ratified, the Supreme Court ruled in Brushaber v. Union Pacific Railroad Co., 240 U.S. 1 (1916) that the income tax was an excise tax even though both the government and Burshaber argued that it was a direct tax exempted from apportionment.

In Brushaber v. Union Pac. R.R. Co., Mr. Chief Justice White, upholding the income tax imposed by the Tariff Act of 1913, construed the Amendment as a declaration that an income tax is indirect, rather than as making an exception to the rule that direct taxes must be apportioned. The Income Tax and the Sixteenth Amendment, 29 Harvard Law Review 536 (1915-6).

Cornell Law Quarterly also weighed in on the Brushaber Case.

The contention of the appellant was as follows:

(1) The Sixteenth Amendment provided for a new kind of a direct tax, a tax on incomes from whatever source derived.

The court, through Chief Justice White, held that the tax [in Brushaber] was constitutional. The major proposition of the appellant's argument is not true. Hence, the conclusion does not follow. The sixteenth amendment [sic] does not permit a direct tax, (in fact as it will later be shown, the court does not think that the amendment treated the tax as a direct tax at all), carrying with it the distinguishing characteristic of a hitherto unrecognized uniformity.

The amendment, the court said, judged by the purpose for which it was passed, does not treat income taxes as direct taxes but simply removed the ground which led to their being considered as such in the Pollock case, namely, the source of the income. Therefore, they are again to be classified in the class of indirect taxes to which they by nature belong. Ramon Siaca, The Federal Income Tax Law of 1913: Construction of the Sixteenth Amendment, 1 Cornell Law Quarterly 298, 299 and 301 (1916).

Years later we have Congress reaffirming in a couple of reports that the income tax is an excise tax. Reporting on "The Revenue Bill of 1941," the House's Committee on Ways and Means prepared House Report No. 1040 dated July 24, 1941. On page 17 of this report, in the section called Constitutionality of Proposal, the Committee on Ways and Means stated:

It seems clear that Congress has the constitutional power to enact this proposed amendment. Generically an income tax is classed as an excise (Brushaber v. Union Pac. R.R. Co., 240 U.S. 1). The only express constitutional limitation upon such taxes is that they be geographically uniform. H. Rep. No. 1040, at 17 (1941).

And finally, appearing in the Congressional Record in 1943 we find a reprinting of a report by,

“Mr. F. Morse Hubberd, formerly of the legislative drafting research fund of Columbia University, and a former legislative draftsman in the Treasury Department.

…The sixteenth amendment authorizes the taxation of income ‘from whatever source derived’…. So the amendment made it possible to bring investment income within the scope of a general income-tax law, but did not change the character of the tax. It is still fundamentally an excise or duty with respect to the privilege of carrying on any activity or owning any property which produces income.

The income tax is, therefore, not a tax on income as such. It is an excise tax with respect to certain activities and privileges which is measured by reference to the income which they produce. The income is not the subject of the tax: it is the basis for determining the amount of tax.” 89 Congressional Record 2579-80 (1943).

It is refreshing to see a court do what it should do all the time – rule on the law based on the evidentiary record. Murphy’s award was not taxable because such taxation would have constituted an unapportioned direct tax. An unapportioned direct tax is not allowed by our Constitution. If this case is appealed to the Supreme Court, Murphy should do well as there is an abundance of evidence in the historical record proving that there is no such thing as a “Sixteenth Amendment exception” to the apportionment rule required for direct taxes.

The Appellate Court’s opinion can be found here.

Phil received a bachelor's degree in Civil Engineering from the University of Utah and a master's degree in Business Administration from the Wharton School at the University of Pennsylvania.

In 2004, Phil Hart was elected by the Citizens of North Idaho to represent District 3 in the Idaho Legislature. District 3 encompasses the northern part of Kootenai County. Phil Hart is actively seeking re-election for the 2006 legislative term.

Phil has dedicated a significant amount of personal time for the past ten years in trying to resolve the constitutionality Income Tax. His efforts have resulted in the publication of his book Constitutional Income , which is in its third edition. His book has been steadily covering ground across the United States. He also litigated the issue with the IRS and petitioned the Supreme Court.

NOTE: In accordance with Title 17 U.S.C. section 107, any copyrighted material herein is distributed without profit or payment to those who have expressed prior interest in receiving this information for non-profit research and educational purposes only. For further information please refer to: http://www.law.cornell.edu/uscode/17/107.shtml

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