In rehearing Murphy v. IRS, decided 11 months ago, the same three-judge panel of the D.C. Circuit has reversed itself and held that damages for non-physical injuries such as emotional distress and mental anguish are taxable. Last August, that Court ruled that Marrita Murphy's $70,000, awarded for emotional distress and loss of reputation by the Department of Labor Administrative Review Board in a whistleblower case against her employer, was akin to an award for physical injuries and therefore tax exempt. This week, the Court held that the money should have been included in her gross income:
Murphy no doubt suffered from certain physical manifestations of emotional distress, but the record clearly indicates the Board awarded her compensation only “for mental pain and anguish” and “for injury to professional reputation.” Although the Board cited her psychologist, who had mentioned her physical aliments, in support of Murphy’s “description of her mental anguish,” we cannot say the Board, notwithstanding its clear statements to the contrary, actually awarded damages because of Murphy’s bruxism and other physical manifestations of stress.... At best — and this is doubtful — at best the Board and the ALJ may have considered her physical injuries indicative of the severity of the emotional distress for which the damages were awarded, but her physical injuries themselves were not the reason for the award.
Thus, it is not enough that the emotional distress has some physical symptoms (such as sleeplessness, loss of appetite, etc.), and it appears that unless physical injuries are the reason for the award or settlement, emotional distress damages will be taxable. Because discrimination and other employment-related cases rarely involve physical injuries, it is safe to assume that all non-economic damages will be taxable in most employment cases.