A federal appeals court ruled that the government can't tax cash settlements plaintiffs receive for emotional distress and other "intangible injuries."

The U.S. Court of Appeals said that Section 104(a)(2) of the U.S. tax code, which declares only compensation for physical injuries as being tax exempt, is unconstitutional.

"At the outset, we reject the government's breathtakingly expansive claim of congressional power under the 16th Amendment -- upon which it founds the more far-reaching arguments it advances here," the court wrote in its decision. "[The amendment] simply does not authorize the congress to tax as 'incomes' every sort of revenue a taxpayer may receive."

Marrita Murphy, who paid $20,665 in taxes on a $70,000 judgment for emotional distress and injury to reputation following a 1994 whistleblower case against the New York Air National Guard, filed the case.

Murphy's attorney had argued that the IRS treating the money as a windfall was unconstitutional. The court ruled that the award for emotional damages were "compensation for the loss of a personal attribute" -- closer to an award for physical injuries.

The ruling affects only Washington, but depending on whether the Internal Revenue Service appeals to the Supreme Court or decides to adopt the finding nationwide, it could mean the end of tax bills following a variety of trials.

The full opinion is available at http://pacer.cadc.uscourts.gov/docs/common/opinions/200608/05-5139a.pdf.

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