February 7, 2012
TAX FILE MEMORANDUM
SUBJECT: Murray Taxpayer Issues Regarding Damage Award
Facts: Murray Taxpayer was previously employed by a company who was illegally dumping chemicals into a river. Murray had knowledge concerning these illegal activities of his employer and made an ethical decision to report this to the Environmental Protection Agency. Upon inspection, the Environmental Protection Agency determined that Murrays employer was in fact illegally dumping and was appropriately fined for the charges. Murray’s employer reacted to his whistleblowing by firing him and making deliberate efforts to prevent Murray from gaining employment elsewhere. Murray then sued his former employer for damaging his reputation. Murray won the lawsuit and was awarded for “damages to his personal and professional reputation and for his mental suffering.” Murray claims that his award is excludable from income because it is for recovery of his human capital and therefore cannot be taxed. Murray would like to know if his award is taxable. Issue 1: Are awards received for damages to personal and professional reputation and mental suffering included in income and therefore taxable? Analysis: I would like to start by referring to a case in which similarities to Murray’s situation and issues arise. The case, Marrita Murphy and Daniel J. Leveille, Appellants v. Internal Revenue Service and United States of America, Appellees, is a landmark case that involves a woman named Marrita Murphy whom, like Murray, was also a whistleblower and suffered mental distress and damage to her reputation by her former employer. This is a landmark case because at its origination in Court, it challenged and succeeded in striking down 26 U.S.C. § 104(a)(2), which states that “except in the case of amounts attributable to (and not in excess of) deductions allowed under section 213 (relating to medical, etc., expenses) for any prior taxable year, gross income does...
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