Wednesday, June 18, 2003
Taxation and equal protection - Sixth Circuit upholds challenge to different treatment of money damages for physical injuries
In employment cases involving no personal injuries, one tricky element of every settlement is dealing with Uncle Sam - figuring out the role of the IRS. Contrary to the expectations of the plaintiff, he or she may have to pay taxes on the full amount of the settlement, and the employer may be required to withhold taxes from the settlement amount as if it was a paycheck. When plaintiffs realize this they sometimes throw a fit, or, as in the case of Young v. U.S., file a lawsuit. In the Young case, the plaintiff settled with his employer for $60,000, the employer withheld payroll taxes and paid the rest of the settlement to Young, who then "sought a tax refund from the Internal Revenue Service on the theory that the relevant tax statute, 26 U.S.C. § 104(a)(2), is unconstitutional." Section 104 "exempts from the calculation of gross income the amount of any damages received 'on account of personal physical injury or physical sickness' but does not exempt payments for non-physical injuries or non-physical sickness," and Mr. Young "argued that the distinction between physical and non-physical injury violates the equal protection component of the Fifth Amendment," and also that "because the money he received under the settlement cannot be considered 'income,' the statute creates a 'direct tax' in violation of Article I, § 9 of the United States Constitution." Unsurprisingly, the Sixth Circuit rejected these arguments without much discussion.