Three judges on the federal appeals bench in Washington, have ruled that compensatory damages awarded in a lawsuit don't count as "income" even under the expansive language of the 16th Amendment. As a result, the government's attempts to tax such monies are unconstitutional.
The plaintiff in this case, Marrita Murphy, had won a whistleblower action against the New York Air National Guard, and an administrative judge awarded her $70,000 in compensatory damages for a combination of emotional distress and damage to her reputation. She initially paid income taxes of $20,665 on that award, but eventually asked for a refund on the grounds that compensatory awards don't count as "income" under the 16th Amendment.
Income tax law has traditionally recognized that compensatory damages for, say, a physical injury or destroyed property aren't truly "income." Such awards simply use money to return a person to the way things were before, instead of providing a windfall or compensating for some service.
The latest ruling extends this reasoning to compensation for intangible damages. This may not be true for monies received as punitive damages, which count as taxable income.
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