The Tax Court yesterday rejected a married couple’s reliance on Murphy v. IRS, 460 F.3d 79 (D.C. Cir. 2006), and held that the couple could not exclude from income under § 104(a)(2) a $41,000 settlement received in a wrongful termination suit because it was not received for physical injury or sickness.  The Tax Court also held the couple liable for a $2,293 accuracy-related penalty. Suder v. Commissioner, T.C. Summ. Op. 2008-97 (8/7/08):

Appearing tacitly to invoke the short-lived decision in Murphy v. IRS, 460 F.3d 79 (D.C. Cir. 2006), .. petitioners contend that the settlement proceeds were for "the loss of * * * human capital". Consequently, they contend, petitioner’s "award is not income and § 104(a)(2) is therefore unconstitutional insofar as it would make the award taxable as income." Petitioners’ argument is a nonsequitur. If the settlement proceeds were not includable in gross income under § 61, then the constitutionality of § 104(a)(2) would be irrelevant. As previously discussed, however, the settlement proceeds are includable in gross income under § 61. In any event, petitioners’ contentions as to the unconstitutionality of § 104(a)(2) are without merit. See Murphy v. IRS, 493 F.3d 170 (D.C. Cir. 2007); Ballmer v. Commissioner, T.C. Memo. 2007-295; Hawkins v. Commissioner, T.C. Memo. 2007-286. …

We also reject as without merit petitioners’ contention that they had substantial authority for excluding the settlement proceeds from gross income. The plain language of § 104(a)(2) limits the exclusion to damages received on account of "personal physical injuries or physical sickness". As previously discussed, petitioners’ ill-founded arguments as to the unconstitutionality of § 104(a)(2) have no bearing on the inclusion of the settlement proceeds in gross income pursuant to § 61. We also note that Murphy v. IRS, 460 F.3d 79 (D.C. Cir. 2006), ultimately vacated by the U.S. Court of Appeals for the District of Columbia Circuit, had not been issued when petitioners filed their 2003 return.