On July 3, 2007, the panel held that the IRS can tax damage awards based solely on compensating victims who suffer personal injuries. However, on August 22, 2006, the same panel in the same case held that such taxes were unconstitutional, as compensation for a documented "loss" was not "income" subject to the tax code.

In a major reversal, the three-judge panel, (Chief Judge Douglas H. Ginsburg, and Judges Judith W. Rogers and Janice Rogers Brown), held that 'make whole' compensation to restore personal injuries losses are taxable.

The case arose as a result of the Department of Labor ruling in the whistleblower case of Marrita Murphy. In that case, the Labor Department held that Ms. Murphy suffered substantial damages to her health and reputation, and awarded her $70,000 in compensatory damages strictly related to her losses.

The IRS taxed Ms. Murphy's damages and she asked for a refund of the tax on the grounds that her damages were not income.

In an August 22, 2006 decision, Judge Ginsburg, writing for the 3-judge panel, agreed with Ms. Murphy, and found that compensation for actual documented personal injury losses were not subject to an income tax. The IRS argued that the decision was wrong, and the panel agreed to vacate its original decision and rehear the case to consider issues that were never timely raised on appeal by the IRS.

Rather than overrule its prior decision (Murphy v. IRS, Aug. 22, 2006) holding that taxing Murphy’s damages was unconstitutional, the panel simply held that Congress intended to amend the tax code “by implication” to tax personal injury damages under its authority to create an excise tax on people who use the courts to vindicate their rights. No court in the history of the United States has ever upheld such an implied tax.

In a remarkable ruling, the Court held that compensation for damages for emotional distress suffered by a whistleblower were not paid to make the employee “whole,” but were instead paid as part of a “forced sale” which Congress could tax under its excise tax authority. The Court reasoned:

"Murphy's situation seems akin to an involuntary conversion of assets; she was forced to surrender some part of her mental health and reputation in return for monetary damages."

Attorneys for Marrita Murphy have asked the full US Court of Appeals for the DC Circuit to reconsider the panel’s holding because it conflicts with Supreme Court and other legal precedent, and it raises questions of exceptional importance.

"The Court's reversal stands reality on its head," suggested David K. Colapinto, who argued on behalf of Ms. Murphy. “This case marks the first time that a court has interpreted the gross ‘income’ statute, 26 U.S.C. § 61(a), to be amended ‘by implication’ to create a tax not expressly enacted by Congress. Additionally, this is the first time that any court has construed the tax code to imply an “excise tax” on the ‘privilege’ of utilizing the ‘legal system’ to vindicate a federal statutory right,” Colapinto added.

"When whistleblowers suffer retaliation, they do not 'sell' their mental health. If people are injured in a car accident, they do not 'sell' their arms and legs. These are real human losses, and compensation to restore that human loss was never intended to be 'income' under our Constitution or the tax code," Colapinto argued.

Stephen M. Kohn, the President of the National Whistleblower Center and co-counsel for Ms. Murphy, stated: "This decision is a terrible setback for all victims of civil rights abuses. Congress did not pass a special tax demanding payment from people who use the legal system to prevent retaliation against whistleblowers. It was error for the Court to imply such a tax. This decision threatens fundamental human rights, including access to the courts."