Of all the wrongs society does to those convicted of crimes they did not commit, taxing any restitution they receive is far from the most horrific. All the same, it is heartening that lawmakers took the time to make clear that such awards come without strings attached.
The recently passed federal spending bill includes many ancillary provisions, some of which we have already discussed in earlier blog posts. The portion dealing with wrongful incarceration is a small section, appearing nearly at the end of the lengthy piece of legislation and taking up less than a full page. But the language makes clear that all wrongfully incarcerated individuals, as defined by the law, can exclude civil damages or monetary awards from their gross income, whether they were convicted at the federal or state level.
To a layperson, it may seem odd that this scenario was even in question. After all, if the government incorrectly convicts you of a crime, and subsequently recognizes that it has done sufficient harm to merit making some sort of compensation for the suffering you endured, it seems counterintuitive that another branch of the government would then turn around and demand a part of that restitution back in the form of income tax.
Yet prior to this amendment to the tax code, there had effectively been no rulings and a limited number of cases specifically dealing with the federal income tax treatment of such awards.
This may be, in part, because exonerated individuals make up a relatively small portion of the overall population. That is not to say the problem of wrongful convictions is small. In an opinion column for The Washington Post last summer, Samuel R. Gross cited a study he co-authored showing that just over 1 in 25 defendants who receive the death penalty in the U.S. are later found to be innocent. Gross, a law professor at the University of Michigan and the editor of the National Registry of Exonerations, also pointed out that those who are exonerated at all are relatively lucky, given the limited resources of innocence projects and other organizations concerned with such cases.
Yet because of the nation’s high incarceration rate, even a small percent of wrongful convictions creates a population of tens of thousands of individuals. This situation is exacerbated by a justice system where most defendants are encouraged to plead guilty in order to take a plea deal, especially but not exclusively for misdemeanors. According to the Innocence Project, in cases where DNA evidence has conclusively proven an individual to be innocent of the crime for which he or she was convicted, 27 percent were partly or completely due to false admissions of guilt. (The leading cause of wrongful conviction was eyewitness misidentification.)
Given the tragic consequences for individuals who are wrongly convicted, especially those who may spend years or decades incarcerated for crimes they did not commit, monetary compensation seems to be the least they are entitled to expect. And the government’s decision to exempt such payments from gross income for federal tax purposes is ultimately a matter of common sense.
This change did not arrive out of nowhere. Lawmakers had attempted to pass a stand-alone bill on multiple occasions accomplishing the same thing, but had not succeeded. The bipartisan legislation was repeatedly proposed by Sam Johnson, R-Texas, and John Larson, D-Connecticut, as recently as 2015.
Until now, a strict reading of the law meant that victims of wrongful conviction had to argue that all or part of their award related to physical injuries sustained while in prison. The tax code has long exempted awards for personal physical injuries of all types, including car wrecks or sports accidents, from gross income; restitution payments fell under the same umbrella if they were tax exempt at all.
In 2008, the Tax Court considered the case of a petitioner who received a settlement of $49,000 after being mistakenly arrested and jailed for eight hours. That case, Daniel J. and Brenda J. Stadnyk v. Commissioner of Internal Revenue, set groundwork for the tax treatment of damages paid for short-term incarceration. The court ruled in favor of the Internal Revenue Service, concluding that physical detention for a short amount of time was not inherently a “physical injury” under the relevant section of the law.
However, it is obvious that being mistakenly jailed for 8 hours is substantially different than spending 15 or 20 years in prison for a crime one did not commit. What was less obvious was how the IRS would view the physical nature of such long-term imprisonment when characterizing the tax treatment of civil damages or other monetary compensation. A 2010 memorandum, released by the Service, attempted to clarify the situation, but ultimately left the matter resting on the foundation of personal physical injury.
The new legislation relieves the victims of injustice from having to prove the physical dimension of their suffering. While many of those who are wrongfully imprisoned do suffer physically as a result of their ordeals, the IRS will no longer ask them to quantify how much of their awarded damages relate to such injuries, as opposed to the loss of liberty, income and opportunity caused by their convictions.
Wrongful conviction is always harmful, whether or not that harm includes a physical dimension. In the relatively rare cases where its victims win some form of restitution, they should be allowed to keep all of what they receive. Congress did good work in making this principle plain.
Posted by Rebecca Pavese, CPA
Of all the wrongs society does to those convicted of crimes they did not commit, taxing any restitution they receive is far from the most horrific. All the same, it is heartening that lawmakers took the time to make clear that such awards come without strings attached.
The recently passed federal spending bill includes many ancillary provisions, some of which we have already discussed in earlier blog posts. The portion dealing with wrongful incarceration is a small section, appearing nearly at the end of the lengthy piece of legislation and taking up less than a full page. But the language makes clear that all wrongfully incarcerated individuals, as defined by the law, can exclude civil damages or monetary awards from their gross income, whether they were convicted at the federal or state level.
To a layperson, it may seem odd that this scenario was even in question. After all, if the government incorrectly convicts you of a crime, and subsequently recognizes that it has done sufficient harm to merit making some sort of compensation for the suffering you endured, it seems counterintuitive that another branch of the government would then turn around and demand a part of that restitution back in the form of income tax.
Yet prior to this amendment to the tax code, there had effectively been no rulings and a limited number of cases specifically dealing with the federal income tax treatment of such awards.
This may be, in part, because exonerated individuals make up a relatively small portion of the overall population. That is not to say the problem of wrongful convictions is small. In an opinion column for The Washington Post last summer, Samuel R. Gross cited a study he co-authored showing that just over 1 in 25 defendants who receive the death penalty in the U.S. are later found to be innocent. Gross, a law professor at the University of Michigan and the editor of the National Registry of Exonerations, also pointed out that those who are exonerated at all are relatively lucky, given the limited resources of innocence projects and other organizations concerned with such cases.
Yet because of the nation’s high incarceration rate, even a small percent of wrongful convictions creates a population of tens of thousands of individuals. This situation is exacerbated by a justice system where most defendants are encouraged to plead guilty in order to take a plea deal, especially but not exclusively for misdemeanors. According to the Innocence Project, in cases where DNA evidence has conclusively proven an individual to be innocent of the crime for which he or she was convicted, 27 percent were partly or completely due to false admissions of guilt. (The leading cause of wrongful conviction was eyewitness misidentification.)
Given the tragic consequences for individuals who are wrongly convicted, especially those who may spend years or decades incarcerated for crimes they did not commit, monetary compensation seems to be the least they are entitled to expect. And the government’s decision to exempt such payments from gross income for federal tax purposes is ultimately a matter of common sense.
This change did not arrive out of nowhere. Lawmakers had attempted to pass a stand-alone bill on multiple occasions accomplishing the same thing, but had not succeeded. The bipartisan legislation was repeatedly proposed by Sam Johnson, R-Texas, and John Larson, D-Connecticut, as recently as 2015.
Until now, a strict reading of the law meant that victims of wrongful conviction had to argue that all or part of their award related to physical injuries sustained while in prison. The tax code has long exempted awards for personal physical injuries of all types, including car wrecks or sports accidents, from gross income; restitution payments fell under the same umbrella if they were tax exempt at all.
In 2008, the Tax Court considered the case of a petitioner who received a settlement of $49,000 after being mistakenly arrested and jailed for eight hours. That case, Daniel J. and Brenda J. Stadnyk v. Commissioner of Internal Revenue, set groundwork for the tax treatment of damages paid for short-term incarceration. The court ruled in favor of the Internal Revenue Service, concluding that physical detention for a short amount of time was not inherently a “physical injury” under the relevant section of the law.
However, it is obvious that being mistakenly jailed for 8 hours is substantially different than spending 15 or 20 years in prison for a crime one did not commit. What was less obvious was how the IRS would view the physical nature of such long-term imprisonment when characterizing the tax treatment of civil damages or other monetary compensation. A 2010 memorandum, released by the Service, attempted to clarify the situation, but ultimately left the matter resting on the foundation of personal physical injury.
The new legislation relieves the victims of injustice from having to prove the physical dimension of their suffering. While many of those who are wrongfully imprisoned do suffer physically as a result of their ordeals, the IRS will no longer ask them to quantify how much of their awarded damages relate to such injuries, as opposed to the loss of liberty, income and opportunity caused by their convictions.
Wrongful conviction is always harmful, whether or not that harm includes a physical dimension. In the relatively rare cases where its victims win some form of restitution, they should be allowed to keep all of what they receive. Congress did good work in making this principle plain.
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