False imprisonment, taxble or tax free recovery?

Are recoveries excludable? It depends on the facts, but also on who you ask. Claims for false imprisonment or wrongful conviction can invoke the common law torts of false imprisonment, malicious prosecution, or abuse of process. Section 1983 allows suits for violation of constitutional rights.  Plus, twenty-two states, the District of Columbia, and the federal government now have compensation statutes for false imprisonment. Although the tax authorities are not clear about false imprisonment, being unlawfully confined behind bars seems by its very nature physical.  As the increase success of efforts such as the innocence project demonstrate, there are a lot of people in prison or on death row in the United States who are likely there based on faulty evidence or prosecutorial misconduct. The question in this podcast and Tax Note article is why should these already injured parties be forced to pay taxes on their awards or settlements?

Interestingly, payments to the following victims were all excluded from income: (1) survivors of Nazi persecution; (2) U.S. prisoners of war during World War II and the Korean War; and (3) Japanese-Americans placed in internment camps.  Unfortunately, though, the IRS has now declared that tax authority "obsolete."  


It is difficult to think of a decent argument for taxing these recoveries. However, by declaring its prior rulings on related subjects obsolete, the IRS has suggested these recoveries are taxable, adding one more gotcha to the odyssey of exonerated prisoners.                

This podcast with Scott Drake, Mark Wahlstrom, Chairman of the Legal Broadcast Network, and Rob Wood, host of the Tax Law Channel, explores what lawyers and settlement professionals can do to help in this growing field. We also have attached a link to the April 2008 edition of Tax Notes, in which Robert Wood elaborates on the rulings, thoughts and opinions that trial lawyers, state governments and settlements experts all need to consider when trying to determine or argue for tax free treatment of a settlement award.

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The Article from April 2008