Tax Settlements to Exonerated Prisoners: A Way to Avoid this Tax Problem

Tax Settlements to Exonerated Prisoners: A Way to Avoid this Tax Problem

Federal Congressmen introduced a bill on March 22, 2012 that would prohibit the Internal Revenue Service from taxing settlements awarded to anyone wrongfully convicted of a crime and then exonerated later. These wards are typically paid out by the State or City who wrongfully convicted the person.

The Wrongful Convictions Tax Relief Act of 2012 would amend the Internal Revenue Code to provide tax benefits to individuals who have been wrongfully incarcerated. The bill would avoid a tax problem by allowing the individual who is exonerated to receive damage awards that are tax-free. At this time, generally the only way the a person wrongfully convicted can  receive their award free of state and federal taxes is to show that the award was the result of a personal physical injury.

Currently, the IRS only allows damages to be tax-free if the wrongfully imprisoned person was physically injured or sick while they were unlawfully jailed (See Office of Chief Counsel Memorandum Number 201045023). If an exoneree was not physically injured or sick, the Tax Court has suggested in recent rulings that those individuals may be taxed on their award.