Compensation For Wrongful Imprisonment

"William Brenner" wrote

I see no reason that the feds would exempt this income.

Technically it's a moot point in Florida. But what if it's paid out in installments, and you receive an installment while residing in another state.

Aww....inquiring minds want to know.......

Publication 525 (2007), Taxable and Nontaxable Income

Court awards and damages. To determine if settlement amounts you receive by compromise or judgment must be included in your income, you must consider the item that the settlement replaces. The character of the income as ordinary income or capital gain depends on the nature of the underlying claim. Include the following as ordinary income.

2. Interest on any award. 2.

Compensation for lost wages or lost profits in most cases. 3.

Punitive damages, in most cases. It does not matter if they relate to a physical injury or physical sickness. 4.

Amounts received in settlement of pension rights (if you did not contribute to the plan). 5.

Damages for: 1.

Patent or copyright infringement, 2.

Breach of contract, or 3.

Interference with business operations. 6.

Back pay and damages for emotional distress received to satisfy a claim under Title VII of the Civil Rights Act of 1964. 7.

Attorney fees and costs (including contingent fees) where the underlying recovery is included in gross income.

Do not include in your income compensatory damages for personal physical injury or physical sickness (whether received in a lump sum or installments).

The relevant lines are:

Punitive damages, in most cases. It does not matter if they relate to a physical injury or physical sickness. Do not include in your income compensatory damages for personal physical injury or physical sickness (whether received in a lump sum or installments).

So is the 50k a year punitive damages or compensatory? Sounds like punitive to me, though if the prisoners were physically beat up or physically tortured, then a part of the 50k would be compensatory damages and consequently tax free (if they were beat up once in the year and the recovery time was 30 days, then I would imagine that

1/12th of the 50k would be tax free).

They are civil damages and federally taxable. Some states have wrongful imprisonment acts that exempt such payments from state income taxes. Some states appear to pass legislation that is individual specific.

California: Not Taxable

CT: Not Taxable While the amount proposed is substantial, you should also be aware that it is the position of the IRS that any compensation that Mr. Tillman or others like him receives for anything other than ?physical injury? is income for federal tax purposes and would be taxable at a rate of 35%. While Mr. Tillman would contest this with the IRS, there is a strong possibility that he would have to pay federal income taxes on the award of up to $1.75 million. The bill does provide that the award would be exempt from state income tax purposes.

Milt Baker CPA Michigan

I'd think the damages are compensatory, not punitive. The state is not trying to punish itself for wrongdoing, it's trying to give the convict something to compensate for his wrongful time in prison.

In addition, it is not for personal injuries - generally the courts require the payment be for actual physical damage rather than psychological injury or generalized bad treatment.

Stu

So if the 50k a year is compensatory damages, you think it is all federally tax free? Or as you saying that the 50k is for not specific personal injury, and is therefore is fully federal taxable? My original response said that the 50k is also fully federal taxable, but because it is punitive damages.

The distinction between "punish itself for wrongdoing" and "trying to give the convict something" seems rather subjective to me. It is punitive damages or compensation, depending on your point of view. In the welfare state, perhaps "trying to give the convict something" is the way to see it, as governments are always-giving entities.

Also, if there was was specific physical injury, as in the case of torture, then I think part of compensation would be tax free.

Huh? No legal expertise on this issue, but certainly sounds to me like (deserved!) compensation for real mental/emotional/personal damages that would certainly be caused/experienced from being falsely imprisoned.

(I'd like 'em to be seriously punitive for the state also, of course.)

I'd say it's all taxable as compensation, not as punitive damages. Sort of as compensation for the money he would have earned if he hadn't been in prison.

I haven't researched this issue, however, and it is possible that under some circumstances some of an award might be excludible as for personal injuries, though I doubt it.

I suppose in this situation it really doesn't make any difference. But in some cases it may make a difference to the payor because punitive damages may not be as deductible as compensatory damages.

And for the recipient the deductibility of attorneys fees with respect to punitive damages may not be as great as for compensatory damages (section 212 versus section 162). I doubt that would apply in this case, however.

The payment would have to be to compensate specifically for that physical injury. Since it's a generalized law based on days incarcerated rather than physical damages caused, no part of this kind of a payment is likely to be tax free on that basis.

Stu

In theory I agree with you. But in practice it won't work that way. First of all in order to get punitive damages he'd have to sue and get a court judgment saying punitive damages. And unless it can be shown that the prosecutor knew he was actually innocent or withheld exculpatory evidence from the defense, he's not likely to win even compensatory damages in a suit like that.

Stu

The state punishing itself? Seems unlikely.

I'd classify it as "compensatory for loss of freedom". I don't know to what extent that might include "loss of wages that would otherwise have been earned".

Only if they had to pay for their own medical treatment, and to the extent of the cost of that treatment.

Seth

If it is indeed income, then it is taxable at the federal level. However, not all payments constitute income to the recipient.

Compensation for losses are generally "matters of equity" in the federal courts (as opposed to "matters of law"). As such, their goal is usually to restore or make whole, and in that sense, the compensation necessary to perform that function is not income at all (to the extent that the loss was never deductible/deducted and that it does not otherwise replace income that is of a taxable nature). Recently (2007), the 2nd Circuit briefly took that position before reversing themselves and I believe that their first impression may have been the correct one. I also believe that IRC 104 is a completely unnecessary statute.

Therefore, from the legal aspect, except for an amount in lieu of wages or earning power lost while imprisoned, the [remaining] amount of the payment should not even meet the definition of income. However, the IRS will probably say that it is simply because one receives it and it is not statutorily exempt.