There are few things that, in my mind, could be more damaging and catastrophic than being wrongly accused, convicted and incarcerated for a crime I did not commit.
As I was looking into the subject, I was shocked to learn that on average, the wrongly convicted person spends about 12.5 years behind bars. The National Registry of Exonerations reports that from 1989 to 2012, there were 873 exonerations and “almost all are tragedies, ” according to them. One wonders why they aren’t all tragic, but who knows?
The federal government, the District of Columbia, and 30 states have compensation statutes of some form. These try to compensate by making cash payments of various kinds to those former inmates. Ostensibly, this would also help them reenter the society from which they were improperly taken away. One of them may be your neighbor.
Besides the statutes I just described, some former inmates sue the government that prosecuted them and win civil awards for the wrongful incarceration.
Some of these payments are substantial and can easily go into the six-figure range, and civil awards can be million dollar payments.
As it turns out, those payments (and awards) were subject to federal income tax, like any other income. But the IRS just issued guidance implementing recent changes in federal law, providing for the exclusion from federal tax, of payments made (and civil lawsuit awards), in favor of the wrongly incarcerated. In some instances, the federal exclusion may also operate as an exclusion from state income tax as well. “Wrongful incarceration” includes reversals of conviction on appeal, pardons that decree the innocence of the person, and some others.
To qualify, you must prove you have received payments because of the wrongful incarceration, and of course, have included them on prior federal income tax returns. If the money was taxed in prior years, you can file amended returns to get refunds on the tax paid. A special provision ending in December of this year allows refunds even from old years that are normally closed to refunds, so if this describes you, shake a leg.
It is far better not to find oneself in this situation, but this special tax benefit lessens the burden.
Orlando Gotay is a California licensed tax attorney (with a Master of Laws in Taxation) admitted to practice before the IRS, the U.S. Tax Court and other taxing agencies. His love of things Mexican has led him to devote part of his practice to the tax matters of U.S. expats in Mexico. He can be reached at email@example.com.