Exonerees, Complexity, and the Tax Law

Innocentproject.21In 2014, at least 125 convicts were exonerated, a significant uptick from previous years.

Two-thirds of exonerees receive some sort of compensation from the state as a result of their imprisonment. In fact, thirty states, the District of Columbia, and the federal government all have statutory compensation schemes for the exonerated. And even in those twenty states that do not have statutory compensation, an exoneree may be able to sue the state and recover.

Whether an exoneree is automatically compensated or has to sue, though, there are potentially tax consequences to an exoneree’s recovery. In general, taxpayers owe taxes on money they receive, including as the result of a lawsuit, unless there’s an explicit exemption written into the tax law.

And there is an explicit exemption for recoveries or settlements received because of physical injury. And, in 2010, when the IRS looked at whether recoveries for wrongful conviction and incarceration were taxable, the IRS used the framework Congress had established. Essentially, the IRS said that any portion of a recovery for wrongful conviction that compensated exonerees for physical injuries or physical sickness would not be taxable income. The rest, though, would be subject to taxation.

Last year’s omnibus Consolidated Appropriations Act, 2016 makes a number of changes to the tax law. Among those changes is a change in the treatment of exonerees’ wrongful conviction recoveries. Now, any individual who was convicted of a criminal offense, served some or all of her sentence, and was subsequently pardoned or had her conviction reversed does not have to pay taxes on any monetary award she receives as a result of her imprisonment.

It’s a small provision, one that will only cost the federal government an estimated $10 million in revenue over the next ten years. And on the surface, it certainly seems fair. Society clearly has a responsibility to individuals it wrongfully imprisoned. And there’s at least an argument that taxing exonerees is unjust. After all, they didn’t receive the benefits we expect of the government; rather, the government (or, at least a government—it may have been a state, rather than the federal, government) infringed on their rights and liberty.

That said, though, the length and complexity of the Internal Revenue Code rests at least partly on our carving out little exceptions—even justified exceptions—from the broader tax law. Sure, this provision only adds a little over 200 words to the Code. And it only applies to a small, discrete group of taxpayers.

But you could say the same about most targeted provision. Taken together, though, they have a noticeable impact.

That’s not to say this isn’t the right thing to do. It isn’t to say that, as a policy matter, exonerees should pay taxes on their recoveries for wrongful conviction. Though I lean toward this being bad as a tax policy matter, I’m fairly agnostic toward whether justice demands it or not.

But we need to recognize that reducing the complexity and bloat of the tax law has consequences. And one consequence is, we can’t provide bespoke tax treatment to every deserving group.

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