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At the newest intersection of criminal justice & tax laws - by Daniel L. O’Neil

by News Editor
in Blog
on 23 February 2016
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How do we tax wrongfully convicted Americans once they are exonerated? Today on the blog we are discussing a relatively uncommon but important intersection of criminal and tax law. 

For purposes of this article we begin with the basic principle that the exonerated usually will receive some amount of compensation from the State for their harrowing time spent behind bars as a factually innocent person. But did you know that there would be a difference in how that compensation would be taxed based on whether it was a substitute in kind for lost wages they could have secured out in the free world – or if it was instead segregated to be more of a personal injury recovery to make whole the person that suffered injury and/or illness in prison?

There was a great article in The Atlantic yesterday discussing the Wrongful Convictions Tax Relief Act that President Obama signed into law at the close of last year. It’s no surprise that these issues are gaining broader attention today than ever before.

Regionally, the State of Texas still receives a high profile amount of attention over the wrongful execution of Cameron Todd Willingham in 2004. The clear innocence of Steven Avery in Wisconsin was detailed in a surprisingly popular Netflix series late last year, and his new attorney Kathleen Zellner is moving the case of factual innocence along further than ever before. For the people fortunate enough to have HBOgo on their phones and tablets there is always the allure of watching HBO’s groundbreaking Oz series which provided an uncensored and relatively accurate glimpse into the criminal justice system.

Pop culture has always had an eye towards what happens in the criminal justice system even back in the genesis of American cinema all the way up to the modern era with J.K. Rowling’s examination of Sirius Black’s unlawful detention and wrongful imprisonment in Azkaban Prison – which for better or worse (depending on representation and humanization issues – compare Orange Is The New Black’s treatment of Suzanne Warren to that of Theodore Bagwell in Prison Break) facilitates the wider conversation that the community has about the criminal justice system outside of those walls.

One thing that the wrongfully convicted (and exonerated before execution) and lottery winners had in common until this tax year was the usually unexpected tax bill. The large Powerball drawing a few weeks ago brought this to the forefront as earlier lottery winners and even quotable wealthy people like Mark Cuban advised the new winners that the first thing they should do is hire a tax attorney due to the huge tax bill they would receive if they took the lump sum without withholding – thanks fellas!

According to a report from the University of Michigan there were 149 Americans exonerated in tax year 2015 – approximately five times as many as were exonerated in 1995. Like orphan drug trials in another unique (incentivized) area of tax law these issues are not so widespread as to affect every taxpayer like the difference between credits and deductions. However the specific way in which the IRS went after the exonerated (emerging from lengthy prison stays – on average 14.5 years) who were already down on their luck with barely any community resources or guidance for jobs and housing, necessitated clarifying this area of the law from a public policy perspective.

Takeaway for newly exonerated Americans:

In brass tacks, the Wrongful Convictions Tax Relief Act means that from now on exonerated Americans that receive any compensation for their wrongful conviction from the State can keep the entirety of these sums.

This is considerably different from how it used to be that you needed to prove your compensation was more of the personal injury recovery variety than a substitute in kind for lost wages. This was very difficult to do, with the impact of needing to pay tax on the wage-like compensation – further complicated by how the State would usually just provide a lump sum with no withholding – and for a person without resources and that had been in prison for 14+ years, they probably were not financially planning for a large tax bill they were set to receive shortly thereafter. The new system provided by President Obama is a great system from a public policy perspective that the wrongfully convicted can start assembling their new free lives with one less legal problem hanging over their heads like a dark cloud. The impact to the federal government in lost tax revenue is approximately $1mm annually, a drop in the bucket with the expectations of $3 trillion being collected in this year.

Takeaway for previously exonerated Americans:

The Wrongful Convictions Tax Relief Act is retroactive. Meaning if you were exonerated and you paid tax on that compensation you received for the wrongful conviction – you can file for a refund on that amount as long as you do it before the end of 2016. The biggest issue with this great tax incentive is actually distributing the information to eligible people – many of whom are low-income individuals and largely mistrustful of “the system” of lawyers and accountants after the shock of the tax bill they had not expected. However, The Atlantic is putting it out there and so are we. If you think you are eligible, talk to an accountant sooner than later. If you know someone you think is eligible, send them this blog post or the link to The Atlantic and recommend that they talk to an accountant sooner than later. If you (or they) need a recommendation to a trustworthy accountant in the Houston please let us know and we can connect you to someone I trust.

If you have other tax issues you want to talk about – civil tax issues or criminal tax issues – you can call me. Or if you are in need of criminal defense now, you better call Sal.

713-227-1717