FS-2023-26, Nov. 2023 This fact sheet issues updated FAQs for the wrongful incarceration exclusion, originally published in the Wrongful incarceration FAQs. In the Protecting Americans from Tax Hikes Act of 2015 (PATH Act), Congress added an exclusion from income under section 139F of the Internal Revenue Code. Under this exclusion, a wrongfully incarcerated individual does not include in income any civil damages, restitution or other monetary award received that relates to his or her incarceration for the covered offense for which he or she was convicted (wrongful incarceration exclusion). These FAQs update question 9 to provide that a United States military service member who is a wrongfully incarcerated individual and who receives back pay following the reversal of a court martial conviction may not exclude the payments under section 139F if the payments are merely the restoration of pay and allowances to which the service member is entitled under the law. These FAQs are being issued to provide general information to taxpayers and tax professionals as expeditiously as possible. Accordingly, these FAQs may not address any particular taxpayer's specific facts and circumstances, and they may be updated or modified upon further review. Because these FAQs have not been published in the Internal Revenue Bulletin, they will not be relied on or used by the IRS to resolve a case. Similarly, if a FAQ turns out to be an inaccurate statement of the law as applied to a particular taxpayer's case, the law will control the taxpayer's tax liability. Nonetheless, a taxpayer who reasonably and in good faith relies on these FAQs will not be subject to a penalty that provides a reasonable cause standard for relief, including a negligence penalty or other accuracy-related penalty, to the extent that reliance results in an underpayment of tax. Any later updates or modifications to these FAQs will be dated to enable taxpayers to confirm the date on which any changes to the FAQs were made. Additionally, prior versions of these FAQs will be maintained on IRS.gov to ensure that taxpayers, who may have relied on a prior version, can locate that version if they later need to do so. More information about reliance is available. These FAQs were announced in IR-2023-211. Wrongful incarceration FAQs Q1. Does the wrongful incarceration exclusion also apply to compensatory or statutory damages and restitution that a wrongfully incarcerated individual receives in a criminal matter? A1. Yes. The wrongful incarceration exclusion also applies to compensatory or statutory damages and restitution that a wrongfully incarcerated individual receives in a criminal matter that relates to his or her incarceration for the covered offense for which he or she was convicted. Q2. Who is a wrongfully incarcerated individual under the wrongful incarceration exclusion? A2. A wrongfully incarcerated individual is an individual who was convicted of a covered offense, served all or part of a sentence of imprisonment relating to the covered offense, and meets any one of the following three requirements: The individual was pardoned, granted clemency, or granted amnesty for that covered offense, because the individual was innocent of that covered offense; or The judgment of conviction for the individual for that covered offense was reversed or vacated and the indictment, information, or other accusatory instrument for that covered offense was dismissed; or The judgment of conviction for the individual for that covered offense was reversed or vacated and the individual was found not guilty at a new trial after the judgment of conviction for that covered offense was reversed or vacated. Q3. What is a covered offense? A3. A covered offense is any criminal offense under federal or state law, and includes any criminal offense arising from the same course of conduct as that criminal offense. Q4. For the year an award for wrongful incarceration is received, what is an award recipient required to report on a federal income tax return (Form 1040), or submit to the IRS, to claim the wrongful incarceration exclusion? A4. There are no reporting requirements for receipt of an award qualifying for the wrongful incarceration exclusion. This means for the year an award for wrongful incarceration is received, an award recipient is not required to report receipt of the award on his or her federal income tax return (Form 1040), or submit documentation to the IRS, to claim the wrongful incarceration exclusion. Q5. What records will the IRS require a wrongfully incarcerated individual to retain in order to substantiate that the award he or she received qualifies for the wrongful incarceration exclusion? A5. To substantiate the wrongful incarceration exclusion, the individual must retain documents establishing that the award was made on account of wrongful incarceration. Generally, these documents must be retained for three years from the date the return is filed. Examples of such documentation include copies of federal or state court orders awarding the compensation, signed settlement agreements accepting the amount of the award, and letters by governmental agencies or private payment sources that may have accompanied the payment of the award that include an explanation of the reason for the payment. Q6. May an individual who was wrongfully incarcerated but released before trial and not convicted of any crime exclude an award from income under the wrongful incarceration exclusion? A6. No. However, section 104(a)(2) excludes from gross income damages received on account of personal physical injuries or physical sickness. Individuals who received a damage award generally may exclude an award from income to the extent the award was received on account of a personal physical injury or physical sickness. See IRS Publication 4345, Settlements — TaxabilityPDF, for more information. Q7. May a spouse, child, parent, or other individual exclude from gross income an award he or she receives for derivative claims such as loss of consortium or loss of companionship of the wrongfully incarcerated individual under the wrongful incarceration exclusion? A7. No. The wrongful incarceration exclusion does not apply to damage awards an individual receives for derivative claims such as loss of consortium or loss of companionship of the wrongfully incarcerated individual. Q8. Are payments received in settlement of an action for wrongful incarceration considered "civil damages" under section 139F(a)? A8. Yes. Payments received in settlement of an action for wrongful incarceration are considered "civil damages" under section 139F(a). Q9. Can a wrongfully incarcerated United States military service member who receives back pay following the reversal of a court martial conviction exclude the payments from gross income under the wrongful incarceration exclusion? (updated Nov. 13, 2023) A9. No. A United States military service member who is a wrongfully incarcerated individual and who receives back pay following the reversal of a court martial conviction may not exclude the payments under the wrongful incarceration exclusion if the payments are merely the restoration of pay and allowances to which the service member is entitled by statute. A wrongfully incarcerated individual, who in a prior year received back pay and excluded the payments from gross income, may file an amended federal income tax return (Form 1040-X) for that prior year to report the back pay as income. Q10. May the estate of a wrongfully incarcerated individual exclude from income a posthumous award (including a posthumous restitution payment) it receives in the current tax year or a prior tax year that meets the requirements of the wrongful incarceration exclusion? A10. Yes. The estate of a wrongfully incarcerated individual may exclude from the estate's income a posthumous award (including a posthumous restitution payment) it receives in the current tax year or a prior tax year that meets the requirements of the wrongful incarceration exclusion. The estate is not required to file a federal income tax return (Form 1041), or submit documentation to the IRS, for the year in which the award is received in order to claim the wrongful incarceration exclusion. However, the estate must possess and retain documents to substantiate that the award qualifies for the wrongful incarceration exclusion. See What records will the IRS require a wrongfully incarcerated individual to retain in order to substantiate that the award he or she received qualifies for the wrongful incarceration exclusion? Q12. What documentation should a wrongfully incarcerated individual submit with his or her amended federal income tax return (Form 1040-X) to substantiate the claim for refund? A12. The Form 1040-X must include two different types of documentation. The first type of documentation must establish that the award was previously reported in income, when it was reported, and in what amount. Examples of such documentation include copies of federal income tax returns, Forms 1099-MISC (Miscellaneous Income), and any other retained records relating to the reported income. However, if a wrongfully incarcerated individual no longer has documentation establishing that he or she previously reported the award in income, then he or she must submit a written statement affirming that the income was reported and that he or she no longer has relevant records. The second type of documentation must establish that the award was made on account of the wrongful incarceration. Examples of such documentation include copies of federal or state court orders awarding the compensation, signed settlement agreements accepting the amount of the award, and letters by governmental agencies or private payment sources that may have accompanied the payment of the award that include an explanation of the reason for the payment. IRS-FAQ
