You are interviewing a client before preparing his tax return. He indicates that he did not list as income $96,000 received as a recovery for false imprisonment.
What should you do with respect to this significant recovery?
Partial list of research aids:
CCA 200809001.
Daniel and Brenda Stadnyk, T.C.Memo. 2008–289.
Rev.Rul. 2007–14, 2007–1 C.B. 747.
§ 104.
SOLUTION
There does not appear to be a clear-cut answer to this question. Section 104 allows exclusion from gross income for damages paid on account of physical injuries and physical sickness. However, the IRS requires observable bodily harm for an exclusion to be available (Ltr. Rul. 200041022).
So is false imprisonment physical? In CCA 200809001, the IRS allowed an exclusion for a settlement with an institution for sexual abuse. However, the Tax Court in Daniel and Brenda Stadnyk, T.C. Memo. 2008-289 would not allow an exclusion for $49,000 received for about one day in a jail.
Brenda Stadnyk was dissatisfied with an automobile purchase, so she placed a stop payment order on the check she tendered to the dealership. Bank One listed the reason for not paying the dealership as a “NSF check.” The dealership then filed a criminal complaint against her for passing a worthless check. She spent about one day in a holding area and a county jail.
Robert Wood in “Why False Imprisonment Recoveries Should Not Be Taxable,” Tax Notes, June 8, 2009, pp. 1217-1220 provides a lengthy discussion of this problem.