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Are False Imprisonment Recoveries Taxable, Robert Wood, 2008

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By Robert W. Wood
Robert W. Wood practices law with Wood & Porter,
in San Francisco (, and
is the author of Taxation of Damage Awards and Settlement Payments (3d Ed. Tax Institute 2005 with 2008
update), available at
This discussion is not intended as legal advice, and
cannot be relied on for any purpose without the
services of a qualified professional.
Copyright 2008 Robert W. Wood.
All rights reserved.
News stories about prisoners released from custody
following the discovery of exculpating evidence have
been cropping up with increasing frequency. As CSI fans
will attest, one path that can lead to this result involves
DNA evidence, a relatively recent scientific phenomenon.1 A more disturbing path involves the discovery of
prosecutorial misconduct.2 Still another involves evidence or witnesses that somehow escaped everyone’s
However the evidence comes about, we cannot help
but notice an uptick in these stories. Given the generally
litigious nature of our society (and the corollary theory
that for every wrong there is a right), it is hardly
surprising that the number and size of settlements from
claims for wrongful conviction and imprisonment have

(statistics show that 145 of the 208 postconviction DNA exonerations have been since 2000).
See (profiles of exonerated individuals whose conviction was partially or completely
overturned based on prosecutorial misconduct: Billy Wardell,
Marvin Anderson, and Jeff Deskovic); Edwin M. Borchard, A
Long Legacy of Error, excerpted from Convicting the Innocent:
Errors in Criminal Justice (New Haven, Yale University Press,
1932) (discussing the inherent flaw in our prosecutorial system
in which a conviction is regarded as a personal victory for the
See Martinez v. Brink’s, Inc., No. CL0103469AH (S.D. Fla. Oct.
2, 2003) (the plaintiff won an $8.26 million verdict for malicious
prosecution after spending six months in pretrial detention);
Bravo v. Giblin, No. B125242, 2002 WL 31547001, at 24 (Cal. Ct.
App. Nov. 18, 2002) (approving an award of $3,925,976, including $3,537,000 to compensate for three years of incarceration).

TAX NOTES, April 21, 2008

As such, it seems inevitable that the income tax affects
of these increasingly large recoveries will bubble to the
surface. When someone who has been in jail is vindicated
and released, and receives money from the state, county,
or federal government on account of their unlawful
incarceration, is that recovery taxable? It would seem
there would be a clear answer.
After all, despite the increase in volume, this is not a
new phenomenon. Although large recoveries may represent a recent trend, recoveries for wrongful imprisonment have occurred for generations.4 Before embarking
on a tour of the pertinent federal income tax law, the
paucity of tax authority on these issues, and the reasons
I believe these recoveries should be tax free, we should
review the types of causes of action that may be brought.

I. Types of Recoveries
Claims for false imprisonment may be brought in
myriad guises. However, all of the legal bases of suing for
unlawful incarceration have more similarities than differences. Someone who has claims for a wrongful incarceration may seek to recover in one or more ways.
A wrongfully convicted individual can attempt to
recover under several common-law tort theories, including false imprisonment, malicious prosecution, and
abuse of process.5 This individual could also bring an
action under 42 U.S.C. section 1983 for violation of his
constitutional rights. A section 1983 action allows a
lawsuit for damages against any official acting under
color of state law who deprives the plaintiff of a constitutional right.6 Some individuals seek to have a private
bill enacted by their state legislature entitling them to
compensation for wrongful incarceration.
Finally, state statutes may expressly allow claims for
false imprisonment. In fact, 22 states, the District of
Columbia, and even the federal government have enacted compensation statutes through which an individual can seek redress for false imprisonment. The
sections that follow briefly review each of these avenues
of recovery. These sections are not intended as an authoritative legal discussion, but only as an overview to
set the stage for an examination of the tax authorities.

A. Common Law
The common-law tort of false imprisonment requires
an individual to prove that he was knowingly and
intentionally confined, against his will and without his
consent, and that the confinement was not privileged.7 A


See Borchard, supra note 2.
See Restatement (Second) of Torts section 35 (1965), section 653
(1977), section 682 (1977).
42 U.S.C. 1983 (1996).
Restatement (Second) of Torts section 35 (1965).


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Are False Imprisonment
Recoveries Taxable?



Restatement (Second) of Torts sections 10, 118, 121-132 (1965).
Restatement (Second) of Torts section 653 (1977).
Restatement (Second) of Torts section 682 (1977).
28 U.S.C. 2680(h) (2000).
Restatement (Second) of Torts section 656 (1977).
Restatement (Second) of Torts sections 118, 121-132 (1965).


immunity is waived, the wrongfully convicted individual
will often have to turn elsewhere for compensation.15

B. Section 1983
Section 1983 was originally enacted as part of the Civil
Rights Act of 1871.16 The statute was amended in 1996 as
part of the Federal Courts Improvement Act of 1996.
Before the 1871 enactment of section 1983, states and
those acting with state imprimatur were not liable for
violations of the U.S. Constitution. Section 1983 allows an
action against any person, acting under color of any
statute, for a violation of an individual’s constitutional
Section 1983 provides a statutory framework by which
a wrongfully convicted individual can seek compensation from police officers, prosecutors, and municipalities
for violating his constitutional rights. The underlying
purposes of section 1983 are to compensate victims for
past abuses and to serve as a deterrent against future
constitutional abuses.18
A section 1983 action can be based on the notion that
a lawsuit for damages against an official, acting under
color of state law, is proper when the official deprives the
individual of a constitutional right.19 A typical claim
would assert violation of the Fourth Amendment’s prohibition on illegal search and seizure, or a violation of the
Fifth Amendment’s guarantee of due process of law.20
For example, in one case, the police withheld exculpatory information from the prosecutor and encouraged
witnesses to pick the defendant out of a police lineup,
contributing to a guilty verdict. After spending 15 years
in prison, the wrongfully convicted individual was found
innocent and pardoned by the governor. The individual
then brought a successful action under section 1983 for a
violation of his due process rights.21
One problem with the viability of many section 1983
claims is that the individual must prove a constitutional
violation. Furthermore, even assuming that this initial
burden is met, the individual must contend with the
probable cause barrier. In the case of a police officer, if the
officer had probable cause (a very low standard), he is
generally immune from prosecution.22
An alternative (although still within the rubric of
section 1983) is to bring an action against the prosecutor
for violating the individual’s Fifth Amendment right to
liberty.23 Such an action against the prosecutor will likely
fail, as prosecutors have absolute immunity from suits
arising out of their prosecutorial duties.24 The origin of

See Adele Bernhard, ‘‘When Justice Fails: Indemnification
for Unjust Conviction,’’ 6 U. Chi. L. Sch. Roundtable 73, 86-92
See generally 42 U.S.C. 1983 (1996).
Owen v. City of Independence, 445 U.S. 622, 651 (1980).
St. Louis v. Praprotnik, 485 U.S. 112, 121-131 (1988).
Elkins v. United States, 364 U.S. 206 (1960).
Newcome v. McCabe, 256 F.3d 747, 752 (7th Cir. 2001), aff’d,
319 F.3d 301 (7th Cir. 2003), cert. denied, 539 U.S. 543 (2003).
Illinois v. Gates, 462 U.S. 213, 238 (1983).
Imbler v. Pachtman, 424 U.S. 409, 420-429 (1976).
Id. at 424.

TAX NOTES, April 21, 2008

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false imprisonment claim can be brought against any
individual, not merely against the state. For example, a
bank robber may be guilty of false imprisonment for
taking a bank’s customers and employees hostage, physically preventing their escape.
Of course, we are not concerned here with the actions
of civilians, but rather with government action leading to
false imprisonment. Suits against the government and
against government officials have their own problems.
The most difficult obstacle for an exonerated person in
bringing such a claim is proving that the actor was not
‘‘privileged’’ to arrest or imprison the individual.8
At common law, an action for confinement resulting
from an arrest under valid process was brought as a
claim for either malicious prosecution or abuse of process. Malicious prosecution is related to, but distinct from,
false imprisonment. To prove malicious prosecution, a
wrongfully convicted person must generally show that:
• a prosecutor initiated a proceeding against him;
• the proceeding terminated in favor of the wrongfully convicted person;
• the prosecutor initiated the case without probable
• the primary purpose of the prosecution involved
malice (or something other than bringing the individual to justice); and
• damage resulted from the prosecution.
Thus, to recover for malicious prosecution, an exonerated individual would need to show that the prosecutor
brought criminal charges without probable cause, resulting in the plaintiff’s wrongful conviction and incarceration, as evidenced by his later exoneration.9
Abuse of process is another common-law tort. It is
related to (but distinct from) malicious prosecution and
false imprisonment. To prove abuse of process, an individual must show that the legal process was used ‘‘primarily’’ to accomplish a purpose for which it was not
designed.10 An abuse of process claim does not focus on
the procurement of process or the wrongful initiation of
proceedings. Rather, the claim focuses on the use of the
process for an improper purpose.11
To recover under any one of these tort theories, the
claimant must prove all of the elements of the offense,
and must overcome any obstacles to recovery, such as a
privilege defense. Precisely who can be sued is a delicate
matter. Notably, sovereign immunity generally insulates
the government from intentional tort claims.12
Likewise, prosecutors and judges have absolute immunity for acts in their official capacities, regardless of
their motives or intent to wrongfully convict the individual.13 Finally, police officers are generally immune
from liability for an arrest, provided it was made within
the scope of their authority.14 For this reason, unless


C. State Legislative Remedies
Although it has not occurred frequently, some individuals (particularly those who have received good press
coverage of their plight) may turn to their state legislature to seek redress for false imprisonment. The victim
may be able to influence the state legislature to pass a
private bill to award compensation directly from the state
treasury.26 This avenue has a couple of major limitations.
The first is that many courts have viewed a private
compensatory bill as potentially violating the U.S. Constitution. Indeed, the 14th Amendment states that a
legislature cannot pass a bill for the benefit of one person
without passing legislation for all similarly situated
people.27 The second stumbling block is the reality that
not all wrongful conviction cases garner significant — or
even favorable — press.
Moreover, few exonerated individuals have the resources necessary to influence the state legislative bodies
to act on their behalf. For these reasons, a private bill is a
remedy available for very few cases.
D. State Compensation Statutes
State compensation statutes are another avenue for a
wrongfully convicted individual to seek compensation
for years spent behind bars. Twenty-two states and the
District of Columbia have enacted general compensation
statutes, allowing an individual to pursue a claim against
the state for wrongful conviction. These statutes all
provide some type of compensation for wrongful imprisonment, but they vary greatly in their requirements, as
well as in their compensation levels.
Some of the state statutes require an official pardon
from the governor before an individual can file a claim.28
Some states only allow a recovery if the conviction was
for a felony.29 Almost half of the statutes preclude a
recovery when the individual entered a guilty plea. The
idea of disqualifying an individual who has pleaded

guilty appears to be that compensation should be unavailable to an individual who played a part in his own
conviction.30 Of course, some defendants are coerced into
confessing, or face such bleak circumstances that a plea
bargain (and confession) may be the only way to avoid
the death penalty or a life sentence.
The states also vary in the amount and measure of
compensation. For example, California’s maximum payout is $100 per day of incarceration, whereas Wisconsin
allows a recovery of only $5,000 per year, up to a
maximum of $25,000.31 Some states, notably including
New York, have no ceiling on the allowable recovery.32
Other states, such as Tennessee, have a $1 million maximum.33 Another variation is Montana, which does not
provide for any monetary compensation. Instead, Montana provides only educational aid to those exonerated
by postconviction DNA evidence.34
The states vary not only in the maximum amount of
their payout, but also in the means used to measure the
amount of compensation. New Jersey and Virginia base
the compensation amount on a measurement of the
exoneree’s earning capacity. In New Jersey, the individual
is entitled to twice his yearly income in the year before
incarceration, or $20,000, whichever is greater. Virginia’s
compensation statute varies slightly, in that the compensation is based not on the individual’s prior earning, but
rather on the per capita income of the Virginia population.35
There are also states that include lost wages as a
component of the total compensation amount. In these
states, lost wages do not make up the majority of the
compensation and are not used as the measure from
which to pay out compensation. In Iowa, Ohio, and
Texas, lost wages are paid in addition to the compensation otherwise provided by the statute.

E. Federal Compensation Statute
An individual may also choose to sue under the
federal compensation statute for unjust conviction and
imprisonment.36 This statute was originally enacted in
1948.37 To succeed, the plaintiff must prove that:
• his conviction has been reversed or set aside on the
ground that he is not guilty of the offense of which
he was convicted, or on new trial or rehearing he


See, e.g., An Act Compensating James C. Tillman for His
Wrongful Conviction and Incarceration, Connecticut H.B. 6673,
Special Act No. 07-5 (May 21, 2007), available at http:// 2007/ACT/SA/2007SA-00005-R00HB-06673SA.htm.
Barry Scheck et al., Actual Innocence: Five Days to Execution
and Other Dispatches From the Wrongly Convicted (Doubleday,
See Cal. Penal Code section 4900; 505 Ill. Comp. Stat. Ann.
505/8(C); Me. Rev. Stat. Ann. Tit. 14, section 8241(4); Md. Code
Ann. State Fin. & Proc. section 10-501(b); N.C. Gen. Stat. section
See Ala. Code section 29-2-156; Cal. Penal Code section
4900; Mass. Gen. Laws Ann. Ch. 258D, section 1(C)(ii); Mo. Ann.
Stat. section 650.055(9)(I); Mont. Code Ann. section 53-1-214(1);
N.C. Gen. Stat. section 148-82; Ohio Rev. Code Ann. section
2743.48(A); Okla. Stat. Ann. Tit. 51, section 154(B)(1); Va. Code
Ann. section 8.01-195.10(B).

TAX NOTES, April 21, 2008

See Cal. Penal Code section 4903; D.C. Code section
2-422(2) (2001); Iowa Code Ann. section 663A.1(b) (West 1998);
N.J. Stat. Ann. section 52.4C-3(C) (West 2001); N.Y. Cr. Cl. Act
section 8-b(5)(d) (McKinney 1989); Ohio Rev. Code Ann. section
2743.48(A)(2) (LexisNexis Supp. 2006); Okla. Stat. Ann. Tit. 51,
section 154(B)(2)(b) (West Supp. 2006); Va. Code Ann. section
8.01-195.10(B) (Supp. 2006); W. Va. Code Ann. section 14-213a(e) (LexisNexis Supp. 2006).
National-View1.php (gives state by state breakdown of the
compensation statutes, their requirements, and their payouts).
28 U.S.C. section 1495 (2000); 28 U.S.C.A. section 2513
(West Supp. 2006).


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that immunity is the concern that ‘‘harassment by unfounded litigation would cause a deflection of the prosecutor’s energies . . . and the possibility that he would
shade his decisions instead of exercising the independence of judgment required by his public trust.’’25


• he did not commit any of the acts charged . . . and he
did not, by misconduct or neglect, cause or bring
about his own prosecution.38
If adequate proof is established, the individual can
recover $50,000 for each year of incarceration, or $100,000
for each year of incarceration spent on death row.39
The Innocence Protection Act of 2004 was enacted as a
part of the Justice for All Act of 2004 (JFAA).40 Signed into
law by President Bush on October 30, 2004, the JFAA was
designed to provide additional victim’s rights, additional
funds and protocol for DNA testing, postconviction testing to prove innocence, and additional compensation for
persons wrongfully convicted.41 The JFAA increased
compensation to wrongfully convicted persons under the
federal wrongful conviction statute from $5,000 to
$50,000 per year ($100,000 in the case of a year spent on
death row).42 The JFAA also expressed Congress’s belief
that states should provide compensation to any person
wrongfully convicted and sentenced to death.43

II. Ancillary Claims
As this brief review of the types of causes of action
arising out of false imprisonment makes clear, there is
significant variety in those claims. Nevertheless, there is
an overwhelming level of consistency in the pertinent
fact patterns and in what must be proven. There are more
similarities than differences.
Moreover, regardless of the precise manner and forum
in which those claims are pursued, there is another
virtual constant. Often, there are ancillary claims expressly or implicitly made in the context of that litigation.44
For example, in addition to false imprisonment, the
plaintiff may have a claim for poor medical care during
the plaintiff’s time in prison, which may constitute medical malpractice under prevailing standards. Other ancillary claims may involve loss of consortium by spouses
and loved ones, rape claims against government employees and institutions (for which the state may bear
some responsibility), battery, invasion of privacy, and so
on. Many of these ancillary claims are indisputably tort
claims (such as medical malpractice), and under tradi-


Justice for All Act of 2004, P.L. 108-405, section 431-432, 118
Stat. 2260, 2260-2261 (2004).
Id. at 2293.
Although I use the term ‘‘litigation’’ here, some disputes of
this nature are resolved far more amicably, with the state
seemingly recognizing, long before any lawsuit is filed, that it
made a mistake and that it should pay for that mistake. See, e.g.,
Azrael Sky, ‘‘Man Receives $5 Million for Rape He Didn’t
Commit,’’ available at
article/248548/man_receives_5_milli on_for_rape_he.html.

tional federal income tax principles, they should presumably yield a tax-free recovery to the injured party.45
Moreover, if one family member is seriously injured in
an accident, another family member may have a loss of
consortium claim against the tortfeasor. Traditionally, a
loss of consortium claim is regarded as physical, and so is
tax free to the spouse (or other family member), based on
the assumption that the injury giving rise to the loss of
consortium is also tax free.46 Such loss of consortium
claims have a kind of piggyback status, deriving their
tax-free character from the underlying tort claim involving the injured party that gave rise to the loss of
It is difficult to address all such ancillary causes of
action within the more standard model of a false imprisonment claim. Generally speaking, however, these ancillary causes of action will make the case for a tax-free
recovery to the falsely imprisoned individual much better.
Example: Gideon is sent to prison for five years for
a crime he did not commit. While in prison, he
receives medical care that is grossly inadequate and
causes him permanent physical injuries. If Gideon
later recovers for these various harms, there is a
better case for his recovery being fully excludable
from his income than if he had the same fact pattern
but without the medical malpractice.
One likely reason there is little discussion of the tax
treatment of wrongful imprisonment recoveries is the
frequent interaction between the underlying false imprisonment claim and the all-too-frequent ancillary claims.
Sometimes the ancillary claims may rise to a primacy of
seriousness (such as medical malpractice in the prison
hospital), in which the causes of action for such ancillary
claims are quite meritorious in their own right. In those
cases, neither taxpayers nor the IRS may be focusing too
clearly on precisely how the wrongful imprisonment
recovery, by itself, should be taxed.
In any event, because of both the variation in these
ancillary claims and the extent to which they cloud (and
frankly make easier) the underlying question whether
false imprisonment claims by themselves should give rise
to damage awards that are fully excludable from the
exonerated individual’s income, I focus here not on any
of the ancillary claims, but simply on false imprisonment



See generally section 104(a)(2); Commissioner v. Schleier, 515
U.S. 323, 115 S. Ct. 2159, Doc 95-5972, 95 TNT 116-8 (1995).
Id.; Francisco v. United States, 54 F. Supp.2d 427, 435, Doc
1999-20985, 1999 TNT 128-8 (E.D. Pa. 1999), aff’d, Francisco v.
United States, 267 F.3d 303, Doc 2001-27013, 2001 TNT 208-8 (3d
Cir. 2001).
LTR 200121031, Doc 2001-15011, 2001 TNT 103-10.

TAX NOTES, April 21, 2008

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was found not guilty of such offense . . . or that he
has been pardoned upon the stated ground of
innocence and unjust conviction; and


III. Tax Authorities
The Internal Revenue Code has provided an exclusion
for personal injury damages for more than 80 years.48
Most states follow suit. For the bulk of this long history,
the exclusion from income applied to any damages
received (by judgment or settlement) for personal injuries
or personal sickness. That meant emotional distress damages were also excludable from income.
In 1996, however, the statute was amended to narrow
the exclusion to cover only damages for personal physical
injuries and physical sickness.49 This simple but farreaching statutory change was made primarily in response to what both Congress and the IRS viewed as
abuses by lawyers and their plaintiff clients in employment lawsuits.50 Although many employees sue for discrimination or wrongful termination, and a portion of
damages received for such claims is almost invariably for
lost wages, some plaintiffs and their counsel became
aggressive in seeking to allocate the bulk of their recoveries from such claims to ‘‘emotional distress.’’ The 1996
amendment to section 104 was expressly designed to
stem that tide and to make emotional distress recoveries
Surprisingly, the IRS has failed to update its regulations since 1996, and has provided no official guidance on
the meaning of the term ‘‘physical.’’51 Private letter
rulings suggest that the IRS believes not only that there
must be a physical striking of the plaintiff, but that the
plaintiff must also experience observable bodily harm
(broken bones, bruising, and so on).52 The legislative
history to the 1996 amendment to section 104 indicates
Congress’s view that mere symptoms of emotional distress do not result in excludable awards. Thus, headaches, stomachaches, and insomnia, commonly

Section 104(a)(2) originates from the Revenue Act of 1918,
ch. 18, 40 Stat. 1057, section 213(b)(6). See H.R. Rep. No. 767 65th
Cong., 2d Sess. 9-10 (1918) (1939-1 C.B. (Pt. 2) 86, 92). Major
revisions of the Internal Revenue Code in 1939 and 1954 altered
the wording only slightly and made no substantive changes to
the provision. Section 22(b)(5) (1939); section 104(a)(2) (1954). In
1982, Congress amended section 104(a)(2) to exclude deferred
payments explicitly by adding the language that ‘‘periodic
payments as personal injury damages are excludable from gross
income of the recipient.’’ S. Rep. No. 97-646, at 4 (1982), reprinted
in 1982 U.S.C.C.A.N. 4580, 4583.
Small Business Job Protection Act of 1996, P.L. 104-188,
section 1605, 110 Stat. 1755, 1838 (1996); H.R. Conf. Rep. No.
104-737, 104th Cong., 2d Sess., 301 (1996).
See Robert W. Wood, ‘‘Tax Treatment of Settlements and
Judgments: Post-1996 Act Section 104 Cases: Where Are We
Eight Years Later?’’ Tax Notes, Oct. 4, 2004, p. 68, Doc 2004-18582,
2004 TNT 189-27. See also Wood, ‘‘Recent Damage Awards
Decisions,’’ Tax Notes, Sept. 5, 2005, p. 1129, Doc 2005-18117, 2005
TNT 169-15.
LTR 200041022, Doc 2000-26382, 2000 TNT 201-10.

TAX NOTES, April 21, 2008

1. Schleier test. The U.S. Supreme Court in Commissioner
v. Schleier56 established a two-part test for determining
whether a payment is excludable from income under
section 104. The test came before the 1996 amendments to
section 104, but the case continues to be relied on, now
with the ‘‘physical’’ modifier. The first prong of this test
requires a taxpayer to establish that damages were received through a tort or tortlike action.57 The second
prong requires a taxpayer to establish that the damages
received were ‘‘on account of’’ personal (physical) injury.58
Despite this seemingly simple test, the courts have
struggled to apply it. Most of the case law has been
decidedly antitaxpayer, giving an unduly narrow focus
to section 104. The cases are legion in which taxpayers
fail to carry their burden of proving a recovery to be
excludable under the Schleier standard. For example, in
Reid v. Commissioner, the Tax Court held a tort recovery
for wrongful discharge not to be excludable because it
was not received ‘‘on account of’’ personal physical
injuries or physical sickness.59
Reid, a cashier at a Florida Chevron station, alleged he
was injured lifting a bucket of ice and filed for workers’
compensation benefits. When his claim was denied and
he was fired, he sued Chevron for wrongful discharge.
The case settled for $5,000.
Reid excluded the settlement from his income, and the
matter ended up in Tax Court. Noting that the settlement
agreement failed to allocate any portion of the recovery
to personal physical injuries or physical sickness, the
court held for the IRS. Even if there was an ancillary

H.R. Conf. Rep. No. 104-737, 104th Cong., 2d Sess., 301
See Vincent v. Commissioner, T.C. Memo. 2005-95, Doc 20059343, 2005 TNT 85-6. See also Wood, ‘‘Ulcers and the Physical
Injury/Physical Sickness Exclusion,’’ Tax Notes, June 20, 2005, p.
1529, Doc 2005-13042, 2005 TNT 115-33.
See, e.g., LTR 200121031, supra note 47, in which the IRS
ruled that an asbestos claim resulting from inhalation of fibers
was excludable (despite the lack of physical touching).
515 U.S. 323, 336-337 (1995).
Id. at 335.
Id. at 336.
T.C. Summ. Op. 2002-55, Doc 2002-12459, 2002 TNT 100-12.


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A. Section 104 Authorities

experienced by those in stressful situations, are not
sufficiently ‘‘physical’’ to give rise to an exclusion from
Unfortunately, there is little authority from which to
divine the line between mere symptoms of emotional
distress on one hand, and physical injuries or physical
sickness on the other. Is a stroke a mere headache? Are
bleeding ulcers mere stomachaches?54
Perhaps more significantly, is the IRS correct that there
must be a striking for an exclusion to be available? I
believe the answer must be no, and that some physical
consequences must be viewed as serious enough to
constitute physical injury or physical sickness, and thus
to give rise to an exclusion from income, despite the
absence of a physical battery.55 Yet the issue remains


Private letter rulings are not technically authority, and can
be used only by the taxpayer to whom they are issued.
However, practitioners routinely read them and rely on them as
indications of the position of the IRS National Office. Moreover,
even the U.S. Supreme Court has cited letter rulings. See Rowan
Cos. v. United States, 452 U.S. 247 (1981).
See supra note 52.
Prasil v. Commissioner, T.C. Memo. 2003-100, Doc 2003-9085,
2003 TNT 69-39.
See Wood, ‘‘Ulcers and the Physical Injury/Physical Sickness Exclusion,’’ supra note 54. See also Wood, ‘‘Physical Sickness
and the Section 104 Exclusion,’’ Tax Notes, Jan. 3, 2005, p. 121,
Doc 2004-24100, 2005 TNT 2-41.
T.C. Memo. 2005-95, Doc 2005-9343, 2005 TNT 85-6.


nately for the taxpayer, this was a case that had settled
after a jury verdict, and the Tax Court reviewed the jury
verdict. Finding no mention whatsoever that the jury had
considered the ulcers, the Tax Court found the entire
recovery to be taxable.
Proving a physical sickness may sometimes be easy,
but proving its cause often will not be. Moreover, when
the sickness itself is mental, the courts have thus far not
addressed the excludability of recoveries attributable to
that sickness.65
In at least one letter ruling involving a serious physical
sickness (cancer) that led to the person’s death, the IRS
did not expressly comment whether this was ‘‘physical
sickness,’’ presumably because it was so obvious that it
was.66 The ruling involved a widow whose husband died
from cancer after being exposed to asbestos. The ruling
concludes that the widow’s recovery for wrongful death
and her recovery for loss of consortium were both
excludable under section 104. The IRS does note that
there was a direct causal link between the deceased’s
inhalation of asbestos and the widow’s claims for wrongful death and loss of consortium.
This letter ruling involving cancer from asbestos may
be an obvious case. Yet it illustrates what is at the root of
many of the Tax Court cases that seem to ignore physical
sickness and even many physical injuries: the problems
of proof. As in many of the cases I’ve noted, the taxpayer
is unable to show much of anything in the way of
medical documentation.
Even when the plaintiff has medical documentation,
plaintiffs often fail to show a causal connection between
the defendant’s conduct and the sickness or injury. Of
course, in some cases, as in Vincent, there is even a failure
to show that the malady was attributed to the defendant
and argued as part of the case. Given such failings, it is
hardly surprising that most of the authority interpreting
section 104, particularly in the post-1996 era, has found
that this exclusion does not apply.
Given the express purpose of the 1996 tightening of
section 104 (to prevent abuses that Congress thought
were occurring in allocations of damages in employment
lawsuits), one should expect that result. Thus, in Tritz v.
Commissioner,67 the Tax Court found settlement payments
for a termination of employment to be fully taxable. The
settlement payment was made under a reduction in force
of many employees, and the taxpayer signed a release
that provided for wage treatment for the entire severance
payment. The taxpayer argued that because he had been
treated for carpal tunnel syndrome, a portion of the
settlement had to be attributed to that, and therefore was
Predictably, the Tax Court concluded that the entire
severance payment was properly treated as severance, as

See Tamberella v. Commissioner, 139 Fed. Appx. 319, 322, Doc
2005-15534, 2005 TNT 140-11 (2d Cir. 2005). (‘‘We expressly do
not decide whether a serious mental illness, such as schizophrenia or bipolar disorder, constitutes a ‘physical’ injury or sickness
within the meaning of 26 U.S.C. [section] 104(a)(2).’’)
See supra note 47.
T.C. Summ. Op. 2001-76, Doc 2001-15770, 2001 TNT 108-12.

TAX NOTES, April 21, 2008

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cause of action based on tort or tort-type rights, the
settlement agreement did not ascribe any amount to
personal physical injuries or physical sickness.
Nevertheless, the IRS has recognized that when there
is physical touching and resulting physical injuries, recoveries (such as for sexual harassment) can be excluded.
In what is generally regarded as a seminal private letter
ruling,60 the IRS bifurcated a sexual harassment recovery
into damages for the period leading up to a physical
battery (what the IRS called the First Pain Incident), and
damages thereafter.61 The physical battery and its consequences became a threshold beyond which all damages
were tax free.
LTR 200041022 clearly indicates that in the IRS’s view,
when there is a battery that causes visible harm, all
damages flowing therefrom (including emotional distress) are excludable. In the real world, however, there is
often no clear event from which both physical and
nonphysical damages flow. The IRS’s desire for bright
lines has probably caused it to virtually ignore the
‘‘physical sickness’’ wing of section 104. Nevertheless, the
statute is clear that physical sickness recoveries are fully
excludable, and physical sickness is not generally triggered by a battery.
There is often simply too little proof from which such
a watershed can be observed. For example, in Prasil, the
Tax Court found a sexual harassment settlement fully
taxable.62 The court dismissed Prasil’s uncorroborated
testimony that the harassment caused or exacerbated
various illnesses. Proving that express tax language in
settlement agreements does matter, the court noted that
the settlement documents failed to allocate any portion of
the payment to physical injury or physical sickness.
2. Physical ‘sickness’ recoveries. One whole wing of the
section 104 exclusion has rarely been explicated.63 The
statute excludes damages for physical injuries or physical
sickness. That physical sickness has almost never been
discussed in rulings, in the tax literature, or in case law is
disturbing. In our common experience, most physical
sickness does not arise from a battery. Thus, physical
touching should arguably be irrelevant.
A few authorities expressly touch on the physical
sickness wing of section 104. In Vincent v. Commissioner,64
the plaintiff claimed her employer’s conduct exacerbated
her ulcers. She claimed that supported the exclusion of 50
percent of her settlement, which she attributed to her
ulcers and emotional distress arising therefrom. Unfortu-


3. Cases on constitutional rights. Although much of our
learning about the current scope of section 104 comes
from employment litigation, there has been some litigation over the tax treatment of recoveries for violations of
constitutional rights. Moreover, several courts have held
compensatory payments in this circumstance to be excludable from income.
For example, in Bent v. Commissioner,68 the taxpayer
was a schoolteacher whose contract was not renewed
after he publicly criticized the school administration. The
plaintiff had a reputation for outspokenness, and at a
teachers’ meeting, made several highly critical remarks
about a school administrator. Shortly thereafter, he received an evaluation by the same administrator concluding that he would not be employed the following year.
When Bent’s contract was not renewed, he sued for
breach of contract and violation of his right to freedom of
speech, suing under section 1983. The court rejected all
claims except that for free speech. However, before the
court reached a decision on damages, the taxpayer and
the defendant settled.
In the subsequent tax dispute, the Tax Court determined that claims for constitutional rights violations
under section 1983 are tort-type claims. Accordingly, the
Tax Court held the recovery to be excludable because the
free speech violation was the only claim on which the
school board was liable. The IRS appealed to the Third
Circuit Court of Appeals, but the appellate court affirmed.
Bent stands for the view that personal injuries include
mental pain and suffering, and not simply physical
trauma. Of course, this view was disapproved by statute
for recoveries after August 20, 1996, which may make
Bent and other constitutional violation cases irrelevant
after 1996. At the very least, they must be read with the
current gloss of required physical (sickness or injury)
However, there is an interesting point regarding the
calculation of damages in Bent. Although the settlement
amount in Bent was calculated by reference to the plaintiff’s wages, the court did not treat this fact as significant.
The reference to wages did not make this settlement
wages. Wages were a measuring device for determining
the tort damages.
4. Sex Abuse Ruling. Up until now, arguably the most
important IRS statement on how the IRS views section
104 came in LTR 200041022, which is now often simply
dubbed ‘‘the bruise ruling,’’ among tax aficionados.69
Broadly stated, this letter ruling indicates that for an
exclusion to be available under section 104, one must
show evidence of physical injuries we can see. Bruises or
broken bones would certainly qualify, but how much less
would qualify is unclear. This ruling also makes crystal

87 T.C. 236 (1986), aff’d, 835 F.2d 67, 88-1 U.S. Tax Cas.
(CCH) para. 9101, 61 AFTR2d (P-H) para. 88-301 (3d Cir. 1987).
See discussion accompanying notes 60-62 above.

TAX NOTES, April 21, 2008

clear the watershed nature of those physical manifestations. Once one crosses the threshold of physicality, all
damages flowing from the physical event, including
emotional distress damages, also become excludable.
Recently, there are signs the IRS is ameliorating its
rigid need to see demonstrable physical harm to recognize exclusions under section 104. In ILM 200809001,70
the IRS determined that a settlement with an institution
for sex abuse that occurred many years previously was
fully excludable under section 104. The IRS reached this
conclusion despite the taxpayer’s failure to be able to
demonstrate any signs of physical injury. While any other
tax result on such a recovery would be indefensible, this
is nevertheless an important stride in section 104 interpretation that should not go unnoticed.71
The IRS does not do away with its demonstrable
physical injury talisman. Instead, the IRS says that in this
case, given what occurred, it is reasonable to presume that
the injuries were physical in nature. That is a momentous
step in the right direction. The IRS does not say that one
is not required to have observable bodily harm in some
situations, but rather that one need not demonstrate it. To
me, the reasoning goes something like this: Some things
are inherently and incontrovertibly physical, whether or
not they leave lasting outward scars. Sex abuse surely fits
this category, as does rape or other sexual assault. I think
wrongful imprisonment does too.
If one can criticize the recent ILM (which I’m certainly
not doing, since I think it is a hugely important ruling) it
would be only in potentially creating ambiguity about
the importance of the plaintiff being a minor at the time
of the abuse, and an adult when the case settled. The
ruling does not emphasize this, and surely the rationale
for not needing to prove observable bodily harm in some
cases does not rest on the minority of the plaintiff.
Nevertheless, one cannot help but wonder whether the
IRS is implicitly restricting its view to such circumstances, or perhaps to more general circumstances in
which the failure to be able to show observable bodily
harm is somehow especially excusable.72 Regardless, ILM
200809001 shows that in at least some cases, proof of
physical harm is not required.

B. Evaluating False Imprisonment
In an archetypal false imprisonment case, how do the
tax authorities suggest that a recovery should be taxed? If
one is deprived of one’s personal liberty, if one is
confined unlawfully behind bars, is that not by its very
nature physical? The answer must surely be yes. It is
difficult to see how it could be otherwise. Perhaps one
might review civil rights law and find cases in which
bona fide deprivations of civil rights might not in all
senses be physical. However, wouldn’t being confined in
a jail cell (unlawfully) always be physical?

Doc 2008-4372, 2008 TNT 42-21. Interestingly, this legal
memorandum was written by the IRS’s Michael Montemurro,
who also authored the bruise ruling.
See Wood, ‘‘IRS Allows Damages Exclusion Without Proof
of Physical Harm,’’ Tax Notes, Mar. 31, 2008, p. 1388, Doc
2008-5734, 2008 TNT 13-31.


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it had clearly been intended by the employer. Those
cases, however understandable they are, arguably trivialize the section 104 exclusion.



See New York State Court of Claims Act, section 8-B.
See Cal. Penal Code section 4900-4906; Iowa Code Ann.
section 663A.1 (West 1998); Wis. Stat. section 775.05 (2006).
See IRS Publication 525, Taxable and Nontaxable Income.
O’Gilvie v. United States, 519 U.S. 79, Doc 96-31894, 96 TNT
240-1 (1996); Francisco v. Commissioner, 267 F. 3d 393, 315, Doc
2001-27013, 2001 TNT 208-8 (3d Cir. 2001); Commissioner v.
Schleier, 515 U.S. 323, 329 (1995); Ervin v. Commissioner, T.C.
Memo. 2002-134, Doc 2002-13101, 2002 TNT 105-5; Rev. Rul.
85-97, 1985-2 C.B. 50; Rev. Rul. 61-1, 1961-1 C.B. 14.
See Wood, ‘‘New Law Radically Changes Tax Rules in
Employment Litigation,’’ Tax Notes, Aug. 19, 1996, p. 1045, Doc
96-23171, 96 TNT 176-75.


between wages, on one hand, and nonwage damages, on
the other. For that reason, perhaps it was inevitable that
the IRS and Congress would eventually act to narrow the
section 104 exclusion. In the false imprisonment context,
there is (quite obviously) no dichotomy between payments for loss of liberty and payments of wages.
Plainly, there is no employment relationship between
the prisoner and the state.78 It is also odd to think of
emotional distress damages here. The IRS could perhaps
argue that a recovery for false imprisonment represents a
payment for emotional distress, and as such, is taxable.
To do so, however, it would seem that the IRS would
have to contend that the emotional distress was not
caused by the physical confinement. This seems counterintuitive, if not downright impossible.
In any event, recall that the legislative history to the
1996 amendment to section 104 makes eminently clear
that the section 104 exclusion applies to damages for
emotional distress triggered by (or emanating from)
physical injuries or physical sickness.79 It is hard to
imagine that a false imprisonment plaintiff would not
have emotional distress. It is equally hard to imagine that
the emotional distress will not be unequivocally caused
by his confinement.

C. False Imprisonment Authorities
Despite the lack of authorities on the tax treatment of
false imprisonment recoveries, there is some history on
unlawful imprisonment recoveries and the tax issues
they raise. Helpful analogies can be found in the tax
treatment of payments made to: survivors of Nazi persecution; U.S. prisoners of war during World War II and the
Korean War; and Japanese-Americans placed in internment camps. In the case of interned Japanese-Americans,
Congress enacted legislation to clarify the tax treatment
of those payments. In the other cases, the IRS issued
revenue rulings providing exclusions from income tax for
the payments.
The Civil Liberties Act of 1988 provided compensation
for Japanese-Americans who were relocated and placed
in internment camps, as well as those wrongfully convicted under Executive Order Number 9066 (the order
providing for their relocation and internment).80 This law
established a fund for compensating those individuals.
For tax purposes, those amounts were considered damages for ‘‘human suffering’’ and were expressly excluded

I ignore here the possibility that the prisoner may perform
menial tasks for menial pay, such as Michael Vick’s reported 12
cents per hour kitchen job. See Holtzclaw, ‘‘Michael Vick’s New
Salary: 12 cents an Hour,’’ New York Daily News, April 7, 2008; see
.story. Any such ‘‘employment’’ should not invoke the dichotomy between wages and tort payments. Plus, if a prisoner’s
recovery were taxable, it would presumably not mean his
attorney fees would be deductible under the above-the-line
deduction for legal fees in employment cases now provided by
section 62.
See Small Business Job Protection Act of 1996, P.L. 104-188,
section 1605, 110 Stat. 1755, 1838 (1996); H.R. Conf. Rep. No.
104-737, 104th Cong., 2d Sess., 301 (1996).
Civil Liberties Act of 1988, P.L. 100-383, section 101-109, 102
Stat. 903, 903-911 (1988).

TAX NOTES, April 21, 2008

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In determining whether damages or settlement payments paid on account of wrongful conviction should
qualify under section 104 (as paid on account of personal
physical injuries or personal physical sickness), the statutory scheme under which the exonerated person recovers
is clearly relevant. Some state statutes limit recoveries to
circumstances in which there has been an actual imprisonment (as opposed to merely a wrongful conviction in
which the person remains free on bail or is otherwise not
If one accepts the notion that incarceration is itself
physical, such restrictions in the underlying statute
would seem to help rather than hurt the case for excludability under section 104. Moreover, if one accepts the
notion that the wrongful incarceration is itself physical, it
should not matter whether the state statutory scheme (or
any other basis of recovery) includes damages for loss of
income, emotional distress, and so on.
Consider an automobile accident case in which there is
physical injury. Plainly, the tools that may be used to help
measure damages (loss of income, pain and suffering,
and so on) do not make the recovery for injuries in the
accident taxable. In other words, despite the origin of the
claim test that governs the tax treatment of litigation
recoveries, wage loss is not income if it is awarded
because of physical injuries or physical sickness.
There are suggestions that in calculating the damages
to which a plaintiff in a false imprisonment case should
be entitled, the number of days, months, or years in
confinement serve as a kind of litmus test for the amount
of appropriate damages.74 This does not make the payment wages. Wage loss is often used as a measure of
damages in auto accident (and other tort) cases, but this
does not make the damage payments taxable.75 If the
amounts paid to compensate the individual are tax free
under section 104(a)(2), the amounts paid for wages lost
as a result of the injury are tax free as well.76
There is another way in which unlawful imprisonment should be evaluated in the context of existing
section 104 authority. Before the 1996 statutory change to
section 104, it became common practice in resolving
employment cases to denominate some portion of the
damages as ‘‘emotional distress damages.’’ The goal, of
course, was to achieve tax-free treatment for those damages.77
In almost every employment case (whether employment discrimination, sexual harassment, wrongful termination, and so on), there was a natural dichotomy



Rev. Rul. 56-462, 1956-2 C.B. 20.
Rev. Rul. 55-132, 1955-1 C.B. 213.
Rev. Rul. 58-370, 1958-2 C.B. 14.
Rev. Rul. 56-518, 1956-2 C.B. 25.
See Rev. Rul. 2007-14, 2007-12 IRB 747, Doc 2007-4230, 2007
TNT 34-15, obsoleting these and other revenue rulings. Although the IRS does not publish reasons for an obsolescence, I
understand from IRS personnel who were involved in this
obsolescence that the IRS considered the rulings no longer valid
in light of the 1996 changes to section 104.

TAX NOTES, April 21, 2008

imprisonment is by its very nature physical, the fact that
these are pre-1996 revenue rulings does not matter.

D. The General Welfare Exception
Exclusions from income are narrowly construed and
generally have been limited to those specified in the
code.87 There is, however, a little-known administrative
exception to gross income that could conceivably apply
to false imprisonment recoveries.88 To be clear, this is
entirely independent from the section 104 exclusion, and
one might argue them in the alternative.
Under the general welfare exception (GWE), some
government payments do not constitute gross income to
the recipients. Under the GWE, the IRS has ruled that
payments made under legislatively provided social benefit programs for promotion of the general welfare are
excludable from gross income.89 In determining whether
the GWE applies to payments, the IRS requires the
payments to be:
• made from a governmental general welfare fund;
• for the promotion of the general welfare (that is, on
the basis of need rather than to all residents); and
• not made as payment for services.90
The IRS has applied the GWE to a handful of disparate
government payments. Perhaps the most classic example
of the GWE’s application is a government payment to
victims of a natural disaster.91 The IRS has applied the
GWE doctrine to government payments ranging from
housing to education to adoption, and even crime victim
restitution.92 Thus, it is not farfetched to suggest that the
GWE could apply to government payments for wrongful
imprisonment. Many such payments could arguably
satisfy the GWE requirements.
This may particularly be the case when the payment is
made under a state or federal compensation statute.
However, any payment from the government in this
context, even one prompted by a lawsuit for false imprisonment, could arguably qualify. After all, the GWE is
intended to exempt from taxation amounts the government pays for the general welfare. Plainly, that is what
payments to victims of false imprisonment do.
IV. Conclusion
Perhaps victims of false imprisonment may be no
more numerous today than they were 100 years ago. Yet

O’Gilvie v. United States, 519 U.S. 79 (1996); Commissioner v.
Schleier, 515 U.S. 323 (1995).
See Wood and Richard C. Morris, ‘‘The General Welfare
Exception to Gross Income,’’ Tax Notes, Oct. 10, 2005, p. 203, Doc
2005-20172, 2005 TNT 191-34.
See ITA 200021036, Doc 2000-14946, 2000 TNT 104-74; LTR
200451022, Doc 2004-23902, 2004 TNT 244-53 (Dec. 17, 2004).
See ITA 200021036.
Many disaster payments have now also been statutorily
exempted from income under recently enacted section 139. Rev.
Rul. 2003-12, 2003-3 IRB 283, Doc 2002-27748, 2002 TNT 245-6,
acknowledges that the GWE doctrine overlaps the application
of section 139, so both can apply.
See Rev. Rul. 76-373, 1976-2 C.B. 16; Rev. Rul. 74-205, 1974-1
C.B. 20; Rev. Rul. 76-395, 1976-2 C.B. 16; Rev. Rul. 75-271, 1975-2
C.B. 23; LTR 200409033, Doc 2004-3963, 2004 TNT 40-26; Rev.
Rul. 74-153, 1974-1 C.B. 20; Rev. Rul. 74-74, 1974-1 C.B. 18.


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from income.81 Moreover, the payments were also not
considered resources for purposes of determining Social
Security eligibility.
Similarly, Rev. Rul. 56-46282 dealt with payments by
the U.S. government to U.S. citizens who were captured
and held by the enemy during the Korean War. This
ruling cited Rev. Rul. 55-132,83 which provided a tax
exemption for payments made to U.S. citizens who were
prisoners of war during World War II. In both rulings,
these payments were treated as compensation for the loss
of personal rights during imprisonment and were excluded from income for federal income tax purposes.
Rev. Rul. 58-37084 and Rev. Rul. 56-51885 provided
tax-free treatment for payments by Germany or Austria
for persecution by the Nazis. Rev. Rul. 58-370 states that
the payments represent reimbursement for the deprivation of civil or personal rights, and as such, are not
includable in income. Similarly, Rev. Rul. 56-518 states
that the payments were made on account of persecution,
resulting in damage to life, body, health, liberty, or to
professional or economic advancement. Thus, they were
excluded from income for tax purposes.
Being incarcerated has dramatic effects on one’s ability
to work and earn a living. Yet, plainly, the consequences
of incarceration are more of a measuring tool, much the
way wage loss is used as a measuring tool for damages in
auto accidents and other more traditional personal physical injury cases. That a wrongfully incarcerated person
experiences wage loss does not ascribe the character of
wages to a payment for unlawful incarceration.
Indeed, in all of those historic cases, the individual
was not being compensated for a loss of wages or some
other economic claim. Instead, like wrongfully convicted
individuals, the IRS recognized that those persons were
being compensated for the loss of the simple pleasures of
life we may take for granted. These revenue rulings
reflect the prevailing view that the ability to take a breath
of fresh air, to sleep in one’s own bed, to attend a family
gathering, is not taxable.
Unfortunately, of course, those authorities predate the
1996 changes to section 104, imposing the ‘‘physical’’
requirement. How big an impact that timing should have
is not clear. Yet all of the aforementioned revenue rulings
were ‘‘obsoleted’’ by Rev. Rul. 2007-14, issued on March
19, 2007.86 That is disturbing.
After all, despite the lack of IRS guidance since 1996,
the legislative history to the 1996 act makes clear that all
emotional distress damages that flow from physical
injuries or physical sickness are still excludable from
income. Thus, if one believes, as I do, that wrongful


Whatever triggers the payment, it is appropriate to ask
what federal income tax consequences face the victim.
Like the tax treatment of victims of clergy sex abuse, this
may be the type of tax question we’re afraid to ask. Not
only should this be a tax question we want to ask, but it
should be one we embrace with open arms, seeking tax
certainty that helps to bring finality to a painful incident
for all parties. Unfortunately, we do not yet have crystal
clear answers to this tax conundrum.
Yet I believe there is no question that these recoveries
should be tax free, either under section 104 or under the
GWE. It should not take congressional action to do it,
although clarifying legislation would be appropriate. I

believe being wrongfully incarcerated is manifestly
physical, and that a payment for same must therefore be
excludable from income.
It is especially easy to reach this conclusion when the
victim has ancillary claims, such as medical malpractice,
battery, and so on. At least with such ancillary claims,
there is existing federal income tax authority speaking
more clearly to the excludability of the recoveries from
income. Moreover, in the vast majority of cases, there will
be ancillary claims. They may vary in type and severity,
but they inevitably add to the physicality of it all, as if
being locked up by itself was not palpably physical
But to return to my initial assumption, even taking the
somewhat unrealistic fact pattern in which there are no
ancillary claims — that is, even when there are no such
separate tort causes of action — the point seems clear. It
is difficult to think of a decent argument based on the
existing tax authorities, or for that matter, based on social
or tax policy, for taxing these recoveries.

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they are certainly more easily identified today. Not only
that, but society has clearly recognized that they deserve
compensation. The compensation may come via a state or
federal statute, legislative edict, or an old-fashioned