The Unfortunate Reality
Should the Settlement Paid on My Discrimination Claim be Subjected to Withholding and Taxes?
DISCLAIMER: We are NOT licensed tax attorneys; we have never received any formal training relating to the Internal Revenue Code or any topic raised herein. This Post is based solely upon an interpretation of the cases and statutes discussed herein. You should NOT rely upon this Blog Post in any way, and should instead retain a licensed tax professional if you require guidance as to any issue discussed below.
 |
| Settlements Paying Lost Wages to Discrimination Victims Taxable |
But, how about
any portion of such a settlement that is intended to compensate the plaintiff
for his/her emotional distress?
Unfortunately, it appears that such compensation is also to be treated
as ordinary W-2 income.
NOTE: Settlements or judgments paid to a plaintiff who has brought a claim under the Family and Medical Leave Act of 1993 may NOT be subject to taxation.
NOTE: Settlements or judgments paid to a plaintiff who has brought a claim under the Family and Medical Leave Act of 1993 may NOT be subject to taxation.
FMLA Claims Subject to Different,
Perhaps More Favorable Tax Treatment
Settlements
Paid Out on Claims for Lost Wages and Compensation Made Under
Anti-Discrimination Laws Such as Title VII Are Treated as Ordinary Income and
Subject to Withholding and Taxes and are Paid as W-2 Income Just Like a Regular
Employee Paycheck
Any portion of a settlement or judgment paid to compensate a
plaintiff for lost wages on a claim made pursuant to anti-discrimination laws
such as Title VII, the Americans With Disabilities Act and the Age
Discrimination in Employment Act is to be treated as “ordinary income.”
Hence,
any such recovery is paid out like a regular paycheck, i.e. reduced by FICA, state
and local tax obligations, as well as required contributions to Social Security
and Medicare. As per Publication 4345 (Rev.
4-2015)
 |
| Settlement Check Looks Just Like Regular Paycheck - Although Hopefully LOT Bigger! |
Lost wages or lost profits
• If you receive a settlement
in an employment-related lawsuit; for example, for unlawful discrimination or
involuntary termination, the portion of the proceeds that is for lost wages
(i.e., severance pay, back pay, front pay) is taxable wages and subject to the
social security wage base and social security and Medicare tax rates in effect
in the year paid. These proceeds are subject to employment tax withholding by
the payor and should be reported by you as ‘Wages, salaries, tips, etc.” on
line 7 of Form 1040.
This
comes to a surprise to many people, and perhaps understandably so. That is due to the widespread understanding
that recoveries made on personal injury claims are by and large tax free. As
per the same Publication 4345:
Personal physical injuries
or physical sickness
• If you receive a settlement
for personal physical injuries or physical sickness and did not take an
itemized deduction for medical expenses related to the injury or sickness in
prior years, the full amount is non-taxable. Do not include the settlement
proceeds in your income. BUT [portion discussing medical expenses omitted]…
. . .
Emotional distress or mental anguish
• The proceeds you receive for
emotional distress or mental anguish originating from a personal physical
injury or physical sickness are treated the same as proceeds received for
Personal physical injuries or physical sickness above.
If
I Sue for Discrimination and Some of the Settlement or Judgment is Intended to
Compensate me for Emotional Distress, is That Part of my Recovery Taxable Like Ordinary Income?
Any
employment-related claim will virtually always include a claim for emotional
distress. That is so because a loss of employment resulting from illegal
employment practices is not only damaging to an individual’s feelings of self-worth,
but also to one’s financial stability.
It
is axiomatic that when conscientious human beings with ordinary obligations are separated from employment through no fault of their own, great psychological pain
almost always surfaces, and endures. When the root cause of the separation was
an immutable human characteristic such as an individual’s sex, color, national
origin, age, disability or religious beliefs, it stands to reason that the pain
is exponentially greater.
 |
| Victims of Discriminatory Termination Often Suffer Great Emotional Distress |
The
pain caused by such insults to one’s self-esteem, reputation and social
standing are in all such cases exacerbated further by the anguish that inevitably
results when one no longer has sufficient financial means to meet his/her
living expenses.
Hence,
whenever there is a settlement negotiation on a claim for loss of employment resulting from unlawful
employment practices, plaintiff's lawyers always seek and recover some compensation for their client’s
emotional harm. Indeed, in some cases, a
substantial portion of the settlement paid on a discrimination claim is
intended to compensate the plaintiff for such emotional distress.
Logic
dictates that damages in the form of mental/psychological
pain are in essence personal injuries and, if a personal injury plaintiff’s
recovery for such damages is not taxable, the very same should be true for
victims of unlawful employment practices. Regrettably, that does not appear to be the case.
HERE ARE SOME OTHER ARTICLES YOU MAY FIND WORTHWHILE:
What
is an ILLEGAL Hostile Work Environment? Workplace Bullying Alone is Not Illegal
in Pennsylvania
What
is an ILLEGAL Hostile Work Environment? Workplace Bullying Alone is Not Illegal
in Pennsylvania
Employee Complaints and
Retaliation - What is Legal and What is Illegal
FILING A CHARGE OF
DISCRIMINATION IN PENNSYLVANIA - A FEW TIPS FROM CONTINGENT FEE LAWYERS
United States Employment and Discrimination Laws - An
Overview by Pennsylvania Employment Lawyer
The
Majority View is That All Portions of a Settlement Paid on Employment-Related
Claims Such as Race, Sex, Age or Disability Discrimination, are Subject to
Ordinary Withholding and Taxation and Should be Paid Out as W-2 Income
One reading of Publication 4345 could be that the only part of a settlement received in an
employment-related claim that is subject to withholding and taxes is “the portion
of the proceeds that is for lost wages (i.e., severance pay, back pay, front
pay).”
 |
| The Final Word: All Settlement Proceeds on Employment-Related Claims May be Taxable as Ordinary Income |
Alas,
the IRS may see things differently.
IRC §104(a)(2), (entitled “Compensation for injuries or sickness”), provides that only proceeds paid to a litigant “on account of personal physical injuries or physical sickness” are entitled to tax free recovery.
The Code of Federal Regulations, which are administrative regulations published by the executive departments and agencies of the federal government in order to explain federal statutes, specifies that “[e]motional distress is not considered a physical injury or physical sickness [unless such distress is] attributable to a physical injury or physical sickness.”
Based
upon these provisions, numerous commentators, including the
American Bar Association, have concluded that all
portions of a settlement or judgment paid out to a plaintiff making an
employment-related claim are subject to ordinary withholding and taxes.
Based on the foregoing, it appears that the most prudent course
is likely to treat all portions of a settlement or judgment received by a plaintiff
making an employment-related claim exactly the same as the paycheck said
plaintiff once earned while employed by the former employer he/she has
sued. That is virtually what the employer that has been sued will insist on.
Are My Attorneys Fees in a Discrimination Lawsuit Settlement Taxable to Me? Do I Have to Pay Taxes on My Legal Fees?
It appears not.
NOTE: A Tax Court has held that any portion of a settlement or judgment that is payable to the plaintiff’s attorney is not taxable to the plaintiff. It is as far as we understand to be treated as an "above the line" deduction.
 |
| At Least... Attorneys Fees Not Taxable to Plaintiff |
NOTE: A Tax Court has held that any portion of a settlement or judgment that is payable to the plaintiff’s attorney is not taxable to the plaintiff. It is as far as we understand to be treated as an "above the line" deduction.
Philadelphia, Pennsylvania Employment Lawyers Representing
Individuals With Claims for Discrimination, Retaliation, Wrongful Discharge and
Unemployment
We are employment attorneys who
represent workers in the Philadelphia Area of Southeastern Pennsylvania.
We typically represent employees who need an
employment lawyer in the Delaware Valley, including those employed in Philadelphia
County, Delaware County, Montgomery County, Bucks County, Chester County, Berks
County and Lancaster County.
THERE IS NOT CHARGE FOR AN INITIAL TELEPHONE CONSULTATION
610-647-5027
If you believe you require guidance concerning any
aspect of your employment, and you live or work near Philadelphia, feel free to send us an e-mail via our Contact Form or give us a call at 610-647-5027. We are always glad to spend some time with
people via a free telephone consultation.
Need an Experienced Attorney to Help You With a
Severance Agreement?
Thanks for checking in with us.