Wednesday, September 6, 2017

IS A RECOVERY IN AN FMLA CASE SUBJECT TO WITHHOLDING TAXES OR IS IT 1099 INCOME?

DISCLAIMER:  I am NOT a licensed tax attorney; I have never received any formal training relating to the Internal Revenue Code or any topic raised herein.  This Post is based solely upon my 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.


Consult a Knowledgeable Tax Advisor
WHAT ARE THE TAX CONSEQUENCES ASSOCIATED WITH A SETTLEMENT OF OR A JUDGMENT IN A FAMILY AND MEDICAL LEAVE ACT ("FMLA") CASE?

In the ordinary course, an employee suing his/her former employer relating to the end of employment due to discrimination, retaliation, wrongful discharge, etc. is suing primarily for loss of earnings and benefits. Consequently, any recovery made by way of settlement or judgment in such cases is subject to normal withholding and taxes (i.e. is w-2 income). This is in contrast to, say, personal injury cases, where the recovery is often primarily for pain and suffering and is exempt from taxation (i.e. 1099 income).


The Code Has Spoken
NOTE:  In some employment-claim settlement situations, the employee will be paid some or all of the proceeds via a 1099, but remains responsible for paying taxes on the same the following tax year. 


In contrast to other employment-related claims, recoveries made on claims relating to violations of the Family and Medical Leave Act (“FMLA”) may not be taxable income, at least in cases decided in the Federal District Court sitting in the Eastern District of Pennsylvania.

PENNSYLVANIA FEDERAL DISTRICT COURT SITTING IN PENNSYLVANIA DETERMINES THAT FMLA RECOVERIES ARE NOT TAXABLE AS W-2 INCOME 

Click Here to read how FMLA Leave and short-term disability benefits fit together.

In a July 2016 decision issued by a judge sitting in United States District Court for the Eastern District of Pennsylvania, Gunter v. Cambridge-Lee Industries, LLC, there was a settlement and the plaintiff maintained that the settlement proceeds were not wages and therefore should not be subject to withholding or reported as w-2 income, but rather, should be reported to IRS as 1099 income not subject to withholding. The defendant maintained that the settlement proceeds were tantamount to w-2 income.


Treated Differently Than Other Employment-Related Statutes
The district court observed that the Third Circuit, the patron court of the district courts located in Pennsylvania, New Jersey, Delaware and the Virgin Islands, and yet to rule on the issue. The court then engaged in a thorough analysis of prior decisions in the Eastern District of Pennsylvania and elsewhere, as well as to certain IRS Revenue Rulings. After an exhaustive analysis, the court determined that the language found within the FMLA was unique to all other discussed employment – related statutes, and therefore held that there were no that no withholding was required for the proceeds of the settlement.

Although the decision by the court in Gunter is not binding upon the IRS, nor is it controlling precedent in the Third Circuit, it is highly persuasive.

From what I have been able to determine, the Third Circuit has yet to return to decide the issues the issue in question since Gunter was published, nor has any court that I was able to find come to a different decision. Of course, you should not rely upon this post, but rather to conduct all of your own research.

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