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The answer to this question is - Yes - and it has been that way for some time.
In 1996, Congress reversed nearly seventy-five years of settled law by amending § 104(a)(2) of the Code, making damages recovered for personal non-physical harms (e.g., emotional distress) taxable.
This law is known as the Small Business Job Protection Act of 1996, Pub. L. No. 104-188, § 1605, 110 Stat. 1755, 1838 (codified at I.R.C. § 104).
The SMJPA makes it clear that taxes must be paid on all recoveries made in a discrimination case, even if some of the settlement is payment for emotional distress.
WE HANDLE DISCRIMINATION CASES EVERY DAY
ON A CONTINGENT FEE BASIS
Employment Discrimination Settlements Are Taxable
In a discrimination lawsuit, the relief that is granted is what is known as a "make whole remedy," i.e. a payment of money that puts the plaintiff in the same position that he/she would have been absent the discrimination. For plaintiffs that have lost income as a result of illegal discrimination due to failure to receive a promotion, demotion, constructive discharge or termination, this means a payment of lost wages and benefits subject to taxation just as if the plaintiff had not been fired, etc.
Settlements in Discrimination Cases are Treated as W2 Income
Do I Have to Pay Taxes on an Employment Discrimination Settlement?
Think of it this way.
Jane Doe was employed by Company and paid a salary of $50,000 in 2018. Her take home pay after taxes and withholdings was $35,000. On January 1, 2019, she was fired. She does not find a job until the December 2019. She sues and agrees to settle for $51,0000, which the parties agree is allocated 11 months of lost pay, i.e. $46,0000, plus $4,000 for emotional distress. Pursuant to the SMJPA, all of her recovery is subjected to taxation, i.e. she will ultimately receive the same net of $35,000 just as if she had worked all of 2019 for Company.
Think of it this way.
Jane Doe was employed by Company and paid a salary of $50,000 in 2018. Her take home pay after taxes and withholdings was $35,000. On January 1, 2019, she was fired. She does not find a job until the December 2019. She sues and agrees to settle for $51,0000, which the parties agree is allocated 11 months of lost pay, i.e. $46,0000, plus $4,000 for emotional distress. Pursuant to the SMJPA, all of her recovery is subjected to taxation, i.e. she will ultimately receive the same net of $35,000 just as if she had worked all of 2019 for Company.
Treated Differently Than Discrimination Cases
Settlements of Family and Medical Leave Act ("FMLA") Cases Are NOT 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.
THIS IS NOT TAX ADVICE. WE ARE NOT A CERTIFIED TAX ATTORNEYS. CONSULT A LICENSED PROFESSIONAL TAX ADVISOR FOR ADDITIONAL INFORMATION.
THIS IS NOT TAX ADVICE. WE ARE NOT A CERTIFIED TAX ATTORNEYS. CONSULT A LICENSED PROFESSIONAL TAX ADVISOR FOR ADDITIONAL INFORMATION.
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