Taxes on Settlement of Employment Discrimination Lawsuit?!

[JAP1958]

Pennsylvania

My husband is likely to receive a sizable settlement from his employer for age discrimination, which will include punitive damages, lost back pay, future pay, lost benefits, emotional distress and the requirement for the employer to pay his attorney fees.

What portion of the settlement is taxable to him - or is all of it subject to Federal and State Tax? Does he have to pay taxes on the amount of his attorney's fees that the employer pays directly to the attorney (I read that somewhere!)??

ANY information will be appreciated!

 

[Zigner]

Did you try typing "What are the taxes on a settlement of an employment discrimination lawsuit?" in to your favorite web search engine?

Any information you get is necessarily general in nature. He would be wise to consult with a local tax professional.

ETA: You may wish to review the following page from the IRS: https://www.irs.gov/pub/irs-pdf/p4345.pdf

 

[JAP1958]

I did try that and got a LOT of conflicting information. Our financial adviser told us that none of the settlement is taxable - which I find hard to believe!

 

[Zigner]

The IRS would disagree.

 

[JAP1958]

Can you point me to the IRS document/webpage that covers this?

 

[Zigner]

Can you point me to the IRS document/webpage that covers this?

I edited it in to my post above - here it is again: https://www.irs.gov/pub/irs-pdf/p4345.pdf

 

[Taxing Matters]

Pennsylvania

My husband is likely to receive a sizable settlement from his employer for age discrimination, which will include punitive damages, lost back pay, future pay, lost benefits, emotional distress and the requirement for the employer to pay his attorney fees.

What portion of the settlement is taxable to him - or is all of it subject to Federal and State Tax? Does he have to pay taxes on the amount of his attorney's fees that the employer pays directly to the attorney (I read that somewhere!)??

ANY information will be appreciated!

Your financial advisor might know how to advise you on investments but it is clear he or she is not a tax expert. All of it would be included in income for federal income tax purposes. The rule for federal income tax is that all income is subject to tax unless the Code provides some express exclusion for it. An age discrimination case is a tort type claim. Internal Revenue Code (IRC) section 104 is the provision that provides for the exclusions for certain tort claim awards, the most significant being § 104(a)(2), which provides that amounts attributable to physical injuries are excluded from income. Thus, if you get injured in a car accident, for example, the award you get from that is not included in gross income for federal income tax. But suits for age discrimination under the Age Discrimination in Employment Act (ADEA) are not claims of physical injury and thus are not excluded from income. There is no doubt on this since the U.S. Supreme Court itself addressed that specific issue, and it held that:

In contrast, no part of respondent's ADEA settlement is excludable under the plain language of § 104(a)(2). Respondent's recovery of back wages, though at first glance comparable to our hypothetical accident victim's recovery of lost wages, does not fall within § 104(a)(2)'s exclusion because it does not satisfy the critical requirement of being “on account of personal injury or sickness.” Whether one treats respondent's attaining the age of 60 or his being laid off on account of his age as the proximate cause of respondent's loss of income, neither the birthday nor the discharge can fairly be described as a “personal injury” or “sickness.”​

Commissioner v. Schleier, 515 U.S. 323, 330, 115 S. Ct. 2159, 2164, 132 L. Ed. 2d 294 (1995). You will note that the Court stated that “no part” of the settlement was exludable.

Bottom line: ALL of it is included in your husband’s taxable income for federal income tax.

 

[Zigner]

JAP1958 - Taxing Matters is a practicing tax attorney - just so you know.

 

[JAP1958]

Thank you both SOOOOO much!

 

[LdiJ]

Pennsylvania

My husband is likely to receive a sizable settlement from his employer for age discrimination, which will include punitive damages, lost back pay, future pay, lost benefits, emotional distress and the requirement for the employer to pay his attorney fees.

What portion of the settlement is taxable to him - or is all of it subject to Federal and State Tax? Does he have to pay taxes on the amount of his attorney's fees that the employer pays directly to the attorney (I read that somewhere!)??

ANY information will be appreciated!

My opinion is that all of it is going to be taxable. Anything that can be classified as pay (back, lost, future etc) would automatically be taxable and punitive damages are normally taxable as well. The attorney fees would have been included in AGI but deductible on Schedule A but Trump's tax reform eliminated all miscellaneous itemized deductions so unless something gets changed there they are probably no longer deductible.

I think that you should prepare for it all to be taxable, and use a tax professional to do your tax return for the year that he receives the settlement, if you do not do so already. Make sure that you use someone who has some experience in dealing with settlements.

 

[Taxing Matters]

Anything that can be classified as pay (back, lost, future etc) would automatically be taxable and punitive damages are normally taxable as well.

If it had been an award for a physical injury portion of the award for lost wages that are attributable to that physical injury would not be included in income because of the exclusion under IRC § 104(a)(2), but the punitive damages would of course still be included in income. But, as I pointed out earlier, since an age discrimination lawsuit does not involve a personal injury, all of the award the OP's husband gets ends up as included income. Any doubt on that was resolved by the Supreme Court in the case I cited. So you are correct that it is all taxable in this instance, but it is not the case that awards for pay are always (“automatically”) included in income.

 

[LdiJ]

If it had been an award for a physical injury portion of the award for lost wages that are attributable to that physical injury would not be included in income because of the exclusion under IRC § 104(a)(2), but the punitive damages would of course still be included in income. But, as I pointed out earlier, since an age discrimination lawsuit does not involve a personal injury, all of the award the OP's husband gets ends up as included income. Any doubt on that was resolved by the Supreme Court in the case I cited. So you are correct that it is all taxable in this instance, but it is not the case that awards for pay are always (“automatically”) included in income.

I said that all of the wage portions would be taxable specifically because no physical injury was involved. I did not see your reply before I replied myself, and you were obviously more detailed than I was.