August 13, 2010 (Press-News.org) Every April, our collective stress level rises as we scramble to meet our tax deadlines. Particularly tricky federal tax issues come up when an employee either receives money from a lawsuit settlement with his or her employer, or severance pay upon leaving a job. In most situations both are taxable as income, but subtleties in the law create some exceptions.
Taxation of Settlements Generally
A settlement is an agreement reached between parties to a lawsuit. Usually the plaintiff receives money damages to compensate for his or her injury, and in exchange agrees to dismiss the legal claims against the defendant.
Very broadly, most settlements are taxable under federal law, which takes a very inclusive approach to what constitutes taxable income. Except for a few exceptions, "gross income means all income from whatever source derived." So the basic rule is that if you earn money, you must pay taxes on it. Courts have looked at whether the receiver of money has more wealth that they control.
Federal law specifically excludes from taxable income damage awards and settlements for "personal physical injuries or physical sickness" -- except for punitive damages, which are taxable. Punitive damages are more in the nature of fines and are meant to punish wrongdoers for particularly reprehensible behavior, above and beyond money to compensate for the cost of the losses themselves.
The relationship between employee and employer is often significant both personally and economically, leaving the door wide open to the possibility of major conflict. Employers by definition yield more power and control in the employment relationship, and accidental or deliberate harm to employees can occur in the workplace.
Lawsuits filed by employees against employers for a variety of reasons are common:
- For unlawful discrimination such as in promotion, firing and pay on the basis of attributes like race, national origin, gender, age, disability, religion, veteran status and others
- For breaches of employment contracts, including over benefits
- For wrongful termination
- For retaliation
- For sexual harassment
- For torts like defamation, fraud, invasion of privacy, intentional infliction of emotional distress, concealment of or failure to warn of hazards, negligence and more
Usually recovery of damages for physical (and sometimes mental, depending upon the state) injuries in the workplace is exclusively governed by workers' compensation, and workers' compensation awards are generally not taxable. The exclusive nature of workers' compensation means that usually it is the only legal remedy available to an injured worker against his or her employer.
In many states, however, lawsuits are allowed directly against employers outside of the workers' compensation scheme for egregious conduct like intentional or malicious harm.
Taxation of Employment Suits
Application of the rule that damages for physical harm are not taxable, along with interpretation by the Internal Revenue Service (IRS) and the courts, have had the following consequences for amounts received in settlement of most employment claims:
- Nontaxable: damages for physical injury or sickness; damages to compensate for pain, suffering and emotional distress only if caused by physical injury; medical expenses (even for mental treatment); most attorneys fees (deduction allowed); interest, even on money otherwise taxable in the award
- Taxable: lost wages; back pay; front pay (finite amount of future lost wages); damages for pain, suffering and emotional distressnot from physical injury (except related medical expenses) even where such mental distress causes physical symptoms of stress like headaches, chest pain and stomach upset; punitive damages (even as punishment for causing physical injury); liquidated damages (preset compensation for violation of certain employment laws)
Many view as harsh the outcome that some suffering from mental harm are getting tax-free compensation just because that mental harm stems from a physical injury, versus those suffering mental harm whose compensation is taxed only because it is independent of an earlier, related physical injury or sickness.
Because of the importance of physical injury in federal taxation of employment settlements, employees should carefully document medical proof of such injuries. Plaintiff's lawyers should be sure to clearly refer to physical harm in all related communication and court pleadings.
When crafting or agreeing to language in the settlement agreement, rather than agreeing to a vague lump sum that could ultimately be classified as falling within the taxable categories enumerated above, the damages should be individually classified according to the taxable or nontaxable categories they represent. The IRS generally will tax the entire lump-sum award unless it is clearly divided into damage categories, some of which may not be taxable.
Taxation consequences generally should be part of the plaintiff's consideration in considering acceptable settlement terms. For example, if a large settlement falls all or mostly into taxable categories, especially if the amount reaches a level high enough to fall under the alternative minimum tax, the tax liability may justify holding out for a higher award.
In some states that allow recovery of workers' compensation damages for mental or emotional harm, a workers' compensation award may be a way to recover for mental harm in a way that is not taxable to the employee.
The Nature of Severance Pay
Severance pay, sometimes also called separation or termination pay, is a payment of money by an employer to an employee when the employee is terminated, often because of downsizing or reorganization on the part of the employer. Sometimes an employee may have a choice between job relocation and a severance package.
Severance pay is meant to assist an employee during the transitional time between jobs, which is often an unplanned-for surprise. Severance payments may be made according to an employer's internal policy or plan, required by state law, or pursuant to a one-time arrangement.
Tax Consequences of Severance Pay
The basic rule is that simple severance will be taxable as income, subject to withholding when paid out. Salary continuation when a job is lost is taxable. However, complicated tax questions can arise when severance money comes from certain types of employment trusts, or qualified retirement or benefit plans.
Legal Advice Important
This article is a simplified summary of some complicated issues. Many complex matters in this area are being litigated in the courts, and the courts are often split on the answers to particular questions. It would be difficult for an employee to bring a lawsuit against his or her employer without the guidance of an experienced employment law attorney with knowledge of applicable tax laws. Negotiation against a former employer would be challenging without the support of legal counsel and failure to properly classify damages could result in a high tax burden. In addition, issues of state tax law may arise that a lawyer licensed in the particular state would be qualified to examine.
Article provided by Kilgore & Kilgore
Visit us at www.kilgorelaw.com
Consider Tax Impact When Negotiating Employment Suits or Severance
Particularly tricky federal tax issues arise when an employee either receives money from a settlement or severance pay upon leaving a job.
ELSE PRESS RELEASES FROM THIS DATE:
North Carolina's Contributory Negligence Rules Outdated and Unfair
Imagine that you were in a bad car crash. Not only was there extensive property damage to your vehicle, but you also suffered severe injuries and have thousands of dollars in unpaid medical bills to prove it. In an attempt to recoup your losses from the insurance company of the driver who hit you, you file a personal injury lawsuit. While there is some question about whether the other driver is 100% at fault, you are confident that he is at least partially responsible for your losses. The court, however, disagrees and finds you shared fault - 10% of it - for causing ...
Public Outcry for FDA Reform
High-profile, deadly and previously undisclosed side-effects of mass-marketed prescription medications like Vioxx and Avandia have consumer watchdog groups, medical professionals and the public at large wondering if the Food and Drug Administration can stem the tide of "bad medicine." Most people think of the FDA as the gatekeepers of our country's food and medical supplies - there to prevent any harm from befalling us, responsible for making sure that only the highest quality products hit the marketplace. Unfortunately, in its quest to be better, the FDA may have hindered ...
Federal and Florida State Policies Put Bikes on More Equal Footing
Today cyclists are a familiar sight on Florida's streets, but it has only been in the last generation or so (since the 1970s) that cycling among adults has really taken off. Before that, cycling was generally regarded as a children's pursuit. While many Florida roads have had bike lanes added to them, in many cases it's not a perfect fit, and on other roads adding bike lanes has proved difficult due to traffic patterns, natural and man-made obstacles, and expense. In March of 2010, Transportation Secretary Ray LaHood announced a major policy change, saying that it was ...
An Increase in Efforts to Enforce Financial Fraud Crimes
Federal officials are not keeping secret their escalated efforts to prosecute financial fraud crimes involving U.S. government funds as well as U.S. government-backed or government-insured funds. Prior to the economic turbulence of the past few years, civil and criminal actions against firms suspected of defrauding government agencies or their proxies were mostly separate matters. But FBI investigators and Department of Justice prosecutors have announced their intention to investigate alleged wrongdoing involving federal funds, and individual criminal indictments have become ...
Too Much Plastic Surgery Can Have Devastating Effects
Medical malpractice claims against plastic surgeons can involve a variety of procedures. Patients who undergo breast implants, breast reduction, liposuction or facelifts may have to consider legal action if the medical professional they trusted caused severe scarring, infection, disease, malformation, tissue damage or other unexpected and often unexplained results. People who sought vast improvements in their personal appearance may face a future of embarrassment, pain, discomfort, medical complications and corrective surgeries. But imagine the combined effect of undergoing ...
High Stakes for Overdue Borrowers: Are Debtors Prisons Coming Back?
Overwhelming debt puts plenty of pressure on borrowers who must endure constant creditor harassment while they choose which obligations to face during difficult financial times. But that is a minor nuisance compared to spending a night or two in jail. The practice of locking up debtors who fail to respond to legal notices is not practiced everywhere, but reports from communities across the country reveal that debt collection companies have enlisted local authorities to use the full force of the law in enforcing warrants for even minor debt. Formal debtor's prisons were ...
The Dodd-Frank Act: Financial Reform and New Whistleblower Protections
President Obama's July signing of the Dodd-Frank Wall Street Reform and Consumer Protection Act brings increased oversight to an industry that many feel recklessly brought about "The Great Recession" and sent the economy into a tailspin. The stated aims of the new law include improving transparency and accountability in the financial system, ending bailouts by American taxpayers, putting an end to the idea that any institution is "too big to fail," and protecting consumers from improper financial services practices. One important strategy is the extension of incentives ...
A Backlog for SSDI Cases: Is Help on the Way for Disability Applicants?
One little known side effect of the prolonged recession is a rise in the number of applications for Social Security Disability Insurance (SSDI) and Supplemental Security Income (SSI). In an average year, the Social Security Administration considers 2.5 million applications for disability benefits. But cases were up by 20 percent over the past year and are likely to increase to well over 3 million in the coming year, according to SSA chief actuary Stephen Goss. One obvious reason is that workers who have endured disabilities may decide to seek benefits after losing a ...
Bureaucratic Reform of Truck Driver Safety Inches Ahead
This scene is all too common on North Carolina highways and back roads: on a recent July night near the end of a long drive, a Georgia trucker hauling over 20 tons of a highly combustible chemical overturned on a sharp mountain curve. He had followed GPS commands onto a rural gravel road between Lenoir and Banner Elk, where he planned to sleep for the night before delivering his load the next day. Perhaps the only uncommon thing about this accident is that no other vehicles were involved, and nobody was severely injured or killed. Trucking accidents like this happen ...
Convenient Gaffney Hotel Offers Comfortable Accommodations to Limestone College Orientation Attendees
Hampton Inn Gaffney Hotel offers convenient lodging to students and parents touring Limestone College or attending their upcoming fall semester orientation session. Orientation is scheduled from Friday, August 20 through Saturday, August 21, 2010. The local school, which is a 4 year liberal arts college, is only a few miles from this Gaffney South Carolina hotel. Limestone College, a Christian, non-denominational college, was established in 1845 as the first women's college in South Carolina. In the late 1960s Limestone became coeducational. Nine of the campus buildings ...
LAST 30 PRESS RELEASES:
Scientists model 'true prevalence' of COVID-19 throughout pandemic
New breakthrough to help immune systems in the fight against cancer
Through the thin-film glass, researchers spot a new liquid phase
Administering opioids to pregnant mice alters behavior and gene expression in offspring
Brain's 'memory center' needed to recognize image sequences but not single sights
Safety of second dose of mRNA COVID-19 vaccines after first-dose allergic reactions
Changes in disparities in access to care, health after Medicare eligibility
Use of high-risk medications among lonely older adults
65+ and lonely? Don't talk to your doctor about another prescription
Exosome formulation developed to deliver antibodies for choroidal neovascularization therapy
Second COVID-19 mRNA vaccine dose found safe following allergic reactions to first dose
Plant root-associated bacteria preferentially colonize their native host-plant roots
Rare inherited variants in previously unsuspected genes may confer significant risk for autism
International experts call for a unified public health response to NAFLD and NASH epidemic
International collaboration of scientists rewrite the rulebook of flowering plant genetics
Improving air quality reduces dementia risk, multiple studies suggest
Misplaced trust: When trust in science fosters pseudoscience
Two types of blood pressure meds prevent heart events equally, but side effects differ
New statement provides path to include ethnicity, ancestry, race in genomic research
Among effective antihypertensive drugs, less popular choice is slightly safer
Juicy past of favorite Okinawan fruit revealed
Anticipate a resurgence of respiratory viruses in young children
Anxiety, depression, burnout rising as college students prepare to return to campus
Goal-setting and positive parent-child relationships reduce risk of youth vaping
New research identifies cancer types with little survival improvements in adolescents and young adul
Oncotarget: Replication-stress sensitivity in breast cancer cells
Oncotarget: TERT and its binding protein: overexpression of GABPA/B in gliomas
Development of a novel technology to check body temperature with smartphone camera
The mechanics of puncture finally explained
Extreme heat, dry summers main cause of tree death in Colorado's subalpine forests[Press-News.org] Consider Tax Impact When Negotiating Employment Suits or Severance
Particularly tricky federal tax issues arise when an employee either receives money from a settlement or severance pay upon leaving a job.