employment litigation and claim settlements: tax...
TRANSCRIPT
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Presenting a live 90-minute webinar with interactive Q&A
Employment Litigation and Claim
Settlements: Tax Withholding and
Reporting Implications for Employers Maximizing Tax Benefits and Avoiding Penalties When Allocating Settlement
Proceeds, Drafting Settlement Agreements, and Reporting Payments
Today’s faculty features:
1pm Eastern | 12pm Central | 11am Mountain | 10am Pacific
THURSDAY, OCTOBER 26, 2017
Jared R. Callister, Shareholder, Fishman Larsen & Callister, Fresno, Calif.
Charles H. Wilson, Vice Chair, Office Managing Partner, Cozen O’Connor, Houston
Robert W. Wood, Managing Partner, Wood, San Francisco
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Taxation of Employment Settlements
Strafford Webinars October 26, 2017
by Robert W. Wood
Wood LLP
www.WoodLLP.com
1. Origin of the Claim Controls.
Underlying Dispute. Payments are taxed
according to the underlying nature of the
claim. Hence, a suit for breach of employment
contract results in taxable wages.
Wages. If payments constitute wages, they
are also subject to employment taxes,
including income tax withholding, Social
Security (FICA), and unemployment tax
(FUTA).
Robert W. Wood
www.WoodLLP.com 5
2. Wage and Employment Taxes.
Should a discrimination or wrongful
termination recovery (in the absence of
physical injury) be treated as taxable tort
damages (and hence not as wages), or
treated as wages?
See Wood, IRS Speaks Out on Employment
Lawsuit Settlements, Vol. 124, No. 11, Tax
Notes (Sept. 14, 2009), p. 1091.
Robert W. Wood
www.WoodLLP.com 6
3. Wage Caution.
The safest approach may be for employers to
treat all settlements as wages, but this is
overinclusive.
If an amount is truly a tort settlement, even if
it is now taxable income, there should be no
employment taxes. Allocate between W-2
and 1099 amounts.
Robert W. Wood
www.WoodLLP.com 7
4. Wage Authorities.
Former employees can still receive wages.
Numerous authorities examine many different
types of payments.
But most wage issues are factual.
Robert W. Wood
www.WoodLLP.com 8
5. Don’t Assume Wages are Terrible.
In employment disputes, some amount is almost always intended as wages. Yet many plaintiff lawyers seem to think wage treatment is terrible and try to avoid it. This can be short-sighted for several reasons.
With wages, the employer and the employee each pay half of the Social Security tax.
If it is self-employment income, the former employee must pay the entire tax.
Robert W. Wood
www.WoodLLP.com 9
5. Don’t Assume Wages are Terrible.
(Cont.)
If there is no or little wage withholding, the
former employee may not have tax
withholding for the first time and may
therefore have to budget for paying taxes.
Robert W. Wood
www.WoodLLP.com 10
6. Consider W-2s and Withholding vs.
1099s.
The wage vs. non-wage allocation issue
should be considered in every employment
case!
Checks and Forms 1099
Be very explicit.
Don’t leave reporting to chance.
Robert W. Wood
www.WoodLLP.com 11
7. Using Structured Settlements.
In P.I. cases, structured settlements are used
so all payments (including interest) are tax-
free.
In employment cases, payments can be
spread over many years, but each payment is
taxed when received.
You cannot structure wages.
Robert W. Wood
www.WoodLLP.com 12
8. Structure Details.
Structures must be implemented as part of
settlement agreement to avoid constructive
receipt.
Some defendants will balk at the additional
documentation.
Consider the numbers and have someone
run examples and pro forma tax returns.
Robert W. Wood
www.WoodLLP.com 13
9. Qualified Settlement Funds.
Used frequently in class actions and cases with
multiple plaintiffs.
Allows defendant to pay and be out of the picture.
Allows time to consider structures.
Properly done, not a tax event for plaintiffs or
lawyers.
See Wood, The QSF, The Employee Advocate
(Spring/Summer 2009), p. 25.
Robert W. Wood
www.WoodLLP.com 14
10. Section 104 Exclusion.
For over 80 years, our tax system has
exempted from taxation recoveries in personal
injury cases.
But it was only in 1996 that this time worn rule
was cut back to exempt only damages for
personal physical injuries and physical
sickness. See O’Gilvie v. U.S., 519 U.S. 79
(1996) and the parallel changes to § 104 as a
result of the 1996 Act.
Robert W. Wood
www.WoodLLP.com 15
11. Exclusion Checklist.
What happened?
What language can you get?
What tax reports will be issued?
What level of certainty does the client need?
Robert W. Wood
www.WoodLLP.com 16
12. Domeny v. Commissioner, T.C. Memo 2010-9. The Tax Court held that a portion of a payment
that Domeny received from her former employer
was compensation for physical illness, an
intensification of her multiple sclerosis symptoms
caused by her hostile and stressful work
environment. Therefore excluded from gross
income under Section 104(a)(2).
See Wood, Is Physical Sickness the New
Emotional Distress?, Vol. 126, No. 8, Tax Notes
(Feb. 22, 2010), p. 977. Robert W. Wood
www.WoodLLP.com 17
13. Parkinson v. Commissioner, T.C. Memo 2010-142. The Tax Court held one half of Parkinson’s settlement
was for emotional distress, and the other was for physical
injuries and sickness after a heart attack on the job.
The court appeared to distinguish symptoms of
emotional distress from signs of emotional distress by
defining a symptom as “subjective evidence of disease or
a patient’s condition.” In contrast, a sign is evidence
perceptible to the examining physician.
See Wood, Tax-Free Physical Sickness Recoveries in
2010 and Beyond, Vol. 128, No. 8, Tax Notes (Aug. 23,
2010), p. 883.
Robert W. Wood
www.WoodLLP.com 18
14. Blackwood v. Commissioner, T.C. Memo. 2012-190.
The Tax Court ruled that Blackwood’s $100k
settlement for depression symptoms exacerbated
by her wrongful discharge did not qualify under
Section 104.
Qualitatively and quantitatively, Blackwood’s
evidence did not show the level of physical injury
or physical sickness present in Domeny. See
Wood, Are Damages for Exacerbation of
Depression Tax Free?, Vol. 136, No. 10, Tax
Notes (Sept. 3, 2012), p. 1211. Robert W. Wood
www.WoodLLP.com 19
15. Perez v. Commissioner, 144 T.C.
No. 4 (Jan. 22, 2015).
The Tax Court concluded that amounts received by
a donor for use in fertility treatments were taxable.
This is the first answer by a court. It is unlikely to be
the last, even though some people are reading the
case as conclusive regarding egg donations and
perhaps even for other medical procedures.
See Wood, Taxing Egg Donations With The Wisdom
of Solomon, Vol. 147, No. 13, Tax Notes (June 29,
2015), p. 1581.
Robert W. Wood
www.WoodLLP.com 20
16. Settlement Wording is Key.
Settlement agreement wording is very
important.
Remember that the Murphy award was for
“emotional distress or mental anguish” and
for “injury to professional reputation.”
Physical injury and physical sickness were
not mentioned in the order.
Robert W. Wood
www.WoodLLP.com 21
17. Tax Treatment of Attorney Fees.
If a case is truly a personal physical injury case
and 100% of the recovery will be tax-free, there
will be no problem with the tax treatment of the
attorney fees. See PLR 9024017 (Mar. 14, 1990).
But note how terribly qualified is this rule. The
case must be a true personal physical injury case
(a wrongful death case for this purpose will
qualify), and 100% of the recovery must be tax-
free.
Robert W. Wood
www.WoodLLP.com 22
18. Above-the-Line Deduction.
Attorney fees can be deducted above-the-line
in employment cases and False Claims Act
cases.
In 100% wage cases, are attorney fees also
wages?
Robert W. Wood
www.WoodLLP.com 23
19. Capital vs. Ordinary?
Consider capital gain vs. ordinary income in
equity cases.
Ask about:
Options
ISO vs. NSO
Section 83(b) election
Robert W. Wood
www.WoodLLP.com 24
20. Expect Forms 1099!
Many defendants and insurance companies
still issue them.
The only reliable way to insure that no such
form is issued is to expressly so provide in
the settlement agreement.
Robert W. Wood
www.WoodLLP.com 25
21. Indemnity Issue.
Should you include an indemnity obligation
on the part of the recovering plaintiff to hold
the defendant harmless in the event failure to
withhold or employment tax penalties are
imposed on the defendant?
Is it:
Worthwhile?
Risky/Red Flag?
Robert W. Wood
www.WoodLLP.com 26
22. Consider Taxes Early.
In all of this, the timing is important.
Obviously, these issues must be addressed
before signing a settlement agreement. In
fact, it's rarely too early to start discussing it.
Don't leave it for the last minute, or there may
not be time to set it up properly.
Robert W. Wood
www.WoodLLP.com 27
Employment Settlements Wage Characterization & Reporting
October 26, 2017
Jared R. Callister
flclaw.net
Disclaimer
The materials presented in this outline are for seminars and training exercises conducted by Fishman, Larsen & Callister (“FLC”). No other or entity may use or reproduce this document, in full or part, without the express written authorization of FLC.
The materials do not constitute an integrated text or an exhaustive analysis of the law or the subject matter. The materials are not intended to be, and should not be construed as constituting legal advice with regard to a specific case, set of facts, or transaction, or an opinion or advice of FLC.
Jared R. Callister
Flclaw.net 29
Origin of the Claim Doctrine
• As mentioned previously, the origin of the claim doctrine dictates whether settlement payments are taxable income.
• Once a payment is considered taxable income, one must also consider the nature or origin of the claim to determine whether the proceeds are taxable as wages.
• Any payments constituting wages will be subject to employment taxes, including income tax withholding, Social Security (FICA), and unemployment tax (FUTA).
Jared R. Callister
Flclaw.net 30
What Are Wages?
General Rule: Anything that constitutes “remuneration” related to an employee’s services is taxable as a wage for withholding and reporting purposes.
So payments related to back pay, front pay*, severance payments, and overtime are wages.
Meal & Rest Period Payments: Classified wages as considered extra compensation for the employee’s additional services. (distinguished from “penalties” like waiting time penalties)
*Except for the Fifth Circuit
Jared R. Callister
Flclaw.net 31
What Are Not Wages? Compensatory Damages: So damages for emotional distress (e.g., insomnia, weight loss, stress, insomnia) as the result of alleged discrimination or hostile work environment are not classified as wages (although included in income unless the result of a battery).
Costs & Interest
Punitive/Liquidated Damages: Punitive or liquidated damages are not considered wages (but are included in income)
“Waiting Time Penalties”: Statutorily imposed penalty for not timely paying an employee’s wages. Based on employer’s misconduct (typically based on number of days late).
Jared R. Callister
Flclaw.net 32
Reporting & Withholding
Unfortunately, the reporting and withholding requirements of employment settlements are not necessarily intuitive and depend on the nature of the claim, classification of wages, how attorneys’ fees are to be paid and how checks are actually cut.
Generally: – Amounts allocated to “wages” are reported on a W-2 (with
appropriate withholdings
– Amounts NOT considered wages and included in income are reported on a 1099-MISC (Box 3).
– If not income then no W-2 or 1099 reporting
Jared R. Callister
Flclaw.net 33
Complications With Reporting & Withholding
• If a single check is made payable to employee and the attorney then:
Employee: Amounts determined wages reported on W-2. Non wages (including attorneys’ fees) reported on 1099-MISC (box 3).
Attorneys: Full amount of the check reported on Box 14 of 1099- MISC.
• If separate checks, to attorneys for their fees, rest to employee then:
Employee: Amounts determined wages reported on W-2. Non wages (including attorneys’ fees) reported on 1099-MISC (box 3).
Attorneys: Amount of check payable to attorneys reported on Box 14 of 1099-MISC.
Jared R. Callister
Flclaw.net 34
Complications With Reporting & Withholding
• If single check made payable to Employee then:
Employee: Amounts determined wages reported on W-2. Non wages (including attorneys’ fees) reported on 1099-MISC (box 3).
Attorney: No reporting by employer
• If single check made payable to Attorney then:
Employee: Amounts determined wages reported on W-2. Non wages (including attorneys’ fees) reported on 1099-MISC (box 3)
Attorney: Total amount of check reported on box 14 of 1099-MISC.
For helpful tables on withholding & reporting in employment cases see Program Manager Technical Advice (PMTA) 2009-035, Oct. 2, 208, Doc 2009-
15305, 2009 TNT 129-19. Can’t be cited as precedent but still helpful.
Jared R. Callister
Flclaw.net 35
Charles H. Wilson
Cozen O’Connor, P.C.
1221 McKinney, Suite 2900
Houston, Texas 77010
713-750-3117
Presented By:
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