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 THURSDAY, OCTOBER 26, 2017 1pm Eastern | 12pm Central | 11am Mountain | 10am Pacific Today’s faculty features: 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 The audio portion of the conference may be accessed via the telephone or by using your computer's speakers. Please refer to the instructions emailed to registrants for additional information. If you have any questions, please contact Customer Service at 1-800-926-7926 ext. 10 .
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Taxation of Employment Settlements Strafford Webinars October 26, 2017 by Robert W. Wood Wood LLP LLP www.WoodLLP.com wood@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 5 www.WoodLLP.com
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 6 www.WoodLLP.com
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 7 www.WoodLLP.com
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 8 www.WoodLLP.com
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 9 www.WoodLLP.com
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 10 www.WoodLLP.com
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 11 www.WoodLLP.com
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 12 www.WoodLLP.com
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 13 www.WoodLLP.com
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 14 www.WoodLLP.com
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 15 www.WoodLLP.com
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 16 www.WoodLLP.com
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 17 www.WoodLLP.com
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 18 www.WoodLLP.com
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 19 www.WoodLLP.com
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 20 www.WoodLLP.com
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 21 www.WoodLLP.com
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 22 www.WoodLLP.com
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 23 www.WoodLLP.com
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 24 www.WoodLLP.com
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