civil rights violation compensatory damages settlement

Former government employer fired me for declining to submit to a random, suspicionless drug test. ACLU sued former employer on my behalf for violation of my civil rights. Former employer now wants to settle by paying compensatory damages. What are the tax consequences and would it be better to have an annuity set up to pay it out over several years?

Thanks.

Reply to
Mt. View
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The settlement amount is ordinary income.

If the legal fees are taken from the settlement, and the settlement is agreed to be based on discrimination, the legal fees can be deducted as a misc adjustment to income.

However, I seriously doubt the company will agree that they were guilty of discrimination and, moreover, will insist that both parties agree there was no fault by the company and the settlement was to avoid further costs.

Reply to
Arthur Kamlet

The settlement amount is ordinary income. =====================Agreed as this is a personal injury at law, as opposed to a natural injury (physical harm or mental disease/defect). Furthermore, it is an amount in lieu of wages that would have been earned. This type of injury is taxable as of

1996 (to the extent that any type of damages are taxable) in that it is not excludible per Section 104.

As far as recognizing the settlement in full now vs. an annuity, as tax rates look as if they must go up, you will have to run actual numbers and compare.

Reply to
D. Stussy

suspicionless drug test. ACLU sued former employer on my behalf for violation of my civil rights. Former employer now wants to settle by paying compensatory damages. What are the tax consequences and would it be better to have an annuity set up to pay it out over several years?

Your settlement is not for personal injury. As such, it is all taxable income. As a cash basis taxpayer, you would pay tax on the settlement based on when you receive it. If you receive a lump-sum, then you include that amount in annual income and pay tax at whatever marginal rate you are in. An annuity, would obviously reduce the amount of income you have to declare in the first year and increase your reportable income in subsequent years. The tax affect is going to depend upon the size of the award, your marginal tax rate today and the projected marginal tax rates in the future. Note that you would include in income the amount of the settlement before your attorney got his percentage or fee.

On another note, how you deduct your legal fees paid to obtain taxable income will depend upon the terms of the setlement. In 2004 Congress amended tax law to allow an "above the line" deduction for certain employment and federal false clams acts. This included many civil rights violations. If your claim falls under this law (Section 703(a) of the American Jobs Creation Act of 2004, P.L. 108-357) then you can deduct your legal fees as an adjustment to income on page one of the 1040. If not, then your deduction can only be taken on Schedule A as a miscellaneous itemized deduction subject to the 2% AGI limitation. More importantly, as a misc. itemized deduction, you could not use that deduction in computing alternative minimum tax (AMT).

You will need to have a discussion with a professional who understands the 2004 law and its tax consequences for your legal settlement.

Reply to
Alan

random, suspicionless drug test. ACLU sued former employer on my behalf for violation of my civil rights. Former employer now wants to settle by paying compensatory damages. What are the tax consequences and would it be better to have an annuity set up to pay it out over several years?

No one has addressed whether this is back pay or forward pay that might be subject to payroll taxes (Soc Security, Medicare).

I'd like to know. The IRM is full of references to court cases.

Reply to
Mark Bole

random, suspicionless drug test. ACLU sued former employer on my behalf for violation of my civil rights. Former employer now wants to settle by paying compensatory damages. What are the tax consequences and would it be better to have an annuity set up to pay it out over several years?

No one has addressed whether this is back pay or forward pay that might be subject to payroll taxes (Soc Security, Medicare).

I'd like to know. The IRM is full of references to court cases. =====================That's correct, but there was no indication that any of the compensatory damage was for an amount in lieu of wages, as opposed to solely for the violation of law.

Reply to
D. Stussy

Compensatory damages means that a person is paid to compensate for a specific loss. A person is seldom entitled to money simply because there was a violation of the law. Actual damages have to be shown.

In a case like this I can't imagine what else damages could be awarded for other than loss of wages. There may be a claim for defamation. But if so, what did he lose due to the defamation? Probably wages.

Normally when an employer pays a judgment that includes lost wages, the employer withholds from the payment whatever should have been withheld from the pay if he had properly been paid when it should have been.

___ Stu

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Reply to
Stuart A. Bronstein

On 2012-11-18 18:24, Stuart A. Bronstein wrote: [...]

OK, here's a real-life scenario where there was a settlement for violation of the law:

Employer settles a class-action employee lawsuit over violations of California labor law. Failure to pay compensation on a timely basis, and failure to provide accurate wage statements, are the two main sources of damages and penalties sought in the suit. (The compensation in question includes commission payments which were not calculated with each pay period but instead were delayed for up to 4 months). There was not a question of whether total wages owed were paid, as it appears they were.

Is this taxable income also subject to payroll tax too? If it matters, settlement is reported on 1099-MISC box 3.

Reply to
Mark Bole

On 2012-11-18 18:24, Stuart A. Bronstein wrote: [...]

OK, here's a real-life scenario where there was a settlement for violation of the law:

Employer settles a class-action employee lawsuit over violations of California labor law. Failure to pay compensation on a timely basis, and failure to provide accurate wage statements, are the two main sources of damages and penalties sought in the suit. (The compensation in question includes commission payments which were not calculated with each pay period but instead were delayed for up to 4 months). There was not a question of whether total wages owed were paid, as it appears they were.

Is this taxable income also subject to payroll tax too? If it matters, settlement is reported on 1099-MISC box 3.

Reply to
Mark Bole

It shouldn't be subject to payroll tax. This is one of those fairly rare situations where the litigant collects a statutory penalty that is meant to punish the defendant rather than compensate the plaintiff for actual losses. There aren't many of them in the scheme of things.

I suppose an award of attorney's fees in addition to compensatory damages might come under this category. Those fees are apparently normally considered part of the award, and so are taxable if the award is taxable (but may not be fully deductible). It's compensatory rather than a penalty, but not in compensation for the loss of taxable income per se.

___ Stu

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Reply to
Stuart A. Bronstein

I don't see how this could be considered back wages as the employees had received all their wages. It is taxable income not subject to payroll taxes. As these people were employees, the employer would have had to issue W-2s with withholding if it was considered back wages.

As a separate comment to Stuart: There are a variety of violations of law that trigger damages without the plaintiff having to prove the amount of damages. E.g., a variety of civil rights violations come with payments to the litigants if they prevail.

Reply to
sfcnm-mtm

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