Employment Litigation and Claim Settlements: Tax Withholding and Reporting Implications for Employers

Transcription

1 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, pm 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 ed to registrants for additional information. If you have any questions, please contact Customer Service at ext. 10.

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4 Taxation of Employment Settlements Strafford Webinars October 26, 2017 by Robert W. Wood Wood LLP

5 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

6 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 Robert W. Wood 6

7 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

8 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

9 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

10 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

11 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

12 7. Using Structured Settlements. In P.I. cases, structured settlements are used so all payments (including interest) are taxfree. 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

13 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

14 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

15 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

16 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

17 12. Domeny v. Commissioner, T.C. Memo 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 Robert W. Wood 17

18 13. Parkinson v. Commissioner, T.C. Memo 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 Robert W. Wood 18

19 14. Blackwood v. Commissioner, T.C. Memo 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 Robert W. Wood 19

20 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 Robert W. Wood 20

21 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

22 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 (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 taxfree. Robert W. Wood 22

23 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

24 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

25 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 25

26 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 26

27 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 27

28 Employment Settlements Wage Characterization & Reporting October 26, 2017 Jared R. Callister flclaw.net

29 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

30 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

31 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

32 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

33 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

34 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 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

35 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) , Oct. 2, 208, Doc , 2009 TNT Can t be cited as precedent but still helpful. Jared R. Callister Flclaw.net 35

36 Presented By: Charles H. Wilson Cozen O Connor, P.C McKinney, Suite 2900 Houston, Texas cwilson@cozen.com

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