In employment cases, the structure of settlement payments may have significant tax consequences for clients. Often the tax consequences depend on whether the settlement payments are for loss of income damages, which are taxable, or emotional distress types of damages, which are not.
Wage and hour mediation settlements, especially in California, may involve somewhat different considerations. In those cases, emotional distress types of damages often play less of a role. More often, the tax issues relate to whether the payments are allocated to wages or to penalties or other types of non-wage payments.
Settlement payments to an employee are often reported to taxing authorities in one of two ways. Wages and other types of payments considered to be wages are usually reported by a W-2 form issued by the employer. Non-wage payments are reported by the employer issuing a form 1099. The type of form used can have significant tax consequences for both parties for such things as Medicare taxes and self-employment taxes.
On the employee's side, payments for wages, reportable through a W-2 form, often are subject to withholding by the employer. If the payments are not for wages and are reported via a form 1099, the employer does not withhold taxes from the settlement payment. The employee receives more cash up front but is responsible for payment of Medicare and other types of self-employment taxes that may apply to non-wage income.
The classification of...
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