Question for CPA's, and possibly Lawyers - regarding back pay and taxes

[Tidybuoy]

I had the unfortunate experience of being laid off a few years ago. My former employer attempted to screw me out of some accumulated vacation pay due to a verbal agreement we had when our system crashed and I had to forgoe my earned vacation and work twelve weekends and all holidays (kind of an emergency situation).

That said, everything was going well until my boss was let go and 6 months later, I was laid off when they closed my local office.

I was due many days/months of vacation time but there was no official record of this and I got screwed.

long story short, i sued them and it is looking like I will win. The employer has agreed to a settlement (were still negotiating the amount) but they have made an offer that is close.

My questions:
1) since this is considered back pay, I am stuck with a tax bill - I understand that.

2) we are agreeing that I will take 1/2 now and 1/2 on the first of the year (to help minimize tax)

3) I wondering, should I force the employer to pay me thru their payroll system so that they are forced to pay 1/2 of the SS & Medicare?

4) I'm feeling like they will tend to just cut me a regular expense check and since I am self-employed, I may get stuck with the full 15+% self-employment tax.

5) My lawyer is a great friend and lawyer but her specialty is not labor law, so I am trying to research as much as possible - this is my responsibility as far as i am concerned.

Any advice would be appreciated.

[A930Rocket]

No idea, but good for you winning!

[Tobra]

"Should I force the employer to pay me thru their payroll system so that they are forced to pay 1/2 of the SS & Medicare?"

Yes, you should do just exactly this. The money was earned when you were employed by them. If they do it any other way, they are failing to fulfill their payroll tax responsibilities.

[Tidybuoy]

Thanks

Just to be clear...I have incured about $14k in legal expenses and it looks like the tax law specifies that I have to report the full settlement amount and then deduct my legal expense (for income tax). But for SS & Medicare tax, shouldn't I deduct the $14k first, before calculating SS & Medicare. For Income tax, it's a whole different calculation.

Obviously, I am going to find the specific tax law but I'm getting all the free advice I can here - thanks

This is fairly important because I beleive under the Obama "stimulous", I only have to pay 4.2% for SS, vs the normal 6.2%. And I think the employer still has to pay the full 6.2%. And I definately do not want to pay the full 4.2+6.2 myself.

Thanks to all you experts out there.

[McLovin]

I think there are all sorts of ways these types of settlements are characterized for tax purposes. For example, not as back wages, but as some other kind of non-taxable damages or penalty, etc.

If there are significant numbers involved, you should speak with a CPA and or lawyer familiar with it.

[Tidybuoy]

Originally Posted by McLovin

I think there are all sorts of ways these types of settlements are characterized for tax purposes. For example, not as back wages, but as some other kind of non-taxable damages or penalty, etc.

If there are significant numbers involved, you should speak with a CPA and or lawyer familiar with it.

The number is not super significant compared to many huge settlements that you read about it - but, it's slightly less than one year's salary.

We are working thru a mediator, who is a retired judge, and he tells me there is no way around this because it "is indeed" back wages. The employer is not going to be flexible in any way. It would be different if this was a personla injury situation. However, a portion of the payment is to cover my legal expense, which includes the cost of the mediator (and that is definately not back wages).

My primary issue is that I definately feel the employer should not get out of their 1/2 of the SS & MC.

Thanks again !

[id10t]

Hrm... I'd definately ask both your lawyer and a money guy about this - a quick google indicates that lawsuit winnings that are compensation aren't taxed and punitive damages are ...

Quoth the google -

The winnings would be taxable income if they are "punitive". If they
are "compensatory," they are non-taxable. Internal Revenue Code (IRC)
section 61 states that all income from whatever source is taxable.

However, compensatory settlements would be to compensate for a prior
loss on the part of a plaintiff, and so would not represent a gain of
income on their part and they would not have to be taxed.

An IRS study found that many lawsuit winnings were falling through the
cracks as reportable income, or that people were classifying
non-compensatory settlements as compensatory, so there are many ways
to get around this.

IRS Code 104(a)(2) states that lawsuits involving personal injury or
illness are excluded from taxation, but the IRS has found many cases
of fraud related to this and there are many court cases stemming from
it. Issues litigated have included whether mental anguish counts as a
personal sickness or injury, or whether personal injury damages are
actually punitive. "The Service's current position is that punitive
damages are not received on account of personal
injuries under IRC section 104(a)(2), and therefore are not excludable
from gross income."
http://www.irs.gov/pub/irs-mssp/a9lawsut.pdf

Other than that, there are no specific statutes on which types of
lawsuits are exempt or not. Most cases have elements of both kinds of
compensation. The courts at the time of settlement deem whether the
money is compensatory or punitive, and the plaintiff must abide by
that ruling.
The winnings would be taxable income if they are "punitive". If they
are "compensatory," they are non-taxable. Internal Revenue Code (IRC)
section 61 states that all income from whatever source is taxable.

However, compensatory settlements would be to compensate for a prior
loss on the part of a plaintiff, and so would not represent a gain of
income on their part and they would not have to be taxed.

An IRS study found that many lawsuit winnings were falling through the
cracks as reportable income, or that people were classifying
non-compensatory settlements as compensatory, so there are many ways
to get around this.

IRS Code 104(a)(2) states that lawsuits involving personal injury or
illness are excluded from taxation, but the IRS has found many cases
of fraud related to this and there are many court cases stemming from
it. Issues litigated have included whether mental anguish counts as a
personal sickness or injury, or whether personal injury damages are
actually punitive. "The Service's current position is that punitive
damages are not received on account of personal
injuries under IRC section 104(a)(2), and therefore are not excludable
from gross income."
http://www.irs.gov/pub/irs-mssp/a9lawsut.pdf

Other than that, there are no specific statutes on which types of
lawsuits are exempt or not. Most cases have elements of both kinds of
compensation. The courts at the time of settlement deem whether the
money is compensatory or punitive, and the plaintiff must abide by
that ruling.

[Tidybuoy]

Thanks, I will read up on this tomorrow. It's bed time now.

[dienstuhr]

Originally Posted by Tidybuoy

5) My lawyer is a great friend and lawyer but her specialty is not labor law, so I am trying to research as much as possible - this is my responsibility as far as i am concerned.

Any advice would be appreciated.

First, good for you for looking like you will settle the case.

Second, I'm surprised that you feel that determining the tax consequences of the award are "your responsibility". You're (presumably) not a tax lawyer or accountant, so why would you think that it's appropriate that you become an "expert" in this situation?

Does this case involve issues that are really outside your lawyer's area of competence and expertise? It could be that the amount at stake was relatively small and your lawyer friend thought she could handle it. But the tax consequences of the award are a major part of the settlement decision! The way the settlement is structured has the potential to cause significant consequences for your tax situation! If the settlement is not structured appropriately you could be getting much less money than you think.

You have the ultimate responsibility to instruct your lawyer as to whether to accept a settlement or not. In order to do that, you have to know how much you are going to clear. If you are uncertain of the tax consequences of the structure, you will not have this vital information. Your lawyer has the responsibility to ensure that you have the necessary information to make this decision - she is risking malpractice if she doesn't. Make sure she is aware that you do not take responsibility for figuring out the tax implications of the settlement. This is a legal responsibility.

Regards,

d.

[id10t]

I can see where it makes sense knowing if you'd get the equivalent of a 1099 for the settlement - after all, wtih teh employer paying half of the SS tax (7.5%) that extra 7.5% could be a lot of money...

[Tidybuoy]

Originally Posted by dienstuhr

Second, I'm surprised that you feel that determining the tax consequences of the award are "your responsibility". You're (presumably) not a tax lawyer or accountant, so why would you think that it's appropriate that you become an "expert" in this situation?

Actually, I am an accountant.

It is not technically "my" responsibility but I consider this to be "my" money and so I take responsibility. I will obviously get good advice, but I don't take anybody's word without doing my own research. My lawyer is very good and was a district attorney for 25+ years prior to private practice. she is currently semi-retired. Even so, every ounce of info I have gotten from her has been double checked by me - it's just my nature.

And, since there are many competant people on this board, I use this forum for a sounding board. I've gotten a lot of great advice over the years (but even so, I still check for myself).

Yes, I am structuring the settlement but I just want to be sure for myself, that the employer pay's their half of the tax burden. I will get competent tax advice.