The Tax Consequences of Settlement Agreements

Abstract

Employment-related disputes are a major business concern for many companies. These lawsuits are often brought by former employees and can include wage and hour claims (for missed rest breaks, overtime pay and off-the-clock work), discrimination and/or harassment claims, retaliation claims and wrongful termination claims. Claimed damages can include wage damages (such as lost wages, benefits and severance pay), nonwage damages (such as emotional distress, humiliation and injury to reputation), punitive damages, injunctive relief, statutory penalties, interest and attorneys’ fees and costs. Companies periodically agree to settle these types of lawsuits and may enter into agreements to make payments to the claimants and/or their lawyers. The tax reporting of settlement payments can be quite complex, and companies making such payments should be aware of approaches to handle some of the most common issues that arise under these settlement agreements and be aware of the recent Internal Revenue Service guidance on handling these issues.