A federal district court in New Jersey recently approved a settlement in an employment discrimination case under the New Jersey Conscientious Employee Protection Act (CEPA) and the New Jersey Law Against Discrimination (NJLAD), where an employee received both front pay and back pay. Hashing out the settlement figure, however, was the easy part.
Both sides were confused about how to treat the pay for tax purposes. Do IRS regulations consider both front pay and back pay to be wages? If so, must the employer deduct taxes from the gross amount before paying the settlement?
The employee’s attorneys argued that either no taxes should be withheld or the amount should be “grossed up” so the net figure matched the settlement amount. The employer argued it might face liability if it failed to deduct the proper taxes. Both sides punted and asked the court figure it out.
The court determined that front pay and back pay awarded under CEPA and NJLAD were wages as defined in IRS regulations. Therefore, the employer must deduct taxes from these amounts and remit them and the matching withholding to the IRS and state and local taxing authorities.
Because the employee agreed to the amount before determining the tax liability, she ended up with a lower net figure than she actually settled for.
Note: The court observed that this tax treatment was peculiar to this particular situation. For example, the federal requires employees to receive “an amount equal to their wages” in FMLA settlements. CEPA and the NJLAD lack that language. Further, it noted that case law provides a basis for “grossing up” jury awards to yield the net amount for the employee. Since this was a settlement and not a jury award, that precedent did not apply.
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