Here’s something you may not have considered when agreeing to settle a nuisance case for a few thousand dollars. Most of the time, you will need to withhold federal and other taxes. Because of a relatively recent change at the IRS, unless payment is for a physical injury, the proceeds are fully taxable.
Recent case: Genevieve Du Lac settled a sexual harassment claim against her employer, Dick Blick Holdings, for $18,500. She got a check for just $11,904 because the company withheld federal and other taxes.
She sued, claiming withholding was wrong, because she had suffered emotional damage that was nontaxable.
The court explained that the IRS has changed the definition of income to include emotional damage. Only payment for physical damage is untaxed. (Du Lac v. Dick Blick Holdings, No. 10-C-3800, ND IL, 2011)