Income Taxation of FMLA Claims

The Family Medical Leave Act requires employers with 50 or more employees to grant 12 weeks of unpaid leave to an employee in the event of a birth, adoption or serious health condition — whether it’s the employee or someone in her immediate family who is ill or injured. A violation of the FMLA law can lead to a civil lawsuit by an employee, and a settlement can bring about taxable income to the plaintiff. For FMLA cases and other civil lawsuits, the Internal Revenue Service is fairly clear about how settlement money should be reported and how it is taxed.

FMLA Lawsuit Taxation

The only type of lawsuit settlements that are tax-free are payments you receive to compensate you for a physical injury or illness you suffer as a result of the defendant’s actions. However, all other types of settlements, including money you receive for your FMLA claim, are fully taxable. In other words, your FMLA settlement compensates you for employment-relates damages you suffer. And when dealing with employment, the damages ultimately cover lost wages that are subject to tax. If part of your FMLA award includes interest, punitive damages or compensation for mental anguish, the IRS still requires you to include those amounts in taxable income.

Division of Proceeds

In most cases, an FMLA settlement means payment for two or more specific claims against the employer. These can include lost wages, medical bills, attorney’s fees and emotional distress. Taxation of the settlement depends on how the proceeds are apportioned. If an employee has settled with the employer, either through a mediator or before the case goes to trial, the settlement paperwork should give this information in detail.

Deducting Legal Fees

If the basis of your FMLA case is for discrimination by your employer, the IRS will allow you to fully deduct all of the legal fees you pay to attorneys that assist with your FMLA lawsuit. This is an exception to the general rule that you can only take legal fees as a miscellaneous itemized expense subject to the 2 percent adjusted gross income limitation. So rather than reporting the expense on Schedule A, you can claim the deduction as an adjustment to income on the first page of your Form 1040.

Lost Wages

Any FMLA claim for lost wages demands the defendant, the employer, reimburse the plaintiff, the employee, for pay lost through the employer’s negligence or violation of the law. In the view of the IRS, a lost-wage settlement is taxable, because the money would normally have been paid to the employee as regular, taxable wages or benefits. Therefore, a defendant paying this portion of the settlement also has the right to withhold income tax as well as payroll tax from the lost-wage proceeds.

Exempt Settlement Benefits

The courts have also found that individuals, in addition to businesses, can be held liable for violations of the FMLA. In this case, if a settlement includes payment on behalf of a supervisor or manager who violated the law, the damage award is not considered payment for lost wages and is not taxable. Nor are medical benefits, physical therapy and rehabilitation or vocational training taxable if they were paid for as part of an FMLA settlement, as these benefits would not normally be considered taxable compensation.

Other Expenses

As for emotional pain and distress, the tax law makes a careful difference between distress associated with physical injuries and distress that does not arise from physical injuries and for which no medical expenses were incurred. In the latter case, the settlement money is taxable; in the former, it is not. In addition, settlements for medical expenses arising from the FMLA violation are exempt, as is any payment of attorney’s fees. Punitive damages against the defendant, even if associated with a physical injury, are taxable.

Withholding Settlement Payments

Although your FMLA award relates to your employment, the compensation you receive is not ordinary salary or wages, and therefore, is not subject to withholding by your employer. However, if the award is at least $600, the employer must report the total settlement payment to you and the IRS on a 1099-MISC rather than a W-2. Depending on how much you settle for, you may need to make estimated tax payments. This is only necessary if after taking into account the tax withheld on your other taxable earnings during the year you will still have to pay at least an additional $1,000 in tax with your annual return.

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