Not all settlements are taxable

Dear Darlene,
I, too, wish I was receiving a back pay settlement. While the settlement may not be classified as to what it is intended to cover, the origin of your claim determines its taxation.

Back pay and damages for emotional distress received to satisfy a claim under Title VII of the Civil Rights Act of 1964 is includable in income. Title VII of the Civil Rights Act of 1964 prohibits employment discrimination based on race, color, religion, sex or national origin.

Compensatory damages for personal physical injury or physical sickness are not considered income. However, emotional distress itself is not a physical injury or physical sickness. However, damages you receive for emotional distress due to a physical injury or sickness are treated as received for the physical injury or sickness. If your claim only involves emotional distress not related to a physical injury, you will need to include the award as income.

In fact, your former employer should issue a Form W-2 for the amount of the award, withholding the proper amount of taxes such as FICA and federal income tax. Your tax rate depends on the amount of the award, your other income and your deductions, marital status and dependents. If you receive $100,000 and you are single and have no other income, deductions or credits for the year, your tax should be around $20,000.

To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. Taxpayers should seek professional advice based on their particular circumstances.