Tuesday, September 4, 2012

Back and front wages are taxable

No one likes taxes but the IRS. Everything is taxed, including wages under Title VII. That's the rule in a recent Second Circuit case in which the plaintiff objected that a chunk of his large judgment was lost to taxes.

The case is Noel v. New York State Office of Mental Health, decided on August 31. Noel won a Title VII discrimination case in which the jury awarded him $280,000 in back and front pay. When the state paid out the award, it Office of State Comptroller on its own took out the various deductions and sent Noel a check in the amount of $139,582.52. That's fifty percent in taxes! Noel objected that the state made these deductions, and the district court sided with Noel, concluding that the state had no legal authority to withhold these taxes. The court ordered the state to reimburse Noel for the money that it deducted. The court further entered a judgment in the amount of $164,987.59, which reimbursed Noel for the taxes (plus interest and attorneys fees) that the state deducted from his check. The Court of Appeals reverses.

Here's the deal. Title VII authorizes an award of back and front pay if the plaintiff is wrongfully terminated. Since these are the wages that plaintiff would have recovered but for the defendant's wrongful discharge, he has to pay withholding taxes. After all, had plaintiff not been terminated in violation of Title VII, he would have paid taxes on that income. Under the IRS code, income is taxable. And the district court's order that "reimburses" Noel is really a windfall. The Second Circuit (Parker, Katzmann and Wesley) writes,

[P]ayments pursuant to Title VII judgments for back and front pay are “wages” as defined under the Internal Revenue Code and, as such, employers are required to withhold income and Federal Insurance Contributions Act (“FICA”) taxes. Moreover, we conclude that – although district courts have discretion to oversee the procedure by which these deductions are taken – the district court should not have ordered the
double payment.


The obligation on employers to collect taxes by withholding a specified portion of the tax from wages paid is mandatary. Specifically, I.R.C. § 3102(a) provides that FICA taxes “shall be collected by the employer . . . as and when paid.” Likewise, the Code uses mandatory language with respect to the withholding of income taxes. Moreover, an employer who fails to withhold FICA and income taxes from the wages of his employees, or who fails to pay those withheld taxes over to the government, can be held personally liable for an amount that is equal to the amount that should have been withheld and paid over.

The district court's ruling gave an "undeserved windfall" to Noel. This was an "inappropriate hit to the public fisc," the Court of Appeals says.

By the way, the decision says that the state paid out the full judgment to Noel after the district court ordered the state to reimburse to Noel the taxes that it withheld. Now that the state has won the appeal, Noel has to pay all that money back in taxes. I certainly hope Noel did not spend all the money while the case was on appeal.

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