Family and Medical Leave Act (FMLA) Settlements: Who pays the taxes?

The issue often arises in FMLA settlements as to how Plaintiff will be paid. If a plaintiff is paid by W-2, the employer is obligated to deduct applicable taxes, withholdings for Social Security and Medicare and its employer tax. To the contrary, a plaintiff paid by Form 1099-MISC is responsible for all of these taxes.

Until recently, the prevailing case in the Eastern District relating to tax treatment of FMLA awards was the case of Churchill v. Star Enterprises, 3 F. Supp.2d 622 (E.D. Pa. 1998) and its progeny such as Carr v. Fresenius Medical Care, No. 05-2228, 2006 U.S. Dist LEXIS 29627, (E.D. Pa. 2006), which concluded that no portion of the settlement proceeds in an FMLA case was subject to withholding and that the withholding provisions of both federal and state statutes applied only to wages or remuneration for services actually performed.

The Churchill and Carr decisions were premised on the specific statutory language of the FMLA which provides that employers who violate the FMLA are not, in fact, liable for lost wages or “back pay” but are liable for damages “equal to the amount of … any wages, salary, employment benefits, or other compensation denied or lost to such employee by reason of the violation.” This distinction is what makes the FMLA different from other employment statutes wherein the remedy is specifically couched in terms of “back pay.”

A recent case from the U.S. District Court for the Eastern District of Pennsylvania tackled the issue of FMLA settlements. In Gunter v. Cambridge-Lee Industries, No. 14-2925 (E.D. Pa. July 14, 2016), the parties reached terms of settlement as to a monetary amount but could not agree on how the proceeds should be reported to the IRS. The plaintiff argued the settlement proceeds were not wages and therefore not subject to withholding or reporting to the IRS with a Form W-2, but should be reported to the IRS on Form 1099 without withholding. The employer asserted that the settlement proceeds constituted wages to the plaintiff that must be reported to the IRS on Form W-2 subject to withholding of taxes and other payroll charges.

The Court compared and contrasted all of the relevant holdings relating to the tax ramifications of discrimination settlements. The Court took specific note of the Churchill and Carr decisions because of the way those decisions analyzed the IRS revenue rulings. Due to the fact that the IRS rulings were contrary to the plain language of the FMLA statute, the Court found the Churchill line of cases to be more persuasive. Consequently, the Court held that no withholding was required for the proceeds of the settlement in the case payable to the plaintiff.

Therefore, in light of the Gunter decision and its reliance on the Churchill rationale, it is reasonable to believe that future FMLA settlements in this jurisdiction should be handled in a manner where no withholding occurs, even if the settlement or award was premised on some quantification of lost wages or back pay. The rationale being that an FMLA award, unlike other discrimination statutes, provides for damages “equal to the amount of … any wages, salary, employment benefits, or other compensation denied or lost to such employee by reason of the violation.” Thus, the settlement proceeds should be reported to the IRS on Form 1099 without withholding. Contact Gary Dadamo at ghd@mbm-law.net or John Prorok at jhp@mbm-law.net if you have any questions on FMLA or any other business related issue.

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