{"id":37969,"date":"2016-03-31T19:26:17","date_gmt":"2016-04-01T00:26:17","guid":{"rendered":"https:\/\/content.findlaw-admin.com\/ability-legal\/uncategorized\/unexpected-tax-consequences-of-state-harassment-and.html"},"modified":"2016-06-02T07:48:09","modified_gmt":"2016-06-02T12:48:09","slug":"unexpected-tax-consequences-of-state-harassment-and","status":"publish","type":"corporate","link":"https:\/\/corporate.findlaw.com\/litigation-disputes\/unexpected-tax-consequences-of-state-harassment-and.html","title":{"rendered":"Unexpected Tax Consequences Of State Harassment And Discrimination Cases"},"content":{"rendered":"
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In 2003, the Washington State Court of Appeals added a new dimension to the employer\u2019s tax-related obligations with a decision that will affect discrimination and harassment cases all year round.<\/p>\n

The Law As it Used to Be<\/b><\/p>\n

Up until six months ago, employers who were sued for discrimination or harassment under Washington\u2019s Laws Against Discrimination, RCW Ch. 49.60 (\u201cWLAD\u201d), were liable for damages such as lost wages (past and future), medical expenses (such as expenses for counseling), job search expenses, emotional distress, prejudgment interest, and attorney\u2019s fees and costs. A new category of damages now exists, judicially established by Blaney v. Ass\u2019n of Workers<\/i>, 114 Wn. App. 80 (2002). In Blaney<\/i>, Division I of the Washington Court of Appeals expanded the categories of damages to include an award to compensate the employee for taxes on the other damages that the employee receives. Unless it is overturned by the Supreme Court, this new decision is important not only for cases that go to court, but also for placing a value on employee\u2019s claims in administrative proceedings, such as Human Rights Commission complaints.
\nEmployment Law Awards are Taxed Differently than Personal Injury Awards<\/p>\n

By way of background, personal injury awards generally are not taxable under IRC \u00a7 104. Attorneys used to apply this concept to settlements of employment disputes on the theory that the emotional distress<\/a> and its physical manifestations (loss of sleep, loss of consortium, depression, irritability, stomach disorders, etc.) were nontaxable personal injuries.<\/p>\n

Effective August 1996, however, Congress amended IRC \u00a7 104 so that emotional distress is not considered a physical injury or physical sickness even if such physical symptoms as insomnia, headaches and stomach disorders result from such emotional distress. This amendment to IRC \u00a7 104 makes it highly unlikely that an employment discrimination settlement or award can be allocated to avoid taxation. (There may be exceptions for damages caused by the employer making direct physical contact with the employee, such as beating the employee up.) Thus, in most cases the award or settlement is taxable and subject to withholding for income tax and FICA, even if the employee is no longer employed by the employer under IRC \u00a7 3402(a)(1); Reg. \u00a7 31.3401(a)-1; IRC \u00a7 3102; Reg. \u00a7 31.3121(a)-1(i).<\/p>\n

As a result of the change in the tax code, the additional lump sum income may put the employee in a higher tax bracket. In the Blaney<\/i> case, for example, the employee was subject to alternative minimum tax because of the effect of the IRS Code on the payment of attorney\u2019s fees awarded to her.<\/p>\n

The Blaney Holding and the Reasoning Behind It<\/b><\/p>\n

Under the reasoning behind the Blaney<\/i> decision, the effect of the taxability of harassment and discrimination damages<\/a> has been to leave the employee with a net award that can be substantially less than what the judge or jury intended, thereby not making the employee whole. The Blaney<\/i> court referred to a case where a Chicago police officer won a sex discrimination and harassment award of $300,000 and an award of attorney\u2019s fees and costs of almost $1 million. Her lawyer said in a newspaper article that the tax obligation made it so that the plaintiff did not receive any of the damages awarded to her and ended up owing the IRS $99,000.<\/p>\n

In the Blaney<\/i> case, the jury awarded the employee $638,764 in damages and the trial court awarded $235,625.38 for prejudgment interest, attorney and expert witness fees, and costs. The plaintiff moved for a supplemental judgment to compensate her for the federal tax obligations that she would incur upon receipt of payment of the judgment. A certified public accountant testified that the employee would have to pay an extra $244,753 in taxes as a result of winning her case against her employer. The trial judge denied the motion. The court of appeals affirmed the judgment on appeal and remanded the case for further proceedings on the plaintiff\u2019s claim for a supplement judgment and attorney\u2019s fees.<\/p>\n

The employer argued that the tax consequences of the award were not \u201cactual damages,\u201d but the court of appeals disagreed in light of the broad language of the statute and its purpose, which is to \u201cdeter and eradicate discrimination.\u201d The Blaney<\/i> court did not clearly address the fact that the plaintiff would have had to pay taxes on her earnings from her employer if she had been paid them in the normal course of her employment, instead of having them awarded to her as damages in a lawsuit. The court declined to decide whether adverse tax consequences arising from damages awards and\/or attorney\u2019s fees in cases other than those arising under the WLAD could serve as a basis for damages, but the court did leave open that possibility.<\/p>\n

Blaney\u2019s Effect \u2013 Practical Considerations<\/b><\/p>\n