Are Payments to Settle an FMLA Claim Subject to Tax Withholding?

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.

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.

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.

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.