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

When they're part of an FMLA settlement, lost wage payments are taxable.
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The Family Medical Leave Act requires employers with 50 or more employees to grant 12 weeks of unpaid leave to an employee in the event of a birth, adoption or serious health condition -- whether it's the employee or someone in her immediate family who is ill or injured. A violation of the FMLA law can lead to a civil lawsuit by an employee, and a settlement can bring about taxable income to the plaintiff. For FMLA cases and other civil lawsuits, the Internal Revenue Service is fairly clear about how settlement money should be reported and how it is taxed.

Division of Proceeds

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.

Lost Wages

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.

Exempt Settlement Benefits

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.

Other Expenses

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.

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