By Gregory J. Wartman
A Pennsylvania federal court has ruled that an employer doesn’t have to withhold federal payroll taxes from a settlement payment resolving a discrimination claim under the Family and Medical Leave Act (FMLA). The court reasoned that because the FMLA settlement proceeds weren’t wages, they weren’t subject to federal withholdings.
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Background
In 2006, Vincent Gunter began working as a millwright for Cambridge-Lee Industries, LLC (CLI). In 2013, CLI terminated him after a dispute over his absence from work because of a medical condition. Gunter alleged that he had attempted to take family and medical leave, but CLI frustrated those efforts and terminated him as a result of his leave request. He filed a lawsuit against CLI asserting a claim for discrimination under the FMLA, among other things.
The parties reached a settlement but couldn’t agree on whether the settlement proceeds should be reported to the IRS as wages on a W-2 or as Form 1099 income. In June 2016, Gunter filed a motion to enforce the settlement in a Pennsylvania federal court.
He took the position that the settlement proceeds weren’t wages, didn’t need to be reported to the IRS on a W-2, and shouldn’t have taxes withheld from them. CLI countered that the settlement amount constituted wages that it was obligated to report to the IRS and reduce by the appropriate amount of taxes.
Court’s analysis
The court agreed with Gunter, ruling that the settlement proceeds of his FMLA claim weren’t wages that the employer needed to report to the IRS or withhold taxes and other payroll deductions from.
While there have been several unpublished decisions on the issue (which the court didn’t have to follow), there hasn’t been a published decision in the U.S. 3rd Circuit Court of Appeals (which covers Delaware, New Jersey, and Pennsylvania) addressing the taxability of FMLA settlements. Nevertheless, the court reviewed two lines of unpublished federal court decisions.
The first line of cases follows the reasoning of Churchill v. Star Enterprises, in which the judge held that the FMLA requires the performance of services in order for any payment to constitute wages for withholding purposes. The judge ruled that IRS regulations suggesting a different result contradict the FMLA and are not enforceable.
The second line of cases follows the reasoning of Cheetham v. CSX Transportation, in which the court invited the IRS to offer its position on the issue. The IRS took the position that an FMLA award constitutes wages. The court agreed, ruling that the FMLA award was wages because the damages awarded equaled the amount of wages the employee lost. The court didn’t examine the IRS regulations in its opinion.
In Gunters case, the court agreed with the Churchill line of cases, finding “their emphasis on the unique language of the FMLA persuasive.” Accordingly, the court ruled that taxes and other payroll deductions didn’t need to be withheld from the settlement payment, and the settlement amount didn’t have to be reported to the IRS as wages.
Bottom line
This case highlights the split among the courts over whether settlements of FMLA claims constitute wages that you must report to the IRS and from which you must withhold wage taxes. The court’s decision provides guidance on the appropriate treatment of such settlements for the time being. However, the final answer is still unknown because the 3rd Circuit and the U.S. Supreme Court haven’t addressed the issue yet.
Gregory J. Wartman, and editor of Pennsylvania Employment Law Letter, can be reached at gwartman@saul.com or 215-972-7548.