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

When you file a civil lawsuit against a former employer for violating the Family Medical Leave Act (FMLA), the employer may decide to settle the dispute out of court to save on costs defending against the lawsuit. When you eventually receive the settlement payment, the IRS expects to see it on your tax return as taxable income. And although your settlement is not be subject to withholding, you need to make estimated tax payments instead.

FMLA Claims

The FMLA provides certain employees who put in sufficient time with an employer to take up to 12 weeks of unpaid time off to deal with their medical illness or the illness of a close family member. Under the statute, the employee is protected from retaliation by an employer for taking the time off and is eligible to return to her position after the medical leave. When your employer interferes with these federal rights, such as not allowing you to return to work or discriminates against you upon your return, you have sufficient basis to sue your employer for the damages you suffer.

FMLA Lawsuit Taxation

The only type of lawsuit settlements that are tax-free are payments you receive to compensate you for a physical injury or illness you suffer as a result of the defendant's actions. However, all other types of settlements, including money you receive for your FMLA claim, are fully taxable. In other words, your FMLA settlement compensates you for employment-relates damages you suffer. And when dealing with employment, the damages ultimately cover lost wages that are subject to tax. If part of your FMLA award includes interest, punitive damages or compensation for mental anguish, the IRS still requires you to include those amounts in taxable income.

Withholding Settlement Payments

Although your FMLA award relates to your employment, the compensation you receive is not ordinary salary or wages, and therefore, is not subject to withholding by your employer. However, if the award is at least $600, the employer must report the total settlement payment to you and the IRS on a 1099-MISC rather than a W-2. Depending on how much you settle for, you may need to make estimated tax payments. This is only necessary if after taking into account the tax withheld on your other taxable earnings during the year you will still have to pay at least an additional $1,000 in tax with your annual return.

Deducting Legal Fees

If the basis of your FMLA case is for discrimination by your employer, the IRS will allow you to fully deduct all of the legal fees you pay to attorneys that assist with your FMLA lawsuit. This is an exception to the general rule that you can only take legal fees as a miscellaneous itemized expense subject to the 2 percent adjusted gross income limitation. So rather than reporting the expense on Schedule A, you can claim the deduction as an adjustment to income on the first page of your Form 1040.

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