If I accepted a settlement to not file a lawsuit does the payment still count as income for taxes?

I am not entirely clear on your factual situation. I understand that you threatened to file suit but settled your claim before you had to file it. I cannot tell, though, what the dispute about, although it sounds like your employer had not paid you and then agreed to do so to settle the suit.

Normally, a settlement has no effect on the taxability of the money received as a settlement. For example, if your employer pays you wages, you owe tax on those wages and you pay the tax when your employer withholds them and pays them on your behalf. Suppose, though, that your employer fails or refuses to pay you wages until you sue or threaten to sue and then pays them to settle or avoid the suit. In that case you still owe tax on the amount that you receive and are responsible for paying it.

What I think may be happening is that your employer does not want to withhold taxes from settlement because, if it did, it would have to match the social security taxes that it takes out. In other words, it sounds like your employer wants to cheat either you or the IRS by not paying its taxes at all, or making you pay tax on that amount as self employment or independent contractor earnings. If that is the case, it is a pretty crappy move by your employer.

That said, I am licensed only in Ohio, I don't have a complete picture of what is going on and I am not a tax lawyer, which is what you need. So the best advice I can give is to retain a tax lawyer or a CPA. In addition, this article might help:

http://www.myemploymentlawyer.com/Tax-Issues-in-Settlement-C-Royer-10-5-2007-1.htm

posted by Neil Klingshirn  |  Feb 23, 2021 5:05 PM [EST]