In a case that will affect thousands of employees
who have lost jobs through corporate downsizings,
restructurings or outright age discrimination, the U.S.
Supreme Court will decide whether back-pay and liquidated
damages awarded under the federal Age Discrimination in
Employment Act ("ADEA") are taxable. In Commissioner
of Internal Revenue vs. Schleier, the plaintiff claimed
age discrimination against United Airlines under ADEA. He
received a settlement for back-pay and liquidated damages of
$146,000, none of which was taxable, according to the Tax
Court and 5th Circuit Court of Appeals. The IRS has appealed
this decision to the Supreme Court.
The Supreme Court's decision could impact the
taxation of awards received by plaintiffs in traditional tort
litigation, where plaintiffs often receive punitive damages,
as well as compensatory damages, in personal injury cases.
Punitive damages serve to deter wrongdoing by the defendant;
they do not compensate the victim for actual injuries
suffered. Liquidated damages under ADEA serve the same
purpose as punitive damages: to deter any future misconduct
by an employer who wrongfully terminates employees.
There is a split between the circuit courts
regarding the taxation of punitive damage awards. In Hawkins
vs. U.S., an auto accident case, the plaintiffs won
$15,000 in compensatory damages and $3,500,000 in punitive
damages from Allstate Insurance. The 9th Circuit Court of
Appeals (which governs California) held that compensatory
damages were non-taxable, but the punitive damages were
entirely taxable. Other circuit courts and the Tax Court have
found, under Internal Revenue Code Section 104(a)(2), that
punitive damages received "on account of personal
injuries" were non-taxable. The Hawkins case has
also been appealed to the Supreme Court, but to date, the
Court has not decided whether to hear the case.
In the Schleier case, Erich Schleier was
an airline pilot for United Airlines for 20 years. Under
United's employment policy, he was forced to retire at age
60. United and Schleier agreed to settle the case and United
made a back-pay award of $73,000 and another $73,000 payment
for liquidated damages. The IRS claimed the full amount was
taxable, but the Tax Court ruled, and the 5th Circuit
affirmed, that none of the payments were taxable under 5th
Circuit affirmed, that none of the payments were taxable
under ADEA. Both courts relied on the same tax code
provision, IRC Sec. 104(a)(2), in holding that liquidated
damages were awarded on account of personal injury (age
discrimination) and were therefore non-taxable.
How the Supreme Court rules on the issue of
liquidated damages, and whether it decides that IRC Sec.
104(a)(2) includes or excludes punitive and liquidated
damages from its scope, could have an unwelcome impact on the
taxation of damages received by injured parties, whether or
not those damages were awarded under federal discrimination
statutes or state tort laws.
**NOTE: The information contained at this site is for
educational purposes only and is not intended for any particular
person or circumstance. A competent tax professional should
always be consulted before utilizing any of the information
contained at this site.**
