Age Discrimination Settlements Can Be Taxable

An example of such taxability can be found in the Tax Court Memo 2008-87. Michael Petit worked for Electronic Data Systems (EDS) until March 5, 2002, when he was terminated as a result of workforce reduction. The forty-seven-year-old was told that he was selected for the termination based on his age and salary. Subsequent to the workforce reduction, EDS hired a younger replacement. As a result, Mr. Petit sued EDS for age discrimination.

After the third day of trial, Mr. Petit and EDS decided to settle matters out of court. EDS agreed to pay its former employee $240,000. In 2003, EDS paid him half the settlement. The settlement provided that $44,250 was attributed to lost wages and was reported to Mr. Petit on Form W-2. The remainder of the payment was for “emotional distress, pain and suffering, and other non-wage damages.” EDS issued Mr. Petit Form 1099-Misc to report this payment.

On his timely filed Form 1040, Mr. Petit properly reported the W-2 as wages. On Line 21 (other income), he included the amount reported to him on Form 1099-Misc. However, he also entered the same amount as a negative “zero out” that portion of the legal settlement. He claimed that portion of the settlement was excludable under §104(a) specifically states that emotional distress is not to be treated as physical injury or sickness. The term “emotional distress” includes symptoms that result from emotional distress.

Even though Mr. Petit experienced headaches and irritable bowel syndrome as a result of the emotional distress stemming from his wrongful termination and the lawsuit, the amounts he received as compensation for this are not excludable. He was required to pay the tax on his tax deficiency. However, the court did not uphold the accuracy-related penalty because he acted with reasonable cause and in good faith.

The downsizing trend of companies seems to be devaluing the experience and knowledge of its older employees and relying on the inexperience of the younger generation to successfully run their businesses. How quickly these companies forget the hard work, loyalty and success its older employees have provided. This writer believes that older employees provide a greater value that seems to be lost in the employment marketplace.