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Lev
Lev, Tax Advisor
Category: Tax
Satisfied Customers: 22351
Experience:  Taxes, Immigration, Labor Relations
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I was involved in an employment dispute with my employer, a

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I was involved in an employment dispute with my employer, a governmental agency. We reached a settlement. The terms of the settlement required the employer to pay me $25,000 in "severance pay." They reported the payment on a 1099. No taxes were withheld. This sum was in addition to pay received for work done and was not remuneration for any tasks performed (in other words, not on an independent contract for services thereafter provided). I did not work for the balance of the year. IRS is now claiming that I owe "self employment taxes" on the $25,000 severance pay settlment. Are t hey correct?
Submitted: 6 months ago.
Category: Tax
Expert:  Lev replied 6 months ago.

Lev :

Hi and welcome to our site!
First of all - let understand WHY the IRS "thinks" that settlement is subject of self-employment taxes. That is based on HOW that payment was reported to the IRS.
If it was reported in box 7 as non-employee compensation - that is what triggers self-employment tax issues.

Lev :

Box 3 of Form 1099-MISC is used to report other income that is not reportable in one of the other boxes on the form. Generally, all punitive damages (even if they relate to physical injury or physical sickness), any damages for non-physical injuries or sickness, liquidated damages received under the Age Discrimination in Employment Act of 1967, and any other taxable damages are required to be reported in Box 3. Generally, all compensatory damages for non-physical injuries or sickness (for example, emotional distress) arising from employment discrimination or defamation are reportable in Box 3. However, if a taxpayer receives an award of back pay that constitutes wages, it generally would be reportable on Form W-2, not Form 1099MISC.

Lev :

So to conclude - because you was not in business and that compensation is NOT your business income - it is NOT subject of self-employment tax, however.
If that amount represents a "severance pay" - which is considered wages - it is subject of employment tax - partly paid by your employer and partly by you - in this case your employer must report the settlement amount on W2 not on 1099MISC,
But if that amount amount does not represent wages - but damages ( including punitive damages) resulted from improper actions of your employer - neither self-employment nor employment taxes are due - and in this case the payment is reported in box 3 form 1099MISC.
See for reference - http://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/Lawsuits,-Awards,-and-Settlements-Audit-Techniques-Guide

Expert:  Lev replied 6 months ago.
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Expert:  Lev replied 6 months ago.
Just in case you were not able to use the chat - I am switching to Q&A mode and posting the answer below.
Please feel free to communicate if you need any clarification or have other tax related issues.

First of all - let understand WHY the IRS "thinks" that settlement is subject of self-employment taxes. That is based on HOW that payment was reported to the IRS.
If it was reported in box 7 as non-employee compensation - that is what triggers self-employment tax issues.

Box 3 of Form 1099-MISC is used to report other income that is not reportable in one of the other boxes on the form. Generally, all punitive damages (even if they relate to physical injury or physical sickness), any damages for non-physical injuries or sickness, liquidated damages received under the Age Discrimination in Employment Act of 1967, and any other taxable damages are required to be reported in Box 3. Generally, all compensatory damages for non-physical injuries or sickness (for example, emotional distress) arising from employment discrimination or defamation are reportable in Box 3. However, if a taxpayer receives an award of back pay that constitutes wages, it generally would be reportable on Form W-2, not Form 1099MISC.

So to conclude - because you was not in business and that compensation is NOT your business income - it is NOT subject of self-employment tax, however.
If that amount represents a "severance pay" - which is considered wages - it is subject of employment tax - partly paid by your employer and partly by you - in this case your employer must report the settlement amount on W2 not on 1099MISC,
But if that amount amount does not represent wages - but damages ( including punitive damages) resulted from improper actions of your employer - neither self-employment nor employment taxes are due - and in this case the payment is reported in box 3 form 1099MISC.
See for reference - http://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/Lawsuits,-Awards,-and-Settlements-Audit-Techniques-Guide
Lev, Tax Advisor
Category: Tax
Satisfied Customers: 22351
Experience: Taxes, Immigration, Labor Relations
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