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Would a settlement agreement with a former employer that

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consisted of part unpaid wages...
Would a settlement agreement with a former employer that consisted of part unpaid wages as one check and another check for compensatory emotional distress be entirely taxable, or would the part related to compensatory emotional distress be non-taxable. This is for someone who has MS that worsened under discriminatory conditions and was forced to leave under the semblence of downsizing but it was really targeted discrimination.
Submitted: 1 year ago.Category: Tax
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11/2/2016
Tax Professional: Robin D., Senior Tax Advisor 4 replied 1 year ago
Robin D.
Robin D., Senior Tax Advisor 4
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Tax Professional: Robin D., Senior Tax Advisor 4 replied 1 year ago

The phrase “on account of” is important. Many cases have been litigated where the taxpayer has attempted to exclude from income awards based on emotional distress. Overwhelmingly, courts have held that in order for damage awards to be excluded from gross income they must have been received on account of personal physical injuries or physical sickness.

To be excludible, an emotional distress recovery must be on account of (attributed to) personal physical injuries or sickness unless the amount is for reimbursement of actual medical expenses related to emotional distress that was not previously deducted under IRC § 213.

The settlement would not be excluded from tax.

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Customer reply replied 1 year ago
Hi, so if the physical condition is pre-existing and alleged to have been made worse by the actions of the employer and that causing emotional consequences...in the case of a pre-existing verified disability, it is still taxable? I'm citing from the IRS: "damages you receive for emotional distress due to a physical injury or sickness are treated as received for the physical injury or sickness. Do not include them in your income." I'm citing from IRS publication 525 under "court awards and damages" section "emotional distress".
Tax Professional: Robin D., Senior Tax Advisor 4 replied 1 year ago

Yes, it is still taxable.

The physical injury or sickness would need to be the main reason for the settlement.

The sickness in this case was not caused by the employer.

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