Believe it or not, there are still a few precious forms of “income” that are not taxed. I’m not a tax attorney, but the last time I checked insurance proceeds are generally not taxed, nor are personal injury damages.
But what about a settlement from a wrongful termination action?
Back in the day, emotional distress damages were viewed as personal injury damages and were not taxed. Since the proceeds of a settlement are somewhat fungible (does the $100,000 represent loss of future income or emotional distress damages?), attorneys would put in the settlement that the damages were for emotional distress.
Those days are gone, and not only will you be taxed on your recovery, you will have payroll taxes withheld from any amount arising from back pay, future lost wages and any overtime or unpaid wage claims. In a sense it all comes out in the wash. Here’s what I mean. Let’s say you worked for a year and received your normal pay, with all of the concomitant withholdings. Now let’s say you were wrongfully terminated at the beginning of that year but found an even better job a year later, making your damages for that year the loss of wages (taking out of the equation for point of illustration all of the other damages to which you might be entitled). Your damages should be what you would have earned but for the wrongful termination, so you should not expect that these lost wages would be exempt from withholding.
However, the problem from a mental standpoint is that we all grouse about the amount that comes out of our checks every pay day, but when it all comes out of a settlement in one lump sum, then you really feel the pain.
So, what type of damages can you recover in a wrongful termination action, and what are the tax consequences? Rather than to reinvent the wheel, I direct your attention to this very fine summary of wrongful termination damages and tax consequences.