Our justice system is best served when opposing parties can settle their disputes without costly litigation. Employees and employers, however, often find it difficult to resolve workplace claims because of the excessive and unfair tax treatment of settlements and awards in such cases.
Parties to these disputes must take into account prior to settlement: 1) the tax an employee must pay on damages for non-economic harm that he or she suffered (e.g., due to egregious sexual harassment); and 2) the tax on lump sum recoveries for multiple years of front and back pay, which are now unfairly taxed in the year of receipt.
To address these problems, on September 17, 2015 Representatives John Lewis (D-GA) and Jim Sensenbrenner (R-WI) introduced H.R. 3550, the Civil Justice Tax Fairness Act of 2015 (CJTFA). Senators Susan Collins (R-ME) and Ben Cardin (D-MD) introduced the Senate bill, S. 2059. The CJTFA has been introduced in previous Congresses as the Civil Rights Tax Relief Act and the Civil Rights Tax Fairness Act.
Over the years, Senators and Representatives on both sides of the aisle, including chairs and ranking members of the Senate Finance and House Ways and Means Committees, have cosponsored this bill.
The CJTFA is endorsed by organizations representing both employees and employers because it promotes early and fair settlement of employment cases and helps reduce costly litigation. Organizations as diverse as the American Association for Justice, the American Bar Association, and the Association of Corporate Counsel, support the CJTFA.
The Present Tax Law Is Unfair, Arbitrary & Confusing
With the enactment of the Small Business Job Protection Act of 1996 (P.L. 104-188), non-economic damages recovered in cases that do not arise from a physical injury—including employment cases brought under civil rights laws and other worker protection statutes—became taxable. Non-economic damages compensate people for pain, suffering, and related health effects. As a result, current tax law penalizes workers who successfully vindicate their workplace rights under various federal, state, and local laws. These laws include Title VII of the Civil Rights Act of 1964, the Americans with Disabilities Act Amendments Act, the Family and Medical Leave Act, whistleblower protection statutes, and those regulating any aspect of the employment relationship.
In addition to taxing non-economic damages unfairly in these cases, workers who recover compensation for wages over multiple years in one lump sum must pay taxes at higher rates because the payment is taxed entirely in the year received. For example, members of the armed services who recover several years of back pay under the Uniform Services Employment and Reemployment Rights Act (USERRA) are required to pay taxes on the entire amount for the year in which they receive payment, thus moving them into a higher tax bracket. The tax consequences for anyone receiving a lump sum recovery for lost wages in one year can be onerous. If the employer had not acted unlawfully, the worker’s wages would have been earned and paid in the usual course of employment, and the worker would have been taxed at a lower rate.
The Civil Justice Tax Fairness Act Restores Equity Among Taxpayers
There is no rational justification for taxing non-economic damages in workplace cases but not in slip and fall cases. Moreover, the tax laws conflict with the intent of Congress that workers should be “made whole” when their rights are violated. They also penalize employers who want to resolve workplace claims because they must “gross up” their settlement offers to compensate workers for the additional taxes they must pay on their recoveries.
The Civil Justice Tax Fairness Act of 2015 resolves these inequities by:
- Restoring the long established tax-free treatment of non-economic damages in unlawful discrimination cases (including other employment and civil rights claims) by excluding them from gross income;
- Mitigating the unfair tax burden imposed on workers receiving lump sum payments for front and back pay by allowing income averaging for those recoveries; and
- Providing an exemption from the alternative minimum tax (AMT) for any tax benefit resulting from income averaging in these cases.
Join The NELA-Led Coalition To Restore Tax Fairness
Since the enactment of the Small Business Jobs Protection Act of 1996, NELA has made enacting the Civil Justice Tax Fairness Act (formerly known as the Civil Rights Tax Relief Act and Civil Rights Tax Fairness Act) its top legislative priority.
NELA achieved partial victory when, in October 2004, the CRTRA provision ending double taxation of attorneys’ fees in employment discrimination, civil rights, and under other workplace cases was passed as part of the American Jobs Creation Act of 2004 (P.L. 108-357, Section 703). The enacted provision permits an above-the-line deduction of attorneys’ fees, meaning that payments will not be subject to the Alternative Minimum Tax or to the 2% floor on miscellaneous deductions. It applies to settlements and awards made, and fees and costs paid, after the date of enactment (October 22, 2004).
To get involved in advancing equality and justice in the American workplace by advocating for the CJTFA, contact NELA Legislative & Public Policy Director, Laura M. Flegel at firstname.lastname@example.org.