Second Circuit Confirms That Title VII Discrimination Awards are Taxable

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[authors: Michael S. Arnold, Christophe R. Difo, and Martha Zackin]

Recently, the Second Circuit Court of Appeals confirmed that awards of back pay and front pay under Title VII constitute “wages” under the Internal Revenue Code and are therefore subject to statutory withholding requirements.  Reasoning that both front and back pay awards are compensation for what the victim would have earned and paid taxes on but for the discrimination, the Court, in Noel v. New York State Office of Mental Health, held that an employer must withhold taxes (Federal, state and local) from judgments paid to an employee relative to claims for discrimination.  Indeed, an employer who fails to do so can be held personally liable for the amount it should have withheld.

While this result is hardly surprising, and is in line with decisions from other circuits, it is worth noting the court’s clear dissatisfaction with the process by which the employer paid the judgment and withheld the taxes.  Specifically, the employer simply withheld the taxes and made other deductions (i.e. for 401(k) contributions) without telling opposing counsel what it intended to do.  The Court made the perfectly sensible suggestion that where the parties may dispute whether withholding taxes and making deductions from the judgment is proper, they should talk to each other.  If they cannot agree, counsel should seek the court’s supervision, approval, and assistance.  Or, if the areas of disagreement do not become apparent until after the court enters the judgment, the parties should request that the court amend the judgment to reference withholdings and other deductions.  Finally, although the Court addressed the taxability of awards under Title VII only, its holding likely also applies to back and front pay awards under other discrimination statutes.