Paul L. Caron at the TaxProf Blog reported on an interesting 3rd Circuit case, Eshelman v. Agere Systems, Inc. Basicially, an employer fired an employee in violation of the Americans With Disabilities Act (the “ADA”). The District Court, the trial court, held that the employer had to pay not only the back pay it owed to the employee, but also had to pay an additional amount to cover her additional taxes. Since the lump-sum back-pay payment would put the employee into a higher tax bracket than she would have otherwise been in had she been continuously employed the whole time, the District Court ruled that the employer had to pay the additional amount the employee would have to pay in taxes.
The 3rd Circuit affirmed this ruling, holding that the only way the employee could be “made whole” for the pay she should have received but didn’t because she was fired illegally, was to have her additional taxes paid by the employer as well. Otherwise, because of the higher tax rate that she would have paid at the time of the back-pay payment, she would end up with less than she would have, if she’d been paid smaller amounts over a longer period of time.
Giving an employee back pay, but forcing her to pay extra taxes because of it, reminds me of the time Oprah Winfrey gave everyone in her audience both a new car, and an obligation to pay income taxes on the receipt of that car. They had to either come up with up to $7,000 of their own money to pay for the income taxes on the car, forfeit the right to get the car, or sell the car (at a used car price) to pay the taxes, and keep the difference.
Thanks but no thanks. I can definitely see the logic behind awarding an employee an additional amount to pay the higher-bracket taxes on the back pay. If you’re going to give someone money or something of monetary value, whether as a gift or because you have to, it’s only fair that you also pay the additional tax liability you’re causing the person by giving the gift/money!