It’s increasingly common for lawyers to try to shield payments in employment cases from taxes by characterizing them as payments for “personal injury.” After a recent decision by a California appellate court, they shouldn’t.
Payments for personal, physical injuries are typically exempt from taxes, whereas payments for non-physical injuries such as lost income and emotional distress are not. But lawyers still try to characterize employment claims like harassment or wrongful termination as claims for personal injuries. That practice may change after Rodriguez v. Cho, a recent appellate court case that held that claims for wrongful termination are clearly not personal injury claims free from taxation. Mischaracterizing employment claims to try to avoid taxes can get both litigants and their lawyers into serious trouble with the IRS. After Rodriguez, payments for employment claims should be assumed to be taxable unless they involve unique physical contact, such as assault, or physical injury for which there is medical confirmation.