Can taxes be deducted out of a settlement award if the recipient is no longer an employee of the company?

Question

I used to work for a company, but was terminated in late 2007. I hired a lawyer to fight them for me, because they were not paying overtime or giving lunch breaks. We reached a settlement (I regret this) for all the unpaid wages, plus "penalties", and I received a check in March of 2008. Taxes were deducted from the "unpaid wages" portion of it (about $1,300), but someone told me that this move was a malpractice, because someone can not be taxed after there is a seperation of employment. He said that if taxes were owed, than the company should have paid them out of their own pockets, and not out of my settlement award. According to him, the entire amount I was supposed to get counts as "damages" and is non-taxable to me. What do you think?

Answer 1

If the award was for back pay, yes they should take the withholding tax out.

Answer 2

Pretty much any of your income, including "damages" is taxable.  For that matter, your ex-employer could be liable if they didn't deduct at least FICA/Medi from your "unpaid wages".

Unfortunately, your friend is wrong here.  Before you spend all your settlement I'd recommend consulting a tax pro.  Otherwise you might have an unpleasant surprise next April.  :(

Answer 3

The award was effectively "wages" that had not been paid previously.  The fact that you had been formally separated from your position doesn't have anything to do with the situation.  The award was not "damages", it was "wages".  Had you been paid the overtime when it was worked, the effect would have been the same--it would have been wages. Employers do not paid taxes for employees.  The employer responsibility is to correctly withhold and remit the taxes.