In Rivera v. Baker West, Inc., the Ninth Circuit in an opinion by Judge Bybee considered the plaintiff/appellant's two contentions regarding the District Court's ruling that the employer was correct in paying taxes out of the settlement money for a Title VII claim:
The appellant's position was this: "first, he argues that the settlement proceeds paid by Baker were intended to reimburse Rivera for personal physical injuries and should therefore be excluded from his gross income under 26 U.S.C. § 104(a)(2); second, he argues that, even assuming the settlement proceeds represent lost wages, an award of back pay under Title VII is not subject to income tax withholding."
The Court ruled that "the district court did not clearly err in finding that the settlement proceeds were not intended to compensate for personal physical injuries, but instead represented lost wages," and "[b]ecause the district court reasonably classified the settlement proceeds as back pay, the district court properly held that Rivera’s settlement proceeds were subject to withholding."
The Court noted that the settlement agreement "does not expressly state that the damages paid to Rivera compensate for personal physical injuries or physical illness" and explained that "if there is no express evidence of the parties’ intent in the settlement agreement, we look to the intent of the payor." There was language in the settlement agreement "stating that Baker would pay Rivera $40,000 'less all lawfully required withholdings.'"
In concluding that the wage part of a settlement agreement under Title VII is subject to withholding taxes, the Court cited the Fourth Circuit's opinion in Hemelt v. United States, 122 F.3d 204 (4th Cir. 1997), along with opinions from the Sixth and Eighth circuits.