Every candidate talks about taxes, and how the tax code is full of loopholes. One area of tax unfairness involves taxation of employment discrimination damages. An employee who complains of employment discrimination often has to wait a few years before the case is heard. In the meantime, her damages have piled up. If the employee obtains a settlement or an award at trial, it often includes (1) damages to compensate for several years of unpaid or underpaid compensation, and (2) non-economic damages, such as emotional distress. Once the money is paid, the employee is taxed on the lump sum as though it were all earned as wages in a single year. The tax bite is hefty.
The Civil Rights Tax Relief Act, introduced last week, is designed to make the tax treatment fairer in two ways. One would treat emotional and physical injuries caused by the discrimination as not taxable. This is how personal injury cases treat monetary compensation for pain and suffering. There is no logical reason why money for an auto accident should be tax free while money for discrimination should be taxed.
The second prong would let the employee use income averaging to stretch out the payments that are intended to make up for lost compensation. The employee would pay tax on the backpay and front pay, but all at the tax rate that would apply if the income were apportioned by year. In other words, the employee is not immediately sent to the top tax bracket for the one year in which he received the payment meant to compensate for seven years of discrimination.
Interestingly, the bill enjoys the support of both employee advocates and business groups. Settlements and sometimes awards are made with the tax consequences in mind. If the tax consequences are eased, settlements will be easier to reach, and can be lower if the tax consequences are not so severe.