Court of Appeal: OK for Employers to Withhold Taxes on Lost Wages Verdict / Settlement

When an employee wins a wrongful termination lawsuit, or settles a case, part or all of the recovery usually will be compensation for lost wages.  After a verdict, though, the court enters a judgment.  Usually interest accrues from the date of the judgment, and continues to accrue unless the judgment is "satisfied."  Additionally, employees may enforce the judgment with collection proceedings.

Employers must withhold taxes from wages, even wages recovered during a lawsuit.  If the employer does so an pays the "net" wage loss, after taxes, is that sufficient to satisfy a judgment?  For years, the answer to that question in California was "no."  At least, that's what one court of appeal had held. The employer would have to "gross up" the amount to include the witthholdings, a significant overpayment, or it would have to pay the gross sum and issue a 1099 to the employee, which could result in under-withholding penalties.

Well, another court of appeal has weighed in, and has now held that employers may satisfy a judgment by paying the net sum, after required tax withholding.

In the current case, Cifuentes recovered lost wages against Costco.  Costco withheld taxes from the recovery and sought a "satisfaction of judgment" ruling from the trial court. The court denied the motion, bound by the prior decision I mentioned, which is Lisec v. United Airlines, Inc. (1992) 10 Cal.App.4th 1500.

Costco appealed, and the court of appeal agreed with Costco that Lisec was wrongly decided.

When Costco paid the judgment, it had two alternatives. It could follow Lisec and risk liability to the IRS and other taxing authorities for the amount of tax it failed to withhold plus penalties. Or it could follow the prevailing federal view and risk a judicial declaration that the judgment is not satisfied. We conclude it chose correctly. Costco's potential exposure for failing to withhold the payroll taxes outweighed the inconvenience to Cifuentes of seeking a refund for the excess withholding.
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The IRC requires that taxes be withheld from wages because it is the most reliable means of assuring that they are paid. (See Baral v. United States (2000) 528 U.S. 431, 436-437.) By adopting the prevailing federal view, we ensure that California employers who withhold taxes from awards of lost wages are not penalized "for fulfilling [their] legal duty." (Noel, supra, 697 F.3d at p. 212.) Moreover, our decision does not leave plaintiff employees without an adequate remedy. They may seek a refund from the taxing authorities for any amounts withheld in excess of their tax obligation. (Rivera, supra, 430 F.3d at p. 1260.) As observed in Thomas v. County of Fairfax (E.D. Va. 1991) 758 F.Supp. 353, 367, footnote 26, "[c]ourts do not disagree . . . that tax authorities must receive their due, and that neither plaintiffs nor defendants should receive windfalls." 

So, this decision creates a split in the courts of appeal, which could result in California Supreme Court review.  Or the Sixth District could re-examine Lisec.  We will have to see.

In the meantime, this is a good case for justifying withholding taxes whether after trial or as a result of settlement. 

The case is Cifuentes v. Costco Corporation and the opinion is here.