After Jack Rivera settled his race discrimination cases against his employer for the “sum of forty thousand ($40,000) less all lawfully required withholdings”, he received a settlement check in the amount of $25,140 after his employer retained $14,860 as a ‘lawfully required withholding.’ The amount withheld included $10,000 in federal income tax, $3,060 in Federal Insurance Contributions Act (‘FICA’) tax, and $1,800 in state income tax.

Rivera cashed the check, but refused to dismiss his case, contending that the withholding was excessive and not required by law. He argued that the settlement proceeds were intended to reimburse him for personal physical injuries and should therefore be excluded from his gross income under 26 U.S.C. Sec. 104(a)(2). Rivera also argued that even assuming that the settlement proceeds represented lost wages, an award of back pay was not subject to tax withholding.

The Ninth Circuit held that Rivera’s settlement for race discrimination did not fall within the Internal Revenue Code exclusion for physical injuries or sickness. It held that there was neither an express designation of settlement amounts apportioned to physical injury, nor any evidence that this purpose was intended by the payor. Second, the panel held that “back pay and lost wages constitute ‘wages’ for taxable withholding purposes, and the district court properly held that these settlement payments were subject to withholding.

Case: Rivera v. Baker West, Inc., No 03-17261 (9th Cir. Dec. 13, 2005)

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