Settlement of a Benefit Claim - How to Report

[TaxLawyer1978]

A company incorrectly made contributions to a defined contribution plan on behalf of an employee for over 20 years.  The employee received  monthly statement and was told a year prior to retirement she had excess of $120K in benefits in the account.  Error was discovered and funds forfeited, but the company settled with her on the side to pay her the amount of the benefit.  

Question:  what kind of W2 compensation is this reportable as? Is this wages that go in box 1? It was agreed that 2/3 of the settlement amount would be W2 and 1/3 reported on a 1099-MISC.

Thanks in advance. 

[jpod]

I can't think of any reason why any portion would be a 1099-MISC item, but putting that aside anything that belongs on a W-2 would be a Box 1 item (plus boxes 3 and 5). 

[TaxLawyer1978]

thanks, I don't know about the 1099 part either but that's what the general counsel agreed to with the woman's attorney.  I'm only their ERISA counsel and was not part of the negotiation

[jpod]

Unfortunately that settlement agreement is not binding on the IRS.

[TaxLawyer1978]

yes I know.  I expressed my concern but the GC likes to do whatever he wants.  they did include an indemnification clause as regards any taxes that "should have been withheld from the payment"

[jpod]

Been in your shoes a million times.  The indemnification provision is nice, but the stuff will hit the fan only if the plaintiff doesn't pay her taxes, and by that point the indemnification may be worthless as a practical matter. 

[TaxLawyer1978]

that is very true.  i hate it when this GC does stuff behind my back. i then end up being the one they go to when stuff does hit the fan.  and they're terrible about managing their plans to begin with

[EBECatty]

Not sure if this will help, but the IRS has a 20-page memo on the topic of taxation of employee claims:

https://www.irs.gov/pub/lanoa/pmta2009-035.pdf

Might not do any good in this case, but we've used it before proactively to nudge the plaintiff's attorney in the right direction. Generally I've seen the plaintiff's attorney wants everything on a 1099 regardless of the claim.

[Larry Starr]

I would suggest it all belongs on a W-2; to put any of it on a 1099 (of any kind) is to avoid the medicare tax on the amount in excess of the SS taxable wage base, which puts the employer at significant risk. It is compensation in lieu of and settlement for wages that the individual might have otherwise demanded if she knew she wasn't really getting the retirement funds.  It is in the nature of back pay.

I would also suggest that none of this is the responsibility of ERISA counsel since it is not payment from an ERISA plan.  Assuming the correction to the plan was made properly, the ERISA counsel should be out of the issue.  Of course, that's no excuse for the GC doing it wrong, which he/she is clearly doing.