An award of attorney fees to an employee will cause a huge tax bill. When a postal indebtedness is repaid, how will the taxes paid by the employee be returned? More employees will need assistance preparing their tax returns.
IRS Reporting Requirements of Attorney’s Fees, Back Pay, or Wages.
The purpose of this notice is to ensure that employees are aware of the Internal Revenue Service (IRS) income reporting requirements when attorney fees are awarded.
In 2005, the IRS issued regulations that changed the manner in which attorney’s fees awards are to be treated for tax reporting purposes based upon the Supreme Court’s decision in Commissioner v. Banks, 125 S. Ct. 826 (2005). Previously, when a payment of an attorney’s fees was made directly to the attorney, only the payment to the attorney was reported to the IRS on Form 1099-MISC, Miscellaneous Income. In Commissioner v. Banks, the Supreme Court concluded that attorney’s fees awarded as part of a plaintiff’s settlement are gross income to the plaintiff just like any other economic gain. Thus, pursuant to Internal Revenue Code Section 6041(a) and 6045(f), these fees cannot be excluded from the plaintiff’s gross income for tax purposes by assigning the gain in advance to another party, such as the plaintiff’s attorney.
Separate Attorney Fees
Accounting Services (AS) will report any payment of attorney’s fees as income to the employee on the employee’s Form 1099-MISC. Further, AS also will report any payment of attorney’s fees made directly to an attorney on the attorney’s Form 1099-MISC.
Back Pay or Wages
Where the payment to the employee constitutes back pay or wages, the entire amount (including any amount that the employee may subsequently pay to his or her attorney from the back pay or wages) will be reported on the employee’s Form W-2 (and will be subject to employment tax withholding). Where the employee alone is to receive a check from the Postal Service™ (and the employee is required to pay his or her attorney from that amount), AS will not issue a Form 1099-MISC to the employee’s attorney.
Payment Jointly to Employee and Attorney
If the payment is issued to both the employee and the attorney, then AS must report the entire amount of the payment (assuming that the payment is not for back pay or wages due the employee) on Form 1099-MISC for the employee. In addition, AS will report the entire amount of the payment (less any withholding) to the attorney on Form 1099-MISC.
— Payroll, Controller, 11-4-10
Salary Overpayment Indebtedness — Year End Tax Treatment
When a postal employee is overpaid, USPS establishes an account receivable for the overpayment and initiates the collection of the debt from the employee through the process described in either ELM 450, Collection of Postal Debts from Nonbargaining Unit Employees, or ELM 460, Collection of Postal Debts from Bargaining Unit Employees. USPS initially bills the employee for the net value of the overpayment, meaning federal, state, and FICA/Medicare taxes are not part of the bill.
However, IRS regulations require that if an employee has not fully repaid the overpayment by the end of the tax year (December 31) in which the overpayment was made, the employer must report the unreturned value of the overpayment as taxable income on the employee’s W-2. Additionally, the employee and employer must pay appropriate federal, state, and FICA/Medicare taxes on the remaining value of the debt.
To administrate this IRS regulation, USPS establishes an additional account receivable at the close of the tax year for the value of the taxes the employee owes related to the unpaid debt. The debt collection processes in ELM 450 and ELM 460 are utilized to collect the additional tax-related debt.
— Payroll, Controller, 11-18-10