California Appellate Court Holds Employer Must Withhold Taxes On Back Pay

On June 26, 2015, a California appellate court rendered a precedential opinion1 that should hopefully put to rest the issue of whether an employer must withhold taxes on settlements or judgments made to former employees in employment-related litigation. The case, Cifuentes v. Costco Wholesale Corporation, is typical of many of these kinds of employment-related disputes. The plaintiff won a judgment for lost wages against his former employer, which then withheld federal and state payroll taxes from the award. The former employee claimed the judgment was not satisfied, citing to Lisec v. United Airlines.2

In Lisec, the court held that an employer could not unilaterally withhold taxes from a judgment because at the time of the payment, the worker was not performing any service for the employer, and thus was not seeking or receiving "wages." The court explained, "In the context of the narrow issue of withholdability, only, we determine that the economic damages award won . . . does not constitute 'wages' for 'services performed,' and therefore is not subject to withholding of state and federal income or Social Security taxes."3

In the more recent case at issue, the employer moved for satisfaction of the judgment. The trial court, believing itself bound by Lisec as authority of a higher court, denied the motion, and the employer appealed.

The appellate court began by setting forth its holding:

In the 23 years since Lisec, the Internal Revenue Service (IRS) and the vast majority of federal appellate courts have broadly interpreted the applicable Internal Revenue Code (IRC) provisions as requiring an employer to withhold payroll taxes for all "wages" arising from the employer-employee relationship, even after that relationship has terminated. Persuaded by these authorities, we adopt this prevailing view and conclude [the employer] properly withheld the payroll taxes.4

The court ran through the statutory provisions of the IRC and California law requiring withholding of taxes on wages.5 followed by a discussion of Social Security Bd. v. Nierotko.6 In Nierotko, the U.S. Supreme Court held that back pay awarded under the National Labor Relations Act to an employee who had been wrongfully discharged was "wages" under the Social Security Act. The Court noted that the back pay constituted remuneration and also held that the remuneration was for "employment" even though the back pay related to a period during which the petitioner did not perform any...