Wait's Over: IRS Says Waiting Time Penalties Aren't Wages

We've long known that California law does not treat Labor Code Section 203 penalties as "wages." Earlier this year, the IRS published its view on how to treat those penalties (often referred to as "waiting time penalties" or WTPs) for purposes of federal income and employment taxes. A Chief Counsel Advice ("CCA") memo concludes that WTPs are not wages for purposes of federal income or employment tax.

Labor Code Section 203 makes a California employer liable if it has willfully failed to timely pay final earned wages to an employee whose employment has terminated. The offending employer must pay an amount equal to the employee's daily wages from the due date until the date of payment, up to a maximum of 30 days. WTPs can result so long as the employer knew what it was doing, the late payment occurred, and the timing of the payment was within the employer's control. The employer's intent to pay the wages on time would not be a defense. The only viable defense would be a showing that the employer, in good faith, disputed that any further final wages were owed on the due date.

When WTPs are paid, are they treated as wages? The California Department of Industrial Relations (DIR) website reports that WTPs are not wages, and thus an employer need not take deductions from a penalty payment.

But what is the view of the federal taxing authority—the IRS? The characterization of WTPs implicates several sections of the Internal Revenue Code. As to any payment of "wages," Sections 3101 and 3111 impose social security tax and Medicare tax (aka FICA tax), Section 3301 imposes federal unemployment tax, and Section 3402(a) requires income tax withholding. All these IRC sections define "wages" as remuneration paid for employment or services performed by an employee for his employer, with certain exceptions.

The General Counsel's CCA begins by recognizing that "wages" is applied broadly for income and employment tax purposes. In United States v. Quality Stores, Inc., 134 S. Ct. 1395 (2014), the Court held that severance payments made to involuntarily terminated employees are wages for FICA tax purposes, and in Social Security Board v. Nierotko, 327 U.S. 358 (1946), the Court defined "employment" to mean not only the work an employee performs, but the entire employer-employee relationship in which the employer pays compensation to the employee.

The CCA also considers contrasting California authority: the California Supreme Court, in Pineda v. Bank of America...