California employment lawyers have long argued about whether (or not) an employer can pay a settlement to an employee and issue a 1099 to the employee for the settlement amount.
Most employers insist on issuing the settlement check subject to usual payroll tax withholdings, reported on a W-2. However, in many cases, to maximize the amount of the settlement check, the employees tries to convince the employer to issue the settlement check without any withholdings and to report the transaction on a 1099. This back-and-forth often delays and sometimes even prevents the parties from settling their dispute.
In Cifuentes v. Costco Wholesale Corp, a California court recently weighed in on this issue. In Cifuentes, the Court determined that employers must withhold payroll taxes from settlement or judgement that involves the payment of “lost wages” — meaning back-pay or front-pay — to the employee. In reaching this decision, the Cifuentes Court openly questioned the correctness of a prior 1992 state court opinion, Lisec v. United Airlines, Inc., which reached the opposite conclusion. After examining the history of wage taxation from 1992 to the present, the Cifuentes Court ruled that Lisec was no longer persuasive or controlling authority. Now, according to Cifuentes, the modern trend as required by the IRS and current federal laws and regulations was to require the withholding of payroll taxes from all settlements and judgments involving the payment of lost wages.
You can read the Court’s decision in Cifuentes v. Costco Wholesale Corp. here.