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Settlement payment to terminated employee

Hi all, I read a previous post regarding this issue and have concluded that a settlement payment may or may not need to have taxes withheld depending on what the settlement is for. My question is regarding the terminated status. If the employee was terminated almost 5 years ago, would taxes still need to be withheld?


  • If the settlement constitutes wages, yes. Does not matter whether the person is still an employee or paid through an attorney. It also does not matter what the parties call it or how they allocate it - if it is compensation for services, it is subject to withholding. The IRS audit guide indicates that both parties have an interest in minimizing the tax effects so there is no arms length negotiation of the allocation. Items that are not compensation for services, for example, damages for personal injury, are not includible in gross pay.

    If you still have it, use the most recent valid W-4. Also Social Security and Medicare should be withheld from the wage portion of any settlement. If it is back pay, all taxes are withheld for the year paid. However, if the payment is the result of a statutory award of back pay such as under a civil rights or labor law, the employer should notify the Social Security Administration of the amounts and quarters the award covers so that the SSA can assign the amounts to the appropriate periods for benefits determination purposes.