It’s my annual “Taxes from A to Z” series! If you’re wondering whether you can claim wardrobe expenses or whether to deduct a capital loss, you won’t want to miss it.
B is for Back Pay.
Back pay is pay or wages received in one tax year for employment attributable to an earlier tax year. You might receive back pay as the result of discussions with your employer, union negotiations, or a lawsuit.
The Internal Revenue Service (IRS) and the Social Security Administration (SSA) treat back pay as wages. However, there are some distinctions, depending on how you received the back pay.
For IRS purposes, wages will be reported – and taxes paid – in the year you received the wages.
For Social Security and benefit purposes, things are a bit more tricky:
- If the back pay is not awarded under a statute, wages are treated for Social Security and benefit purposes as they would be for IRS purposes: received in the year paid. This would include, for example, negotiations for increased pay not affected by a specific statute. It would also include delayed wage payments and retroactive pay increases resulting from union negotiation or payments under local ordinances or regulations.
- If back pay is awarded under a statute, the SSA credits that back pay in the year (more specifically, the quarter) the wages should have been paid. This is important because your benefits are figured back on certain criteria, including pay periods: if your back pay is not properly credited, your future benefits may be affected. Examples of statutes that might result in back pay include the Age Discrimination in Employment Act, the Americans with Disabilities Act, the Equal Pay Act, and state minimum wage laws.
In a lawsuit, back pay may be referred to lost wages: they are the same thing. For tax purposes, lost wages, including those recovered as the result of a discrimination or harassment suit, are considered compensatory damages. Compensatory damages are intended to make you whole, or put you back in the same position you would have been in if the harm had not happened. Those lost wages are still treated as wages, whether you get them as part of your regular pay or in a settlement or lawsuit: that means they are not excluded and are taxed as ordinary income. However, damages for personal injury, as well as interest, penalties, and legal fees which might be included with back pay awards are not considered wages.
(For more on legal settlements related to employment, click here.)
It’s the responsibility of your employer to report this correctly on your form W-2. If you have questions about how your pay is reported, check with your employer or payroll department.
For more Taxes A to Z, check out: