OFFICE OF THE GENERAL
|MEMORANDUM GC 00-07
||September 22, 2000
TO: All Regional Directors,
Officers-in-Charge and Resident Officers
FROM: Leonard R. Page, General
SUBJECT: Reimbursement for Excess
Federal and State Income Taxes which Discriminatees Owe as a Result of
Receiving a Lump-sum Backpay Award
This memorandum sets forth guidance as to
the proper remedy Regions should seek in all pending and future cases in
which a discriminatee would owe excess federal and state income taxes as a
result of receiving a lump-sum backpay award.
Under current tax laws, discriminatees who
receive lump-sum backpay awards covering a multi-year backpay period are
likely to incur higher federal and state income taxes than they would have
had they received their wages in due course. This is because the Internal
Revenue Service (IRS) considers back pay awards to be taxable income1
earned in the year the award is paid, rather than over the previous
years in which a discriminatee would have earned the wages but for the
unlawful discrimination.2 Until 1986,
federal regulations, as well as many state tax codes, incorporated income
averaging for large year-to-year differences in earned income, including
lump-sum backpay awards. By effectively spreading income over the period
of time the award was meant to compensate, the income averaging provision
more evenly distributed taxable income and drove down a discriminatee's
total tax liability. In 1986, however, Congress repealed the income
averaging provision, and many states have since followed suit.3
Thus, a lump-sum backpay award is likely to
move discriminatees into a higher tax bracket, significantly impairing the
Board's ability to reinstate the status quo ante without a
mechanism to compensate discriminatees for the extra taxes. Accordingly,
in any pending or future case Regions should seek a "tax
component" to a backpay award obligating respondents to reimburse
discriminatees for extra federal and state income taxes that would result
from a lump-sum backpay award.
The Board last addressed the propriety of a
tax component to a backpay award in the mid 1980s in Hendrickson Bros.,
Inc.4 and Laborers Local 282
(Austin Co.).5 In both these cases,
the Board rejected proposed tax components solely because the
discriminatees could avail themselves of the then-extant income averaging
provision.6 Thus, the Board has not had
occasion to address the propriety of a tax component since the repeal of
The Board's authority to reinstate the status
quo ante derives from its broad Congressional mandate under Section
10(c) of the Act to determine the proper scope of its remedial orders,
particularly with respect to affirmative relief.7
This wide discretion is necessary insofar as Congress, in enacting the
National Labor Relations Act, could not "define the whole gamut of
remedies to effectuate these [statutory] policies in an infinite variety
of specific situations."8 Thus, by
its plain meaning, Section 10(c) is a grant of authority to the Board to
devise remedies for various unfair labor practices, so long as such
remedies "effectuate the policies of the Act."9
In addition, other administrative agencies,
as well as the federal courts, have incorporated tax components into
remedial schemes under other employment statutes. For instance, in Sears
v. Atchison, Topeka & Santa Fe Railway Co.,10
the Tenth Circuit held that a tax component to a 17-year, lump-sum backpay
award in a racial discrimination lawsuit under Title VII was an
appropriate exercise of the trial court's "wide discretion in
fashioning remedies to make victims of discrimination whole."11
Among the "special circumstances" which favored a tax component
were the protracted nature of the litigation and the ineligibility of the
estates of the deceased discriminatees (of whom there were many) to take
advantage of the then-extant income averaging provisions of the IRS tax
More recently, in O'Neill v. Sears,
Roebuck and Company, the district court appended a tax component to a
lump-sum backpay award in order to satisfy the "make-whole purpose
governing remedies for employment discrimination cases arising under the
[Age Discrimination in Employment Act]".13
The court noted that the discriminatee would have earned the backpay had
the employer not unlawfully terminated him.
Therefore, he is entitled to receive the
value of front pay and backpay that he would have received over his
worklife. That value is diminished when the lump sum is taxed at a
The Equal Employment Opportunity Commission
has similarly sought tax components to backpay awards both in federal
district court (e.g., EEOC v. Joe's Stone Crabs, supra) and in its
own administrative hearings. In Kalra v. Pena, the Commission
remanded a request for a tax component to an EEOC ALJ for a determination
of the amount of the "pecuniary losses incurred as a result of the
increased tax burden of a lump-sum backpay award made as a result of the
admitted discrimination."15 The
Commission's reimbursement order further comports with the EEOC's
"prevailing practice in the settlement of Title VII suits which
commonly include an amount to offset the plaintiff/taxpayer's increased
Accordingly, to fully effectuate the Act's
goals, Regions should seek a tax component in all pending and future cases
to reimburse discriminatees for the excess federal and state income taxes
they would owe from receiving a lump-sum backpay award covering more than
one year of backpay. Such a tax component should reimburse discriminatees
only for their increased tax liability, equal to the difference
in taxes discriminatees would owe upon receipt of a lump-sump payment and
the taxes they would have owed had they not been unlawfully terminated.
Further, in order to notice parties of this change in position, tax
components should be specifically pled in the complaint and/or backpay
specification.17 As with any backpay
remedy, however, Regions have the discretion to settle a case for less
than the full backpay owing.
Cases which present issues not resolved by
this memorandum should be submitted to the Division of Advice.
Leonard R. Page
Washington - Special
Regional - All Professionals
Release to the Public
MEMORANDUM GC 00-07
1 See I.R.S. Revenue Ruling
("Rev. Rul.") 75-64, 1975-1 C.B. 16 (1975) (backpay awards are
wages for the purposes of the Federal Insurance Contribution Act, the
Federal Unemployment Tax Act and the Collection of Income Tax at Source on
2 IRS Rev. Rul. 78-336, 1978-2
C.B. 255 (1978). See also "Reporting Back Pay and Special Wage
Payments to the Social Security Administration," SSA Publication 957
(Rev. September 1997), p.2 ("The Internal Revenue Service (IRS) and
the [Social Security Administration] consider back pay awards to be wages.
However, for income tax purposes, the IRS treats all back pay as wages in
the year paid.") (Emphasis in original.)
3 California, for instance, has
similarly repealed income averaging. Bills to reinstate income averaging
for recipients of backpay and frontpay awards have been introduced before
both the House and Senate, without subsequent action to date. See Civil
Rights Tax Fairness Act of 2000, S. 2887, 106th Cong., 146 Cong.Rec.
S7162-64 (2000); Civil Rights Tax Fairness Act of 1999, H.R. 1997, 106th
Cong., 145 Cong.Rec. H3710 (1999).
4 272 NLRB 438 (1985), enf'd 762
F.2d 990 (2nd Cir. 1985).
5 271 NLRB 878 (1984).
6 Hendrickson, 272 NLRB
at 440; Austin, 271 NLRB at 878. In both cases, the Board cited to
the predecessor of Sec. 10637.3 of the Board's Casehandling Manual (Part
Three - Compliance Proceedings), in which discriminatees are advised to
contact the IRS to determine whether income averaging procedures could
reduce the tax impact of large backpay awards. Clearly, this consideration
no longer has force in light of Congress' repeal of that part of the tax
7 See, e.g., Sure-Tan, Inc.
v. NLRB, 467 U.S. 883, 898-99 (1984) (Congress vested in Board
"the primary responsibility and broad discretion to devise remedies
that effectuate the policies of the Act, subject only to limited judicial
8 Phelps Dodge Corp. v. NLRB,
313 U.S. 177, 194 (1941).
9 Frontier Hotel & Casino,
318 NLRB 857, 863 (1995), enf'd in pert. part sub nom. Unbelievable,
Inc. v. NLRB, 118 F.3d 795 (D.C. Cir. 1997).
10 749 F.2d 1451 (1984), cert.
den. sub nom. United Transp. Union v. Sears, 471 U.S. 1099 (1985).
11 Id. at 1456.
12 These factors are present in
many cases arising under the National Labor Relations Act.
13__ F.Supp.2d __, 2000 WL
1133269, *4 (E.D.Pa., July 31, 2000), quoting Squires v. Bonser, 54
F.3d 168, 172 n.7 (3d Cir. 1995).
14 O'Neill v. Sears, 2000
WL 1133269, *5. To use the court's colloquialism, "It's not how much
you make, it is how much you keep." Id. at *4. See also Gelof v.
Papineau, 648 F.Supp. 912, 930 (D.Del. 1987), remanded 829 F.2d 452
(3d Cir. 1987) (court awarded plaintiff tax component to ADEA backpay
award in light of repeal of income averaging provision); EEOC v. Joe's
Stone Crab, Inc., 15 F.Supp.2d 1364, 1380 (S.D.Fla. 1998), vac. and
remanded 220 F.3d 1263 (11th Cir. 2000) (tax component denied because
plaintiff failed to provide sufficient evidentiary foundation to permit
court to make calculation).
15 EEOC Appeal No. 01924002,
slip op. at 8 (February 25, 1994). Although the Commission ordered the
reimbursement under its authority to award compensatory damages rather
than make-whole relief, its equitable concerns mirror those articulated by
the court in Atchison v. Sears, supra, a make-whole case
upon which the Kalra Commission relied.
16 EEOC v. Joe's Stone Crab,
15 F.Supp.2d at 1380.
17 Nonetheless, a traditional
make-whole order already pled under an existing complaint or ordered by
the Board or an ALJ is sufficiently broad to encompass a tax component. As
the court in O'Neill v. Sears recognized, a discriminatee subject
to a make-whole order is entitled to receive the "value" of the
wages he would have received, but for the discrimination. The
"value" of a backpay award, without a tax component, severely
understates discriminatees' actual damages. Equity, as well as the
effectuation of the Act, thus requires compensation for their pecuniary