Are settlements due to Lost wages or lost profits taxable?
If you receive a settlement in an employment-related lawsuit; for example, for unlawful discrimination
or involuntary termination, the portion of the proceeds that is for lost wages (i.e., severance pay, back
pay, front pay) is taxable wages and subject to the social security wage base and social security and
Medicare tax rates in effect in the year paid.
These proceeds are subject to employment tax withholding
by the payor and should be reported by you as ‘Wages, salaries, tips, etc.”
If you receive a settlement for lost profits from your trade or business, the portion of the proceeds
attributable to the carrying on of your trade or business is net earnings subject to self-employment
tax. These proceeds are taxable and should be included in your “Business income”.