Final Pay Penalties Are Not Wages for Federal Tax Purposes
Employers in California are subject to penalties under Labor Code section 203 if they fail to pay an employee who quits or is terminated in a timely manner. These penalties are referred to as waiting time penalties.
The Internal Revenue Service (IRS) just released a Chief Counsel Advice Memorandum which states that waiting time penalties are not considered wages for federal income tax, FICA (Federal Insurance Contributions Act) and FUTA (Federal Unemployment Tax Act) withholding purposes.
The California Department of Industrial Relations (DIR) also states that waiting time penalties are not wages and thus no deductions are taken from the penalty payment.
The IRS memorandum states it only applies to waiting time penalties and, specifically, does not apply to meal and rest period payments that are made when an employer fails to provide an employee a meal or rest period (one additional hour of pay for each day that the meal or rest period is not provided). “Because the meal and rest period payments are essentially additional compensation for the employee performing additional services during the period when the meal and rest periods should have been provided, it appears those payments would be wages for federal employment tax purposes.”
In 2007, the California Supreme Court held that the hour of additional pay for missed meal or rest breaks is not a penalty but a premium wage that compensates employees (Murphy v. Kenneth Cole Productions, Inc., 40 Cal. 4th 1094 (2007)).
CalChamber Members can find more information on meeting final pay requirements with this simple How To: Prepare a Final Paycheck and in the Final Pay section of the HR Library. Not a member? See how HRCalifornia can help you.