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On March 15, 2013, the IRS issued a private letter ruling responding to a request for a determination of whether incentive awards paid to class representatives under a settlement agreement resolving a class action suit against an employer under the Fair Labor Standards Act were wages for employment tax purposes.  In the Ruling, the IRS acknowledged that it may seem that the class representatives’ services were performed for the class members, rather than the employer.  However, because the underlying claim was wage-based, the IRS determined that the services rendered as class representatives were related to the employer-employee relationship. Under an “origin of the claim” analysis, the IRS determined that because the class representatives also received wage based payments under the settlement, the class representatives’ portion of the wage based settlement included the incentive award paid to the class representative.  The IRS reasoned that the class representative performed services for the employer by determining the correct remuneration owed to employees as a result of their employment relationship.

Other than this ruling, there is only one unreported case dealing with this issue.  <em>See Trotter v. Perdue Farms, Inc.</em>, 253 F.Supp.2d 812 (D. DE 2003).

It is important to note that the applicability of this ruling should be limited to cases where there are wage based claims.  However, the tax implications to both parties after any class action settlement should always be a consideration.

IRS Circular 230 Disclosure:

To ensure compliance with requirements imposed by the IRS in Circular 230, we inform you that, unless we expressly state otherwise in this communication (including any attachments), any tax advice contained in this communication is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or other matter addressed herein.

IRS Says Class Action Settlement Incentive Awards in Wage Based Claims Are Taxable As Wages