What Is a Lost Wages / Back Pay Settlement?
Lost wages or back pay in a lawsuit settlement compensates you for income you would have earned if not for the wrongful act — such as wrongful termination, discrimination, or an injury that prevented you from working. The IRS treats lost wages as ordinary income, just like your regular paycheck. This means they're subject to federal income tax, state income tax (if applicable), and potentially FICA taxes (Social Security and Medicare).
Tax Rules for Lost Wages / Back Pay Settlements
Lost wages and back pay are always taxable as ordinary income. In most cases, they are also subject to FICA taxes — the employer's and employee's share of Social Security (6.2% up to the wage base) and Medicare (1.45% with 0.9% additional above $200,000). The settlement agreement should specify how FICA is handled (whether the defendant pays the employer portion or it's deducted from your share). Your settlement payee should issue a Form W-2 for the wage portion.
IRS Code Reference
IRS treats back pay and lost wages as 'wages' for employment tax purposes under IRC §3101 (FICA) and §3401 (income tax withholding). The Supreme Court confirmed this in United States v. Cleveland Indians Baseball Co. (2001). Lost wages are reported on Form W-2, not Form 1099.
How to Calculate Tax on a Lost Wages / Back Pay Settlement
Enter your lost wages settlement in the 'Lost Wages' field. The calculator treats this as ordinary income and computes both income tax (federal + state) and an estimate of FICA taxes. Be aware that FICA taxes alone can take 7.65% (employee share) of your lost wages settlement. If the settlement agreement requires the defendant to pay the employer FICA share, your tax burden is limited to the employee share.
Tax Reduction Strategies
- If possible, negotiate for the defendant to cover the employer share of FICA taxes
- Consider having the settlement paid as wages over time (reinstatement pay) to avoid all hitting one tax year
- Maximize pre-tax deductions (401k, HSA) in the year you receive the settlement to offset the added income
- If your lost wages claim relates to a physical injury, see if the wages can be allocated to the physical injury claim
Example Scenarios
$60,000 lost wages settlement for wrongful termination
→ Taxed as ordinary income: ~$13,200 federal (22% bracket) + $4,590 FICA + state tax. Net after tax: ~$38,000-$42,000.
$120,000 back pay for discrimination
→ FICA on first $176,100 of wages (2025). After federal income tax (24% bracket), FICA, and state: net ~$78,000-$88,000.