New Minnesota law exempts sexual harassment and abuse settlements from state income taxes
ST. PAUL, Minn. – When a former employer settled her sexual harassment claim, Julie Risser said she was shocked at how small the final payment was. Federal and state taxes took big bites out of the check.
"I was very, very upset because it was a fraction of what I thought I would get," Risser said. "Then I sat down and I thought about how much that I had paid to my attorney, and in terms of the percentage I came away with about 11%, you know, so just a fraction of what I thought."
But this year, Minnesota lawmakers changed the law so the state doesn't line its pockets from tax revenue collected on sexual harassment or abuse settlements -- a lesser-known provision inside a bill that also included one-time rebate checks and social security tax cuts.
Supporters of the change say such settlements should be treated just like financial compensation a person may receive for being physically injured on the job, which is held harmless from both state and federal taxes.
Susan Ellingstad, partner at Lockridge Grindal Nauen and head of the firm's employment law department, said that exception is narrow and rarely applies to sexual harassment cases.
"I can't even remember the last settlement where we carved out something for that kind of physical manifestation and medical treatment, so typically settlements have been fully taxable," said Ellingstad, who works with businesses on sexual harassment and other discrimination claims.
The Minnesota Department of Revenue also noted this in its analysis of the bill, which estimates the new income tax subtraction will have minimal impact to the state's General Fund. This new law won't impact federal tax liability, so Minnesotans who receive these payments still won't walk away with the full amount.
Risser testified at multiple hearings at the Capitol in support of the changes, sharing her experience with lawmakers. She contacted her legislator Rep. Heather Edelson, DFL-Edina, and asked her to take up the issue.
"If somebody's experienced trauma, we shouldn't be taxing or having revenue in the state from that trauma," Edelson said.
Another provision prohibits these settlements from being "provided as wages or severance pay" in a move Edelson said is designed to ensure victims still receive timely unemployment benefits when leaving that job.
A Minnesota worker is not eligible for unemployment benefits "for the number of weeks of regular pay the severance payment represents," according to the Minnesota Department of Employment and Economic Development, which handles jobless claims.
Risser said she experienced that delay because her agreement was characterized as a severance. State law includes severance payments in its definition of wages.
"The second shock was when I got the letter from Minnesota Unemployment [Insurance] that the benefits I was receiving were no longer going to continue because I had received this payment -- these wages -- and they needed to prorate that out over a period of time until I would be qualified to get unemployment," Risser said. "So it really was a double whammy that was not expected."
Ellingstad said this provision -- prohibiting the characterization of the payment as wages -- could cause some confusion for employers.
"For federal tax purposes they look at the origin of the claim or the nature of the claim. And if damages are now not being characterized as wage loss -- that could have some implications on the federal level," she said. "Most of the damages in these cases tend to be wage loss. So I think not characterizing it as wages could potentially make it a little confusing."
The state income tax subtraction takes effect in 2023. It's a small step, Risser said, but a meaningful one.
"People really understood that sexual harassment settlements should not be taxed by the state of Minnesota. That was really healing for me," Risser said.
