Settlement Agreement’s Silence About Tax Treatment Leaves Parties to Fend for Themselves

On Monday, the Sixth Circuit Court of Appeals in Cincinnati issued a decision about whether a bank breached a settlement agreement involving a home mortgage in Blacklick.  McClusky v. Century Bank, FSB, No. 14-3419 (6^th Cir. 1-26-15).  In that case, the parties settled their case with the forgiveness of a disputed amount of the debt and the trial court entered the judgment entry merely noting that the dispute had been resolved.  The Bank later issued a 1099 tax form to the plaintiff for the amount of the cancelled debt, raising his taxes by almost $70K.  He then sued for breach of the settlement agreement, which said nothing about the tax treatment of the cancelled debt.   The Court held that because the settlement agreement and judgment entry did not put any limitations on how the Bank could treat the cancelled debt for tax purposes, there was nothing limiting the Bank from issuing the 1099.  Accordingly, when employment disputes are resolved without an agreement about the tax treatment of any settlement payments, the employer would similarly be free to issue appropriate tax forms based on its own reasonable characterization of the payments.

As noted by the Court:

 The Settlement Order says nothing about how each party would treat the transaction memorialized in the Settlement Order for tax purposes nor about how (or whether) each party would report the transaction to the IRS. Given the complete absence of any reference to tax reporting issues, the Settlement Order cannot be read as precluding Century Bank from issuing the McClusky 1099. Indeed, it would violate Ohio’s fundamental rules of contract interpretation to read into the Settlement Order a limitation on Century Bank’s conduct that the order simply does not contain.

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The absence of any reference to tax treatment/reporting issues in the Settlement Order is especially significant because it is common practice for parties to address these matters in settlement agreements when the parties have, in fact, agreed upon them. Indeed, one treatise on Ohio law advises Ohio attorneys drafting a settlement agreement to specify the tax  consequences that the parties intend to govern the agreement.

 In reaching this conclusion, the Court considered cases from other jurisdictions where the parties had agreed how to characterize the payments, to keep the payments confidential and even to not subject them to any tax withholding.  Nonetheless, the courts refused to find a breach of contract when the payor issued 1099 tax forms to the payee in the absence of a specific contractual promise to not issue such a tax form.

This being said, the Court took no position on whether the cancelled debt constituted taxable income and did not endorse permitting a payor (such as an employer) to make tax withholdings in the absence of a contractual provision entitling it to do so.

NOTICE: This summary is designed merely to inform and alert you of recent legal developments. It does not constitute legal advice and does not apply to any particular situation because different facts could lead to different results. Information here can change or be amended without notice. Readers should not act upon this information without legal advice. If you have any questions about anything you have read, you should consult with or retain an employment attorney.