28 Feb Reporting Back Pay
Reporting back pay is not as straight forward as one imagines. If you issued back pay you should report it on IRS Form W-2 (in boxes 1, 3, and 5) for the year payment is made.
If any punitive damages are involved in a settlement they should be reported by the company on IRS Form 1099-MISC because they are not payment for actual wages.
If the settlement included attorney fees, they are also reported on IRS Form 1099-MISC, whether they were paid directly to an attorney or not.
Interest associated with either the wages or the punitive damages is reported on IRS Form 1099-INT.
If you receive back pay you report the wage portion of the settlement on the tax return for the year in which the back pay is received. Note that only the part of the settlement that relates
to the back pay is subject to payroll taxes.
Interest paid on the settlement is taxable and likewise reported on the return for the year it is received.
IF you receive punitive damages they are reported as other income on line 21 of IRS Form 1040.
Finally, note that any attorney fees associated with the lawsuit may be deducted as a miscellaneous itemized deduction subject to the two-percent-of-AGI threshold.