Rev. Rul. 55-520

Advice has been requested whether an amount paid to an individual as a compromise settlement for the cancellation, before the normal expiration date, of an employment contract constitutes `wages' for purposes of the Federal Insurance Contributions Act and the Collection of Income Tax at Source on Wages, (chapters 21 and 24, respectively, Subtitle C, Internal Revenue Code of 1954).

In the instant case, an individual was employed as a general manager of a television company under a written agreement. Under the contract, the individual was to receive $12,000 per year, to be paid in monthly installments, for services rendered for a period of 2 years. In January of the second year, due to policy differences, the company demanded and received the individual's resignation, conditioned upon the payment of the amount due under the contract for the remaining period. The company offered a lump sum settlement of $5,000 in lieu of the monthly payments of $1,000. This was refused by the individual and he instituted court proceedings. Because the employment contract provided for the payment of wages by the month, it was considered technically necessary to sue initially for only one month's wages and, as ensuing months passed, to amend the complaint until it would cover the full balance of wages due under the employment contract. During the following June, the negotiations were reopened with the view toward a settlement of the pending litigation between the parties. As a result, the individual accepted an offer of $4,760 made by the company and signed a general release of all claims upon the company, and the law suit was dismissed.

For purpose of the Federal Insurance Contributions Act and income tax withholding, `wages' consist of all remuneration for services performed by an employee for his employer, including the cash value of all remuneration paid in any medium other than cash, with certain exceptions not here material.

Under the circumstances stated, it is held that the amount of $4,760 paid in consideration of the cancellation of the employment contract does not constitute `wages' for Federal employment and income tax withholding purposes. Consequently, the company was not required to deduct such taxes from the settlement payment nor to prepare a Form W-2, Withholding Tax Statement, with respect to such payment. However, such amount is includible in gross income for Federal income tax purposes