Rev. Rul. 72-341

Advice has been requested concerning the Federal income tax treatment of payments made by a corporation to certain employees under the circumstances described below.

The United States Government filed suit against a corporation for violation of Title VII of the Civil Rights Act of 1964, Public Law 88-352, 42 U.S.C. 2000e-2, which provides, in part, that it is an unlawful employment practice for an employer to discriminate against any individual with respect to his compensation, terms, conditions, or privileges of employment because of such individual's race, color, religion, sex, or national origin.

By agreement of the parties, a final order was entered requiring the corporation to divide a specified sum equally among the employees who had suffered economic loss as a result of the corporation's employment practices. The amount paid to each employee was based on a formula that took into account the difference between his actual earnings while in the employ of the corporation, and what his earnings would have been had he not been discriminated against.

Section 61 of the Internal Revenue Code of 1954 provides that gross income means all income from whatever source derived, unless specifically excluded by law, including but not limited to compensation for services.

In Walter M. Hort v. Commissioner, 313 U.S. 28, Ct. D. 1502, C.B. 1941-1, 319, the Supreme Court of the United States, in determining whether an amount received for damages was includible in the recipient's gross income, looked to the nature of the item for which the damages were a substitute. The Court determined that the amount received upon the cancellation of a lease was a substitute for the rent which would have been paid under the lease and held that such amount was taxable as ordinary income.

Accordingly, since the payments made by the corporation to the employees in the instant case were based on compensation that they otherwise would have received, the amount of the payments are includible in their gross incomes as compensation under section 61 of the Code.

Moreover, since the payments were ordered as remuneration for services, they are "wages" for purposes of the taxes imposed by the Federal Insurance Contributions Act, the Federal Unemployment Tax Act, and for Federal income tax withholding purposes.