Waiting time penalties imposed under Section 203 of the California Labor Code are not “wages” for purposes of federal income or employment taxes, according to a Chief Counsel Advice Memorandum issued by the Internal Revenue Service. Although the Memorandum is not precedential, it provides guidance regarding the IRS’s current views on the taxability of such payments. The California Department of Industrial Relations (DIR) has long taken the position that waiting time penalties are not wages.
After analyzing federal and state law regarding the definition of “wages,” the Chief Counsel concluded that waiting time penalties were not wages under the Internal Revenue Code because they were not remuneration for an employee’s services. In reaching this conclusion, the Chief Counsel relied, in part, on the California Supreme Court’s decision in Pineda v. Bank of America, 241 P.3d 870 (2010) in which the Supreme Court ruled that an employee could not recover waiting time penalties as restitution because, unlike wages, the employee had no vested interest in those funds. The California Supreme Court stated: “Section 203 is not designed to compensate employees for work performed. Instead, it is intended to encourage employers to pay final wages on time, and to punish employers who fail to do so.” Because the obligation to pay waiting time penalties arises from the employer’s action or inaction, rather than an employee’s labor, waiting time penalties are more akin to liquidated damages and should not be considered wages subject to withholding and employment taxes.
However, the Chief Counsel also emphasized that its ruling did not apply to meal and rest period payments made under California Labor Code Section 226.7 because those payments are “essentially additional compensation for the employee performing additional services during the period when the meal and rest periods should have been provided.” Accordingly, the Counsel concluded that meal and rest period payments would constitute wages for federal employment tax purposes.
Employers should consider reviewing their payroll practices to ensure that any waiting time penalties or meal and rest period payments are subject to the applicable employment taxes and withholdings.