Current Tax Treatment

Payments received for lost business income, lost wages or lost profits are includable in income, but a payment made from BP to an individual to compensate for lost wages will not be wages for purposes of the social security tax and Medicare tax because it is not an actual payment for employment within the meaning of the law. These payments will also generally not be subject to income tax withholding, unless backup withholding applies. However, if the payment is made by an employer to its own employees, or by a third party to employees of another employer in satisfaction of an obligation of that employer to its employees, the payment may be subject to social security tax, Medicare tax, and income tax withholding.

In its Q&As, IRS concluded that self-employed individuals who receive a payment that represents compensation for lost income must include the amount of the payment in net earnings from self-employment for purposes of the self-employment tax. The CRS study says this suggests BP payments received by the self employed may be considered “self-employment income” for purposes of the Self-Employment Contributions Act (SECA), and subject to SECA taxes. However, a Federal Statute, and at least one court case, say otherwise.

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