Fox News reports that the IRS considers payments made by BP to Gulf Coast workers to be taxable income:
Out-of-work Gulf Coast shrimper Todd Pellegal spent his first $2,500 check from BP quickly, paying off bills and buying groceries for his family.
He never even considered putting some of it away for taxes.
Now he’s among the people up and down the Gulf Coast reeling from the oil spill disaster who are surprised — and frustrated — to find out the Internal Revenue Service may take a chunk of the payments BP PLC is providing to help them stay afloat.
Many were already angry about how long the oil giant took to cut the checks. So when they got the money — generally about a few thousand dollars each so far — they spent it fast.
“If they’re going to pay you a lump sum, like for a year, then bam, take the taxes out of the check,” said Pellegal, of Boothville, La. “But a little bit at a time, they shouldn’t.”
This is not a difficult call. The tax code has long considered payments made to individuals in the form of compensation for lost wages or as a substitute for what would have otherwise been taxable income to be taxable income.¹
BP is compensating Gulf Coast workers for the income they lost as a result of the oil spill. Consequently, the IRS is right in considering that compensation to be taxable income.
I would not be surprised, however, if some congressman immediately proposes a bill that would amend the tax code to make these payments non-taxable.
¹ We recently reported in The Tax Man and the Sea that Gulf Coast fishermen have a poor record of compliance with the federal tax laws. That makes the taxation of these compensatory payments even more problematic because these folks didn’t think they had to pay taxes in the first place.