Are California waiting time penalties deductible?
Edvin Givargis Published 7 minute read
The short answer
Generally yes, and the reason is who gets the money. The deduction disallowance for fines and penalties, Internal Revenue Code Section 162(f), which California incorporates through Revenue and Taxation Code Section 24343, reaches amounts paid to a government, and in its current form amounts paid to or at the direction of a government, for violations of law. A waiting time penalty under California Labor Code Section 203 is paid entirely to the employee. It compensates no agency, funds no state account, and is assessed in the first instance by no regulator; it is a statutory payment from employer to worker, measured by the worker's daily wage, triggered by late payment of final wages. A payment to a private party does not become a government fine because the statute that created it uses the word penalty. The label sets off the nondeduction reflex, and on these facts the reflex points the wrong way. The analysis rewards care, though, because adjacent wage-and-hour exposures do flow to the state, and those sit squarely inside the disallowance.
The payment: what a waiting time penalty is
When a California employer willfully fails to pay an employee's final wages on time, the wages of the employee continue as a penalty from the due date at the same rate until paid, up to a maximum of thirty days (Labor Code ยง 203). The exposure accumulates quickly, a full month of wages per affected employee at the cap, and it is a fixture of California employment litigation and payroll remediation projects, which is how it lands on the tax desk: a provision or a settlement schedule arrives carrying a line called penalties, and someone must decide its tax character.
The federal characterization work has largely been done. The IRS has taken the position that waiting time penalties are not wages for employment tax purposes, because they compensate for the delay rather than for services, and that they are reportable to the employee as other income rather than through payroll. Both halves of that treatment underline the same structural fact: this is an amount owed to and received by the employee.
The disallowance: what Section 162(f) actually covers
Section 162(f) has two eras, and both turn on the payee. In its pre-2018 form, the statute denied a deduction for any fine or similar penalty paid to a government for the violation of any law, with the regulations confirming that government includes states and their subdivisions. The Tax Cuts and Jobs Act rewrote the provision for amounts paid or incurred after December 22, 2017: the disallowance now reaches amounts paid to, or at the direction of, a government or specified governmental entity in relation to the violation of any law or an investigation into a potential violation, subject to exceptions for amounts the taxpayer establishes, and the agreement or order identifies, as restitution or as paid to come into compliance with law, reinforced by the government reporting regime of Section 6050X. The rewrite broadened the net considerably, sweeping in settlement payments and directed payments the old statute missed.
What neither era reaches is a payment made to a private person that no government ordered, received, or directed. A waiting time penalty paid to a departing employee, whether in ordinary payroll remediation or in settlement of the employee's own claim, fails the disallowance's threshold condition under both versions of the statute. The deduction analysis then reverts to Section 162(a), where compensation-adjacent payments to employees arising from the conduct of the business are ordinary and necessary business expenses on familiar principles. The same logic has long applied to liquidated damages paid to employees under the wage-and-hour laws: doubling a wage payment and calling the second half a penalty changes the remedy, not the payee, and the deduction follows the payee.
The California overlay, and the conformity timeline
California disallows what Section 162(f) disallows, through Section 24343's conformity to Section 162 (with parallel treatment on the personal income tax side). The interesting wrinkle is temporal. California conforms to the Internal Revenue Code as of a specified date, and for years that date was January 1, 2015, which meant California continued to apply the narrow pre-TCJA version of Section 162(f) while federal law applied the broadened one, a genuine federal-state divergence for amounts paid from 2018 forward. The Conformity Act of 2025 moved California's specified date to January 1, 2025, for taxable years beginning on or after January 1, 2025, which brings the modern Section 162(f), exceptions and all, into the California computation for current years. For the waiting time penalty itself the divergence never mattered, since a payment to an employee is outside both versions, but for the government-facing payments discussed next, open back years and current years can take different California answers, and a schedule that survived audit under one era's rule deserves a fresh look under the other's.
The neighbors that are not deductible
The care in this area goes to keeping the waiting time penalty's answer from leaking onto its neighbors. California wage-and-hour exposure rarely travels alone, and the companions have different payees. Civil penalties assessed by the Labor Commissioner are paid to the state and sit inside Section 162(f) comfortably. Penalties recovered under the Private Attorneys General Act are the treacherous middle case: PAGA penalties are recovered by an employee plaintiff, but the statute directs the majority share of the recovery to the state's Labor and Workforce Development Agency, with only the remainder distributed to the aggrieved employees. The portion paid to the agency is an amount paid to a government in relation to a violation of law, squarely in the modern disallowance absent an identified restitution or compliance exception, while the employee-distributed portion presents the payee analysis again. A settlement that resolves waiting time penalties, PAGA claims, statutory penalties, and unpaid wages in one number invites exactly the mistake the payee principle prevents, in either direction: deducting the government's share, or forfeiting the deduction on the employees' share.
The allocation is therefore the work. Under the current federal regime the settlement agreement itself is a tax document: the restitution and compliance exceptions apply only to amounts identified as such in the agreement or order, and the government side files information returns reporting what it received. An employer negotiating a wage-and-hour resolution should insist that the agreement state the components, because the deduction for each dollar follows the line it sits on.
Practice notes
The deduction file for a wage-and-hour matter is an allocation schedule with authorities attached. First, classify every component by payee and character before anyone books the provision: unpaid wages (deductible compensation, and payroll-taxable), waiting time and similar employee-paid penalties (deductible, reportable to the employee as other income), agency-assessed civil penalties and the government's share of any PAGA recovery (nondeductible absent an identified exception), and interest (its own analysis). Second, make the settlement agreement do the identifying: amounts intended as back pay or restitution should be labeled in the document, since the post-TCJA exceptions are unavailable without identification, and silence defaults to disallowance for the government-facing dollars. Third, mind the conformity years on the California side: for taxable years before 2025 California tested these payments under the old, narrower statute, and open-year amended returns or audits should apply each year's own version rather than whichever one the workpaper was built on. Fourth, coordinate the information reporting with the deduction position: the employee-paid penalty deducted as a business expense should be the same amount reported to the employee, because a schedule that deducts one number and reports another is the discrepancy an examiner finds first.
This article states the law as of September 14, 2026
Statutes, rates, thresholds, and agency practice change, and a different set of facts can change the answer. Before acting on anything discussed above, contact G&G State Tax Group to confirm what has changed since this was written and how the rules apply to a specific situation.
G&G State Tax Group, LLC is a state and local tax advisory firm. The firm provides state and local tax consulting and representation in state and local tax controversies. G&G does not prepare or file tax returns, perform attest services, or provide bookkeeping, and is not a CPA firm.