A dispute between an employee and an employer doesn't always have to end in a verdict. The parties can reach a settlement directly in court or before a mediator, even during court proceedings. Increasingly, especially in employment matters, they are opting for an amicable resolution to the dispute through a settlement, which involves mutual concessions leading to a mutually acceptable solution.
Is a settlement reached before a mediator an out-of-court settlement?
Particularly in employment-related matters, the court may refer the parties to mediation at the initial stage of the proceedings. If the parties agree, further discussions are conducted with the participation of a mediator. If an agreement is reached on the terms of resolving the dispute, mediation may result in a settlement.
Pursuant to Article 183¹⁵ § 1 of the Code of Civil Procedure, a settlement reached before a mediator, once approved by the court, has the legal force of a settlement reached before a court. The court examines, among other things, whether the content of the settlement violates the employee's rights or is intended to circumvent them.
Court settlement and exemption from personal income tax
A settlement concluded before a mediator and then approved by the court may constitute a basis for applying the exemption specified in Article 21 paragraph 1 item 3b of the Personal Income Tax Act.
This provision exempts from tax other compensation and damages received pursuant to a judgment or court settlement, up to the amount specified in that judgment or settlement. However, the exemption does not apply to benefits that the taxpayer could have obtained had the damage not been suffered.
For the assessment of the tax consequences, the actual nature of the benefit is decisive, and not just the fact that it is called “compensation” in the settlement.
It should be noted that the exemption may apply if the amount paid:
- is compensatory in nature;
- compensates for actual damage or harm;
- does not constitute remuneration for work or compensation for lost earnings;
- does not replace the benefits that the employee would have gained if he had continued employment.
Judgment of the Constitutional Tribunal
The significance of a court settlement for the application of tax exemption was confirmed by the Constitutional Tribunal in its judgment of 29 November 2006, file reference SK 51/06. The Tribunal found that a person who has concluded a dispute by means of a court settlement should not, for that reason alone, be in a worse tax situation than a person to whom compensation was awarded by a judgment.
This position remains consistent with the principle of amicable dispute resolution, according to which the court should strive to reach an amicable conclusion at every stage of the proceedings, in particular by encouraging the parties to reach a settlement or referring them to mediation.
Court settlement and interpretations of the Director of National Information System
A similar distinction results from the interpretation of the Director of the National Tax Information Office dated June 29, 2026, no. 0115-KDIT3.4011.406.2026.2.RS. The authority confirmed the applicability of the exemption to the extent that the benefit compensates for actual damage, not lost profits. In turn, in the interpretation dated March 7, 2025, no. 0114-KDIP3-2.4011.16.2025.2.JM, the exemption was denied because the benefit was intended to compensate the employee for lost earnings.
Individual interpretations do not present a uniform position in this regard, and the assessment of the applicability of tax exemptions depends on the circumstances of each individual case, in particular the actual nature and purpose of the benefit being paid. This should be taken into account already at the stage of drafting the settlement, precisely defining the basis, nature, and function of the benefit.
Constructing the content of the settlement
During mediation proceedings, the parties, with the participation of a mediator, agree on and formulate the content of the settlement, specifying, among other things, the amount and nature of the benefit due. Therefore, it is important to clearly state that the amount paid is compensatory in nature, does not constitute remuneration for work or compensation for lost wages or other benefits, and that its amount has not been established as a multiple of the employee's salary.
Correctly describing the basis and function of the benefit is crucial for the employer as the payer. If the conditions of Article 21, Section 1, Item 3b of the Personal Income Tax Act are met, the benefit may be paid without deduction of an advance tax payment. However, the name of the benefit alone is not sufficient – the content of the settlement agreement must reflect the actual nature of the payment.
This article is for informational purposes only and does not constitute legal advice.
The law is current as of September 10, 2026.
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