In addition to cutting taxes, "Tax Cuts and Jobs Act of 2017," passed at the very end of 2017, also acknowledges the importance of the current #MeToo movement and heightened awareness of sexual harassment in the workplace and attempts to remedy the perceived impact that confidentiality provisions in sexual harassment settlements deter victims of harassment or abuse from coming forward.
The new statute, in a provision that received little to no exposure in the debate over the bill, adds Section 162(q) to the Internal Revenue Code, which states:
- PAYMENTS RELATED TO SEXUAL HARASSMENT
AND SEXUAL ABUSE.—No deduction shall be allowed under this
chapter for—
- any settlement or payment related to sexual harassment or sexual abuse if such settlement or payment is subject to a nondisclosure agreement, or
- attorney's fees related to such a settlement or payment.
This new provision is significant because, generally, settlements of lawsuits and attorney's fees related to such lawsuits are deductible as business expenses. However, the new law, which became effective December 22, 2017, and impacts all settlements going forward from that date, changes the tax treatment of settlements in sexual harassment and sexual abuse cases. Under the new law, confidential settlements of sexual harassment or abuse cases, and attorney's fees associated with the cases, will no longer be deductible as business expenses.
One problem that employers and their lawyers will face in evaluating the impact of the new law is determining the extent of its applicability because the statute does not in any way define the crucial phrase "related to sexual harassment or sexual abuse" nor does the Conference Report accompanying the statute provide any guidance on the intended breadth of the statute. Therefore, the scope of what expenses may be "related to" a settlement is unclear. For example, if a settlement requires training employees on sexual harassment, the law does not provide guidance as to whether such an expense would be "related to" the settlement and therefore not deductible. The law also fails to define the "employers" and "payers" who will be subject to the new provision.
Significantly, the new law only applies to sexual harassment settlements and not to discrimination claims or harassment claims based on any other protected status such as race, religion or age. Because many lawsuits often involve multiple interrelated claims, only some of which involve sexual harassment, careful drafting of settlement agreements may be useful in minimizing the impact of the new law because payments could be allocated to other claims which remain deductible. However, under tax law, the IRS can look behind the terms of an agreement to the underlying facts in determining the taxability of a settlement and thus may determine that a settlement is related to sexual harassment even if the parties attempt to make a different designation. Also, because the scope of "related to" is not defined, even if there are multiple claims, the whole settlement may be determined to be related to the harassment claim and not deductible, regardless of the allocation.
Also, and notably, although the bill is clearly intended to protect the rights of victims to speak if they want to, it does not distinguish between when the employees request the confidentiality provision versus when the employers do so. Therefore, regardless of who wants the confidentiality provision in the settlement agreement, it will not be deductible. Additionally, since the provision as drafted does not distinguish between employers and employees, it could have the unintended consequence of adversely impacting the victims of alleged sexual harassment because any attorney's fees that they are paid as part of a settlement would also not be deductible by them. However, legislation is being quickly introduced to clarify that the non-deductibility of attorney's fees is only applicable to businesses and not individuals.
Because of the new law, whenever employers settle any case involving a claim of sexual harassment or abuse, they will have to choose between non-deductibility of the payment and non-disclosure of the settlement. In other words, if an employer requires an employee to sign a nondisclosure agreement as a condition of a sexual harassment settlement, or the settlement agreement contains a confidentiality provision, then an employer cannot claim the settlement payment nor corresponding attorney's fees as a business deduction. The law therefore will inevitably complicate settlement negotiations of sexual harassment claims and make them more expensive for employers, either in terms of monetary cost or reputational cost.
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