United States: Tax Cuts And Jobs Act Affects Settlement Payment Deductions And Paid Family Leave

The Tax Cuts and Jobs Act (the "Act") was signed into law by President Trump on December 22, 2017, and, for the most part, took effect on January 1, 2018. As employers undertake tax planning efforts and assess the impact of the Act on their businesses for 2018, they should be aware of some significant changes impacting employment-related business deductions and tax credits.

In a nod to the recent proliferation of high-profile sexual harassment claims that have been in the public sphere, the Act eliminates the ability of companies to deduct from their taxable income any "settlement or payment related to sexual harassment or sexual abuse" (including attorneys' fees) if the settlement is subject to a nondisclosure agreement. In addition, the Act provides a new tax credit for employers who provide up to 12 weeks of paid family leave in certain circumstances. It is important for employers to understand both of these changes and how they impact company policies and practices.

Deduction Eliminated for Confidential Settlements Related to Sexual Harassment or Abuse

As noted above, the Act eliminates tax deductions for settlements and other payments related to sexual harassment and abuse if those settlements are subject to a nondisclosure agreement. While relatively straightforward in some circumstances, the change requires significant attention for settlements where sexual harassment allegations are being resolved in conjunction with additional claims.

Limit on Business Deductions Added as Section 162(q) to the Internal Revenue Code

Payments to settle claims and lawsuits ordinarily are deducible business expenses under Section 162 of the Internal Revenue Code. The new law, which adds subdivision (q) to Section 162, eliminates the deduction for any payment or settlement related to sexual harassment or sexual abuse that is subject to a confidentiality or nondisclosure provision:

(q) Payments Related to Sexual Harassment And Sexual Abuse—No deduction shall be allowed under this chapter for—

(1) any settlement or payment related to sexual harassment or sexual abuse if such settlement or payment is subject to a nondisclosure agreement, or (2) attorney's fees related to such a settlement or payment.

The common practice of employers including a nondisclosure clause in a settlement for sexual harassment claims is strongly disincentivized by Section 162(q). Thus, at first glance, and without the benefit of regulations or rulings from the Internal Revenue Service, employers must choose between keeping such settlements confidential without a tax benefit or deducting the settlement and related attorneys' fees as business expenses.

Broad Application for Business or Trade Expenses

The Act applies to all taxpayers. Section 162(q), unlike many state and federal employment laws, does not limit its application to certain subsets of employers or entities. All employers, regardless of revenue, size or number of employees, who wish to deduct an applicable settlement or fee payment as business expenses must therefore proceed carefully when settling such claims.

Bar on Deductions Applies to Conduct "Related to" Sexual Harassment or Abuse

Section 162(q) specifies that the business expense deduction is not allowed for any settlement or payment "related to" sexual harassment or sexual abuse. Clearly articulated sex and gender harassment claims under state, federal and local law will fall squarely within the scope of this prohibition. As but one example, however, the tax implication of inserting a nondisclosure provision into a settlement agreement for whistleblower allegations is not certain, based on the text of Section 162(q).

Employers should be aware that the Internal Revenue Service likely will take a broad view of the provision and businesses will need to assess their risk tolerance with respect to tax liability and confidentiality as they structure their settlement agreements. Accordingly, companies should work with counsel and their tax advisor to defend and structure the settlement of employment claims in light of the broad "related to" language of the law.

Bar on Deducting Payments for Attorneys' Fees

Section 162(q) further eliminates the ability of employers to deduct from their taxable income the payment of attorneys' fees relating to a settlement for sexual harassment or abuse if the settlement is subject to a nondisclosure agreement. In other words, in such cases neither the settlement payment to the claimant nor the attorneys' fees incurred to investigate, negotiate, litigate and resolve the claim would be deductible under Section 162. This further incentives companies to forgo nondisclosure provisions in settlement agreements for sexual abuse and harassment, although businesses should work with their legal service providers to ensure that legal tasks are billed and apportioned correctly.

Settling Comingled Claims

A difficult situation will arise for employers who wish to confidentially settle a lawsuit, administrative proceeding or other claim where sexual harassment is alleged in conjunction with one or more other employment-based claims. Due to the broad language of the prohibition on deductions, the IRS may take the position that the entire action will fall within the purview of Section 162(q). This may be the case even if a separate discrimination or wage claim predominates over ancillary sexual harassment allegations. Employing tax-efficient resolution strategies is imperative under such conditions.

Tax-Efficient Resolution Strategies

Businesses have a number of options to settle claims for sexual abuse or harassment. If a claim is not based on allegations that reasonably meet the legal standard for sexual harassment or abuse, counsel may meet and confer in an attempt to have the claimant voluntarily dismiss the claim before settling the lawsuit. Litigants may also move the court to dismiss or summarily adjudicate the claim.

Another option is for businesses to settle claims in parts, where only allegations not of a sexual harassment or abuse nature are subject to a nondisclosure agreement or where the settlement payment is appropriately attributed to each claim according to its value. For example, in a situation where the plaintiff refuses to dismiss a sexual harassment claim, or where litigating the case to summary judgment motion or trial is cost-prohibitive, the parties could apportion the settlement into two agreements so that the employer may be able to avail itself of a tax deduction for at least a portion of the total settlement payment.

Importantly, employers must keep in mind that under the IRS's "origin of the claim" test and general tax doctrine, the IRS will look at the underlying nature of the claim to determine if expenses and fees were properly apportioned.

Of course, the structure of the settlement will depend on the facts and circumstances of the particular case. Companies are advised to consult with counsel and their tax advisor to ensure that the settlement meets their legal and tax planning goals.

Severance Agreements

The Act does not address whether a severance agreement for a departing employee would fall within the scope of Section 162(q). However, the IRS may take the position that the severance payment is nondeductible if the departure is related in any way to a sexual harassment or abuse allegation. Unless and until the IRS provides guidance on this and other issues, employers and their counsel and tax advisor will need to make the best decision considering all possible tax and employment implications in light of the specific facts and circumstances of the situation.

Employer Tax Credit for Paid Family and Medical Leave

Addressing another topic that has been the subject of increased public discussion—paid family leave—the Act also adds Section 45S to the Internal Revenue Code, which provides a tax credit for businesses that voluntarily provide up to 12 weeks of paid family leave to qualifying workers pursuant to a written policy. The tax credit is equal to 12.5 percent of wages paid to the employee on leave, so long as the wages are at least 50 percent of what the employee normally would have earned had he or she been working. The credit increases in intervals of 0.25 percentage points (up to 25 percent of wages) for each percentage point by which the employee's payment under the policy exceeds the 50 percent minimum threshold.

Employers are eligible only if they have a written policy that provides not less than two weeks of annual paid family and medical leave for full-time employees and a prorated equivalent for part-time employees. The leave policy must also satisfy other criteria set forth in the Act. The tax credit is temporary and will automatically terminate after December 31, 2019.

Employers have two full years to take advantage of this new tax credit. Congress is expected to revisit the credit upon its expiration.

What This Means for Employers

The Tax Cuts and Jobs Act made significant structural reforms to the way that businesses across the country plan for, and pay, their taxes. While much of the focus in the media has been on corporate tax rates, employers should be aware of the restrictions on deductions for payments made in connection with sexual harassment and abuse claims, as well as the availability of a new tax credit for providing paid family leave to employees. With the increased reporting of sexual harassment allegations, the fact that a tax deduction for payments made in connection with such claims is no longer available can play a significant role in how employers approach the defense and resolution of sexual harassment claims. Similarly, employers who are contemplating adopting family leave policies would be well-served to factor into their decision-making process the newly available tax credit for payments to employees pursuant to such policies.

In each case, the changes made by the Act are both new and nuanced, and it is recommended that employers seek legal and tax advice when making decisions involving these changes.

For Further Information

If you have any questions about this Alert, please contact any of the attorneys in our Employment, Labor, Benefits and Immigration or any member of our Tax Practice Group.

Disclaimer: This Alert has been prepared and published for informational purposes only and is not offered, nor should be construed, as legal advice. For more information, please see the firm's full disclaimer.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
 
In association with
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration
Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:
  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.
  • Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.
    If you do not want us to provide your name and email address you may opt out by clicking here
    If you do not wish to receive any future announcements of products and services offered by Mondaq you may opt out by clicking here

    Terms & Conditions and Privacy Statement

    Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

    Use of www.mondaq.com

    You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.

    Disclaimer

    Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

    The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.

    Registration

    Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

    • To allow you to personalize the Mondaq websites you are visiting.
    • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
    • To produce demographic feedback for our information providers who provide information free for your use.

    Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

    Information Collection and Use

    We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

    We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

    Mondaq News Alerts

    In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.

    Cookies

    A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

    Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

    Log Files

    We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.

    Links

    This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

    Surveys & Contests

    From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.

    Mail-A-Friend

    If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.

    Emails

    From time to time Mondaq may send you emails promoting Mondaq services including new services. You may opt out of receiving such emails by clicking below.

    *** If you do not wish to receive any future announcements of services offered by Mondaq you may opt out by clicking here .

    Security

    This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

    Correcting/Updating Personal Information

    If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

    Notification of Changes

    If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

    How to contact Mondaq

    You can contact us with comments or queries at enquiries@mondaq.com.

    If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.

    By clicking Register you state you have read and agree to our Terms and Conditions