Settlement Payments Resolving Sexual Harassment Claims Are No Longer Tax-Deductible if Such Settlements Are Subject to a Non-Disclosure Agreement

The Tax Cuts and Jobs Act, signed by President Trump on December 22, 2017, contains a little discussed section that eliminates the deductibility of settlement payments and related attorney’s fees in sexual harassment disputes if the settlement or payments are subject to a non-disclosure provision.

Restrictions In This New Law

This new tax code section provides that no deductions shall be allowed 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.

26 U.S.C. § 162(q).

Effect on Employers and Unanswered Questions

In light of this new section, employers will need to consider the tax implications of including a non-disclosure provision in settlement agreements resolving sexual harassment claims. Specifically, employers should evaluate whether they wish to forgo certain tax deductions that may be available to them regarding a settlement and associated legal expenses of a sexual harassment claim by including a non-disclosure provision in their settlement agreement.

Unfortunately, there are many open questions regarding the interpretation of this new law which may complicate employers’ analysis. For example:

• The terms “sexual harassment” and “sexual abuse” are not defined in the law. It is also unclear what settlement or payments will be considered “related to” sexual harassment and sexual abuse, and covered by the law’s restrictions. For example, it is unclear whether the IRS would interpret sexual harassment broadly to include claims of sex discrimination, or how the IRS will treat settlements that address various claims, including sexual harassment or contain a general release, which would include a claim of sexual harassment, even if sexual harassment has not been specifically asserted.
• It is unclear whether the restrictions on tax deductibility apply only to the employer or party making the settlement payment, or could apply to the party receiving the payment (e.g., the plaintiff).
• It is also unclear which portion of a party’s attorney’s fees are non-deductible, e.g., fees for the actual drafting and negotiation of the settlement agreement, fees for all work performed on the sexual harassment/abuse claim, or fees for all work performed for any claim included in the case, if the case involves multiple claims.

We expect the IRS to issue guidance on this provision; however, it is unclear when such guidance will be issued. We will update this alert following the issuance of such guidance from the IRS.

In the interim, employers should be conscious of these new restrictions on tax deductibility when negotiating a settlement of a workplace dispute. If you have any questions about this new law, or the resolution of sexual harassment or discrimination claims generally, please do not hesitate to contact one of our attorneys.