Articles

New Tax Law Prohibits Sexual Harassment Deductions

January, 2018

NEW TAX LAW PROHIBITS EMPLOYER AND EMPLOYEE DEDUCTIONS FOR SEXUAL HARASSMENT SETTLEMENTS CONTAINING A NONDISCLOSURE PROVISION.

As a legislative response to the #METOO movement, a provision in the new tax law signed by President Trump will increase the “after tax cost” for companies to settle “sexual harassment” or “sexual abuse” claims if they wish to maintain a “nondisclosure agreement” of the details, as reported by The National Law Review and Newsweek.

Effective December 22, 2017, the new law will disallow a business deduction for the amounts paid to settle such claims, including attorney’s fees, if the settlement contains a nondisclosure provision, which currently is ubiquitous in such sexual harassment/sexual abuse lawsuits.

The tax law adds section 162(q) to the Internal Revenue Code as follows:

“(q) 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 settlement or payment.”

However, there are several problems associated with this new tax legislation.

First, there is no definition of “sexual harassment or sexual abuse” provided in the statute.

Also, the law does not define “employers” or “payers” subject to this prohibition.

Some employers may attempt to structure a settlement to avoid language indicating the underlying cause of the suit or claim to avoid the classification of the settlement as a one containing sexual harassment or sexual abuse allegations.  However, the Internal Revenue Service, (“IRS”), has the authority to go beyond the terms of the settlement, such as reviewing the initial complaint or lawsuit, to decide whether the claim or lawsuit alleges sexual harassment or abuse.  Although the employer would have the opportunity to challenge the IRS’s ruling prohibiting the deduction in court, the complaint and pleadings would be subject to public disclosure.

Further, the prohibition against the tax deduction would apply even if the sexual harassment complaint is a parallel claim to, say, a racial or religious discrimination claim.

The new law also fails to address situations where the alleged perpetrator is terminated and a severance agreement is executed.  If the termination is related to the settlement, then the IRS could take the position that the severance payment is likewise non-deductible.  If the agreement requires the employer to take any other action, such as implementation of an educational program to raise awareness of sexual harassment, the cost of such a program might also be nondeductible.

Also, this disallowance will be applicable even if the employee making the claim wishes to have a nondisclosure agreement so the employer cannot comment.  Many times, employees, wanting to get on with their lives and avoid any unwanted publicity, desire language stating that the employee voluntarily terminated her employment and the nondisclosure provision prevents the employer from stating otherwise.

Therefore, although this tax legislation was targeted to businesses that were writing off sexual harassment or sexual abuse settlement fees on their taxes, it can harm victims who receive settlements tied to non-disclosure agreements since they would no longer be able to deduct their legal fees.  They would pay taxes on settlement money they did not receive.

It remains to be seen what guidance the IRS will develop in the form of rulings or regulations on this new provision of the tax law.

However, the new provision could complicate the process of settling sexual harassment claims.  Employers may implement more sexual harassment training and education programs to avoid such claims.