Tax Reform Bill Eliminates Employer Deduction For Amounts Paid in Settlement of Sexual Harassment and Abuse Claims if the Settlement Agreements Require Nondisclosure

December 21, 2017
On December 20, Congress passed a comprehensive tax reform bill (the “Act”), and the president is expected to sign it into law in the coming days. You can read our memorandum on the Act. There is one provision of the Act that will be of interest to employment litigators and their clients. The Act includes the following provision, first proposed by Senator Bob Menendez (D–NJ):
“(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 obvious intent of the provision is to provide a strong disincentive to settlements of harassment claims that include confidentiality provisions. Nevertheless, it could well have unintended consequences. Some plaintiffs welcome confidentiality provisions, because they themselves have no interest in publicity about their claims or because they believe an employer may pay a higher settlement amount in exchange for confidentiality. The provision may ultimately result in fewer settlements, or lower settlement amounts, for plaintiffs. It also may incentivize employee creativity in asserting claims – for example, by not asserting harassment but instead asserting other claims that could continue to be settled confidentially without adverse tax consequences.

The Act leaves several questions unanswered that will need to be resolved by the courts and the Internal Revenue Service:
  • First, what is a claim related to “sexual harassment” or “sexual abuse”? The Act does not define either term.
  • Second, settlement agreements often include releases of any and all claims the employee may have had against the employer, including but not limited to sex-based claims. The settlement payment is consideration for the release of all such claims, not just the sex-based claims. Can the harassment-based piece be separated and excluded from an overall non-disclosure covenant and satisfy the provision, preserving the non-disclosure commitment otherwise? That way, at least part of the payment—if such quantification is permissible under the Act—may be deductible.
  • Third, what attorney’s fees are “related to such a settlement or payment,” and, thus, non-deductible? Is it only the fees related to negotiating a settlement, drafting an agreement, and executing payment? May an employer deduct fees incurred in investigating the underlying claims or evaluating the settlement value of a case?
The provision applies to amounts paid after January 1, 2018.

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