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Recent Tax Legislation Eliminates Deduction for Confidential Sexual Harassment Settlements

Last December, Congress responded to an avalanche of sexual harassment and abuse claims across the country by including a provision within the Tax Cuts and Jobs Act at Section 13307 impacting an employer's ability to obtain a tax deduction for settlements paid that include nondisclosure agreements. Internal Revenue Code Section 162(q) now provides that no deduction will be allowed for any settlement or payment related to sexual harassment or sexual abuse if such settlement or payment is subject to a nondisclosure agreement. Deductions for attorney's fees related to such confidential sexual harassment settlements or payments are also prohibited.

The drafters may have inadvertently created more questions than answers. The legislation includes no definition of when a settlement or payment is "related to" sexual harassment or sexual abuse. When an employee alleges more than one claim, does a payment in settlement of one of those claims "relate to" an additional claim for sexual harassment or sexual abuse? At what point in the life of a claim does an attorney's fees "relate to" a settlement or payment? What factors create a "relation" to sexual harassment or sexual abuse?

Moreover, by targeting the tax deduction benefit of such payments, Congress has increased the costs of such settlements and created a disincentive for employers to resolve claims through confidential settlement. Employers will now be forced to consider the worth of such settlements if the employee is not inclined to agree to a nondisclosure provision.

What should employers be thinking about now?

With an array of unanswered issues, it remains to be seen whether or when the IRS will provide formal guidance to practitioners. To date these questions have not been addressed through a technical corrections bill. Of course, before the above analysis becomes relevant, a "settlement or payment" must meet the threshold standard for a deduction for ordinary and necessary business expenses. Assuming it does, a decision must be made as to how and what kind of nondisclosure language to include within the agreement and how to allocate a payment to provide the maximum tax benefit to your business.

Now is the time to review your severance language and consider how to include waivers dealing with sexual harassment claims, particularly if using a general release of claims. If you are faced with a claim involving any allegation of sexual harassment or abuse within the workplace, consult an attorney in the Labor and Employment Department at Coolidge Wall.

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