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New Tax Law Quashes Deduction for Some Sexual Harassment Settlements

On January 3, 2018 by Schnader in Labor and Employment

By Jo Bennett

Payments made pursuant to a confidential settlement of sexual harassment allegations will no longer be a permissible tax deduction for business under a little-noticed provision in the Tax Cuts and Jobs Act.  The tax law permits the deduction if the settlement agreement does not contain a non-disclosure provision.

The provision is not clear whether a company may deduct legal fees incurred before settlement, or whether some or all of the fees are deductible if there are claims in addition to a claim of sexual harassment.  There is no discussion in the congressional record concerning these issues.

The new tax provision states that “[n]o 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.”

Settlement agreements for workplace claims, including workplace sexual harassment claims, routinely include non-disclosure provisions.   Congress revised the Code in response to the very public conversation about the prevalence of sexual harassment.

As details of the provision circulated, some tax experts have opined that the law might also have negative tax consequences for claimants.  As they note, in many settlements, a company typically issues a payment to the claimant’s lawyer and to the claimant, then issues a Form-1099 to both the claimant and to her counsel for the payment to the claimant’s lawyer.  The claimant was permitted to deduct the amount of the counsel fees from her taxable income.

If this interpretation is correct, these observers suggest that because the statute prohibits any deduction “under this chapter” (i.e., the Internal Revenue Code), a claimant who reaches a confidential settlement agreement of a sexual harassment claim will have to pay taxes on the gross amount of the settlement, not the net amount the claimant actually received.  Others have noted that because the provision is contained in that portion of the tax code relating to “ordinary and necessary trade or business expenses,” it  should not be read to impose a tax on what would be “phantom income” for the claimant.

Counsel for businesses must take this new tax provision into account when resolving claims of sexual harassment or sexual abuse.