In acknowledgment of recent sexual harassment allegations and subsequent confidential settlements, Congress added a new section to the Internal Revenue Code as part of the Tax Cuts and Jobs Act. It prohibits employers from deducting costs related to sexual assault and sexual harassment settlements that are subject to nondisclosure agreements.
While motivation for this new provision was a well-intentioned nod to the #MeToo movement, it may have unforeseen consequences.
The problematic provision
Section 13307 of the act states:
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.
Before this provision was enacted, the law permitted tax deductions for confidential settlement arrangements and related attorneys’ fees. The law did not specifically address settlement arrangements related to claims of sexual harassment or sexual abuse.
The new provision was designed to deter companies from seeking nondisclosure agreements in connection with sexual assault and sexual harassment settlements and to consequently protect victims of sexual harassment. However, this provision of the act raises a number of questions that remain unsettled:
- First, will this new provision actually deter companies from entering into confidentiality agreements in connection with settlement arrangements in the future? It is unclear whether the tax benefits would outweigh the benefits of a nondisclosure agreement. In certain situations, an employer may find it more valuable to keep the settlement confidential than to receive a deduction.
- Second, the provision states that “no deduction shall be allowed under this chapter.” Interpreted literally, it would mean the provision would apply to all of Chapter 1 of the tax code, which covers business entities and individuals. Thus, it could preclude deductibility for not only the employer but also the plaintiff.
More questions than answers
What is the definition of a claim related to “sexual harassment” or “sexual abuse”? The act does not say. What if the settlement arrangement consists of a variety of claims? The new legislation does not appear to address this possibility.
How will this provision affect the victims of harassment? Under the act, victims of sexual harassment may be required to pay taxes on the full amount of the settlement they receive if the settlement is subject to a nondisclosure agreement, even where a portion of the settlement payment goes to their attorneys for legal fees. This may result in lower net settlement amounts for plaintiffs.
Moreover, this may discourage sexual harassment victims from coming forward at all.
Do harassment or abuse claims need to be actually proven for this provision to apply, or does it apply to allegations of sexual harassment or abuse?
Is the prohibition on deductions for attorneys’ fees limited to fees associated with drafting and negotiating the settlement, or does it extend to all fees associated with the settlement?
Corrections may be needed
Because of the numerous questions resulting from this provision of the act, many commentators are predicting the issuance of technical corrections to the act in the upcoming year.
Until then, employers and employees alike may want to be cautious in applying this law.
David Rosner (david.rosner@ogletree.com) is a shareholder in Ogletree Deakins’ Washington, D.C. office, where Alexandra Orsini (alexandra.orsini@ogletree.com) is an associate.
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