Congress, in the new Tax Cuts and Jobs Act (the “Tax Act”), has made settlements of sexual harassment cases more expensive for employers who seek to keep these settlements private.
Current tax law allows an employer to deduct the ordinary and necessary expenses it incurs in carrying on its trade or business. This deduction generally includes legal settlements or payments to a plaintiff (including plaintiff’s attorney fees) and any legal fees the employer has incurred in its defense. However, now a provision in the Tax Act deter employers from using nondisclosure agreements in sexual harassment settlements. Internal Revenue Code Section 162(q), prohibits employers from deducting “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 a settlement or payment.” Section 162(q) applies to payments made after December 22, 2017.
As a result of Section 162(q) the price for confidentially has increased. The inclusion of a nondisclosure provision in a settlement agreement, will prevent the employer from taking business expense deductions for any payments related to the matter, including the settlement payment and attorney’s fees.
The language of Section 162(q) is broad but unclear as to whether the IRS will consider payments made pursuant to a confidential agreement that does not settle sexual harassment claims, but which contains a broad waiver of claims, including for sexual harassment, or as “related to sexual harassment” will preclude getting the business expense deduction.
It is also unclear exactly which deductions the IRS will preclude in connection with the confidential settlement of a sexual harassment claim. The statute clearly applies to the settlement payment as well as attorney’s fees, but is silent as to costs such as those incurred with investigators and experts to assist with the case. It is presently unknown whether these costs will still be deductible. What if the employer provides outplacement services for the plaintiff or pays the plaintiff’s COBRA premiums, are those costs deductible?
There is also concern for employers who have an Employer Professional Liability Insurance insurer that steps up and defend these actions. It is presently uncertain whether an insurer will be denied a deduction for settlement and/or attorney’s fees payments, if it enters into a settlement on behalf of the employer that contains a non-disclosure agreement.
The statute explicitly provides that attorney’s fees related to the confidential settlement of a sexual harassment or sexual abuse matter are not deductible.
It appears the new statute prohibits any deduction for an employer’s own attorney’s fees incurred for defense, or the payments made to the plaintiff’s attorneys. It also appears to prohibit a plaintiff from deducting any attorney’s fees the plaintiff pays to his or her attorneys. Thus, a plaintiff may now owe tax on income that the plaintiff never received and significantly reduce his or her net recovery.
Employers will now have to carefully evaluate the cost/benefit of confidentiality. The boundaries of this new law are just being developed. It is therefore imperative to analyze with your attorney the real necessity for a non-disclosure agreement as part of a settlement.
The information presented is not intended to be, and does not constitute, “legal advice.” Because each situation varies, and only brief summary information is provided here, you should not use this information as a basis for action unless you have independently verified with your own counsel that it applies to your particular situation.
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