The recently enacted Tax Cuts and Jobs Act (the Act) contains a largely unnoticed provision worth the attention of human resources professionals and legal counsel who draft and implement settlement agreements and releases of employee claims. Under the Act, the new Internal Revenue Code Section 162(q) – which took effect on Dec. 22, 2017 – now expressly denies taxpayers the ability to deduct as a business expense 1) any settlement or payment related to sexual harassment or sexual abuse, or 2) any attorney's fees related to any settlement or payment if such settlement or payment is subject to a nondisclosure agreement.
Prior to passage of the Act, businesses were generally able to deduct the payment of a judgment or settlement of a suit or claim arising out of a business matter as ordinary and necessary business expenses paid or incurred in carrying on their trade.
Organizations entering into settlement agreements concerning claims of sexual harassment will now have to choose between demanding confidentiality and the ability to deduct the payments and attorney's fees as a business expense when considering claims of sexual harassment.
Open Questions About New Section 162(q)
This new provision raises many questions – most of which have no clear answers – because the IRS has not issued any direct guidance on the subject. First, Section 162(q) denies deductions for any payment "related to sexual harassment or sexual abuse." It is unclear whether this will be construed as applying to general releases or waivers of all claims (asserted or unasserted) against the business, such as those that are commonly presented to employees upon their separation from employment, which may include sexual harassment claims that have not been expressly raised.
Further, if an employee has raised multiple claims, including claims related to sexual harassment and claims unrelated to sexual harassment, will any employee be permitted to apportion deductible attorney's fees and settlement payments among the claims, or will the entire agreement be considered "related to sexual harassment?"
Effects on Employee Taxes
One apparently unintended consequence of the legislative language is that it restricts all taxpayers – not only businesses – from taking any deductions for "any settlement of payment related to sexual harassment or sexual abuse." On its face, this language would require the recipients of such payments, including victims of sexual harassment, to pay taxes on settlement awards used to pay legal fees and other costs. Sen. Robert Menendez (D-N.J.), who introduced the provision as an amendment to the Act, has stated that, "when the final bill was written, language was inserted that does not reflect my legislative intent, at best has led to confusion, and at worst will inadvertently lead to sexual misconduct victims being further victimized," and that he intends to introduce corrective legislation.
Considerations For Employers
Employers who may enter into general releases of employment claims or settlement agreements concerning sexual harassment claims – or those employers that have continuing payment obligations for agreements already entered into – should consult counsel to determine how to address these obligations to protect their organization's interests most appropriately and identify any new guidance concerning the application of Section 162(q).