In response to Harvey Weinstein and the #MeToo movement, Congress has passed a provision to the Tax Cuts and Job Tax Act referred to as the “Weinstein Tax”. The intended purpose of the provision is to provide transparency to the issues of sexual harassment in the employment setting, and to discourage businesses from offering “hush money” to victims of sexual harassment or abuse. However, due to the hasty drafting of this section, there are a number of issues and concerns related not only to the intended scope and purpose of this legislation and its ambiguous terms, but also the consequences and effects this legislation will have on settlement of claims.

The Internal Revenue Code allows employers to deduct ordinary and necessary expenses paid or incurred in carrying on a trade or business, including those expenses used in settling employment disputes. Prior to the passing of the Weinstein Tax, sexual harassment claims were included in this expense deduction. However, as of December 22, 2017, employers are now prohibited from deducting any settlement expenses related to sexual harassment and abuse claims when there is a nondisclosure term in the settlement agreement.

Section 13307 provides that:

No deduction shall be allowed under this chapter for –

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.

While Congress likely had good intentions in passing this legislation, tax and legal analysts have sounded the alarm as to issues that should have been, but were not, addressed in the drafting of the Weinstein Tax. First, the Weinstein Tax contains no definitions for sexual harassment, sexual abuse, and nondisclosure agreement, resulting in ambiguous terms that create confusion and potential liability.

  • Without any defining terms it is unclear whether sexual harassment and sexual abuse also include claims for gender discrimination and bullying that would fall within the deduction limit. Further, it is unclear where in a settlement of employment claims not involving sexual harassment allegations, whether a general release of all claims, including sexual harassment would be affected by this deduction limit.
  • The term nondisclosure agreement is also not defined, making it unclear as to whether Congress’ intent was to encourage only the disclosure of the settlement agreement and the amount, or, whether all confidentiality provisions relating to alleged harassment or abuse must be removed from the agreement to ensure that the parties can utilize a deduction. Moreover, the Act does not address whether terms limiting the employer’s ability to discuss the circumstances surrounding the employee’s employment with a potential future employer would constitute a nondisclosure agreement, and cause the loss of a deduction.

Second, there is much confusion over whether Congress intended for a plaintiff to lose the deduction if a nondisclosure term is contained in the settlement agreement. The Weinstein Tax provides that if a settlement agreement in a sexual harassment case includes a nondisclosure term, then the deductions the company could have taken as a business expense for attorneys’ fees are lost. However, it is unclear whether the same is true for plaintiff’s attorney’s fees. The plain text of the legislation states, no deductions “under this chapter” which implies this provision is applicable to all of Chapter 1 of the tax code covering businesses and individuals alike. This directly affects the plaintiff when reporting settlement amounts to the Internal Revenue Service (“IRS”). Before this Tax, the plaintiff would include the gross settlement amount as taxable income, and the attorney fee amount would be deducted from the taxable income amount. Thus, plaintiff would be taxed on his or her net recovery after attorney’s fees rather than the gross amount. However, based on this text, if the plaintiff cannot factor in the deduction for attorney’s fees, the plaintiff will be taxed on 100 percent of the settlement, regardless of the fact that the plaintiff’s attorney took a significant portion of the settlement amount.

Third, the Weinstein Tax fails to take into account that some victims of harassment and abuse will want to engage in pre-litigation settlement discussions prior to filing a public complaint in order to maintain their privacy. These individuals are now forced to choose the risk of full public disclosure of claims to ensure they receive a deduction.

Fourth, it is unclear whether the Weinstein Tax will have the desired effect on company transparency. While it is too early to evaluate, companies may ultimately determine that the tax deduction does not outweigh the benefits of a nondisclosure agreement which would undermine the purpose of this legislation.

Fifth, the Weinstein Tax does not address how to handle multiple claims in a settlement agreement, where there is one claim for sexual harassment, and various other unrelated claims. In a multi-claim situation, the parties could potentially enter into two separate settlement agreements, one addressing the sexual harassment claim and another, separate agreement for the remaining claims, with an agreed-upon proportion of attorney’s fees for each agreement.

Finally, this legislation does not address or take into account the number of reasons parties settle claims even when the company denies all liability. Many times financial and business reasons, and/or litigation costs drive an employer to resolve a sexual harassment claim, even when the allegations have neither been proven nor substantiated. Likewise, courts require and/or strongly encourage parties to engage in good faith mediation and/or early resolution of claims in an effort to reduce judicial resources and avoid excessive litigation costs.

While Congress was striving for transparency in passing the Weinstein Tax, it was not well-developed and will require the IRS and the courts to clarify and provide guidance as to all of these issues. During this time of uncertainty, employers are encouraged to use an abundance of caution when engaging in settlement discussions related to sexual harassment claims.