Torn from today’s headlines, the Tax Act of 2017 added a new Code Section 162(q), which prohibits a company from deducting payments related to sexual harassment or sexual abuse covered by a non-disclosure agreement—and any attorney’s fees related to such a payment or settlement. Could this new provision create a potential trap for the decidedly more routine separation and release agreements drafted by most executive compensation professionals? The answer is, as we lawyers love to say: “It depends.”
As pointed out to me by my partners Ruth Wimer and David Rogers, most separation and release agreements include non-disclosure and release provisions that cover a “laundry list” of possible alternative causes of action—generally including sexual harassment. This is true, of course, despite the fact that the majority of executive separations do not involve an allegation by the terminating executive of sexual harassment. The question is whether, even in these routine separation agreement situations, we need to allocate a portion of the severance compensation to the non-disclosure and release of sexual harassment claims, which portion then would be non-deductible.
Neither the new statutory language nor the conference report further defines whether and when a payment is “related” to sexual harassment or abuse. IRS representatives have indicated that they would not deny a deduction in the case where the sexual harassment waiver was part of many possible alternative causes of action and there had been no allegations or claims of sexual harassment or abuse. Apparently, IRS intends to provide guidance on section 162(q) in 12 to 24 months. In the meantime, let’s be careful out there.