Why it matters

Employers, take note: The new Tax Cuts and Jobs Act contains a provision that prohibits deductions for settlements or payments related to sexual harassment or abuse if the payment is subject to a nondisclosure agreement. Effective after Dec. 22, 2017, the provision may have broad application for employers, as neither the statute nor the accompanying legislative history featured definitions of the terms, and as employment lawsuits often include a claim for sexual harassment among other allegations. This change could complicate settlement negotiations, with the need to break out payment for claims “related to sexual harassment or sexual abuse” in order to maintain a deduction for a portion of a payment for other claims in the action, and also has implications for attorney’s fees.

Detailed discussion

President Donald J. Trump signed the Tax Cuts and Jobs Act into law on Dec. 22, 2017. One provision that was included in the mammoth statute received little fanfare and was buried in between sections titled “Information with Respect to Certain Fines, Penalties, and Other Amounts” and “Repeal of Deduction for Local Lobbying Expenses.”

Section 13307 of the measure, the new Section 162(q)(2) of the Tax Code, states: “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.”

For employers, the new provision presents a choice between a nondisclosure agreement and a tax deduction for a settlement related to “sexual harassment or sexual abuse.” One wrinkle: Legislators failed to include a definition or elaboration of the term “related to sexual harassment or sexual abuse,” which leaves unanswered questions about the application of the provision.

It could be read as applying to any action that includes a claim of sexual harassment, or an employer could argue it is limited to a claim with a central focus of sexual harassment. To avoid this problem, employers seeking to maintain confidentiality of at least some terms of a settlement agreement may want to consider separating out payment for various claims, if the facts permit. This could allow an employer to maintain deductibility for at least some of the claims at issue.

The new provision also has implications for employees, as the denial’s inclusion of attorney’s fees is not limited to those costs incurred by defendants. Historically, a plaintiff could claim the expense of attorney’s fees as an itemized deduction, but the new code appears to foreclose that option.

Sen. Robert Menendez (D-N.J.) proposed the provision. “I think most Americans would be outraged to know that they are subsidizing sexual predators in the tax code,” he told The New York Times.

To read the Tax Cuts and Jobs Act, click here.