Employers Lose Tax Deduction for Confidential Sexual Harassment Settlements

Recent federal tax reform legislation added a little publicized provision to the Internal Revenue Code that significantly impacts employer settlements and other payments made to resolve sexual harassment disputes. Signed into law December 22, 2017, the Tax Cuts and Jobs Act (TCJA) added Internal Revenue Code section 162(q) which prohibits employers from deducting settlement or other payments related to sexual harassment if the settlement or payment is subject to a confidentiality agreement.

The law will require employers to consider carefully the tax implications of making confidential payments or settlements to resolve such claims, and to consider creative alternatives when drafting such agreements.

Section 13307 of the Tax Cuts and Jobs Act provides as follows:

PAYMENTS RELATED TO SEXUAL HARASSMENT AND SEXUAL ABUSE—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.”

Just how the new law applies remains unclear, and will no doubt be the subject of IRS regulations to be released at a future date. For example, the law provides that “No deduction shall be allowed under this chapter” for payments covered by the section. Because Chapter 1, the applicable chapter, covers both business entities and individuals, the provision could also prevent deductions taken by employees receiving such settlement or other payments.

Employers weighing the tax implications of such confidential agreements are advised to consult with experienced employment defense counsel.