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New Tax Law Changes How Employers Claim Sexual Harassment Settlements

January 5, 2018
Labor and Employment Advisory

The Tax Cuts and Jobs Act of 2017 (the "Act") was signed into law on December 22 by President Trump. The Act contains a provision that will change how employers are taxed, when settlement is reached in sexual harassment and sexual abuse cases.

Section 162 of the Tax Code generally allows businesses to deduct certain ordinary and necessary expenses paid or incurred during the year as part of running the business. Previously, this section included tax deductions for confidential settlements and for attorney's fees incurred in defense of sexual harassment allegations. In response to the ongoing #MeToo sexual harassment awareness movement, Democratic Senator Bob Mendez of New Jersey proposed an amendment to Section 162 stating "[c]orporations should not be allowed to write-off workplace sexual misconduct as a normal cost of doing business." Subsequently, this amendment (now Section 13307 of the Act) changes Section 162 to now prohibit tax deductions for sexual harassment settlements.

Under Section 13307 of the Act, employers no longer receive a business deduction 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." In other words, if an employer requires an employee to sign a nondisclosure agreement as a condition of a sexual harassment settlement, or the settlement agreement contains a confidentiality provision, then an employer cannot claim the settlement payment, nor corresponding attorney's fees as a business deduction.

This significant provision applies to amounts paid or incurred after December 22, 2017. Until there is further guidance from either the courts or Internal Revenue Service to interpret the statutory text of Section 13307, litigants will be left with the Statute's plain language. As a result, settlement negotiations between employers and employees may be more difficult. Employers now are left with a difficult choice: deduct the settlement as a business expense or keep sexual harassment/abuse allegations confidential.

For questions regarding the recent changes to the Tax Code, contact any member of Varnum's Labor & Employment Team.

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