Sexual Harassment Settlement Payments and Legal Fees No Longer Deductible If Subject to Non-Disclosure Provisions

Under the recently passed Tax Cuts and Jobs Act, IRS Code § 162(q), employers may no longer deduct “(i) any settlement or payment related to sexual harassment or sexual abuse, if the settlement or payment is subject to a nondisclosure agreement; or (ii) attorneys’ fees related to the settlement or payment.”

While the provision was designed to penalize employers interested in covering up settlements related to sexual harassment, and permit victims to discuss their claims publicly, an unintended consequence has arisen whereby victims may no longer be able to personally deduct the legal fees paid to their attorney, if the settlement agreement contains a non-disclosure provision.

As such, plaintiffs will have additional incentive to not agree to non-disclosure provisions as part of any sexual harassment related settlement, or will alternatively ask for more money to cover the taxes on such payments in return for a confidentiality provision. This will likely increase the cost and difficulty in settling claims, even if an employer is willing to forego the deductibility of settlement payments in order to maintain confidentiality.

Also, where there are multiple claims settled under a confidentiality agreement, the parties may need to determine how much of the payment, including attorneys’ fees, is attributable to the sexual harassment claim versus others so that only that portion is non-deductible.

Left unclear is the impact on pre-litigation severance agreements where employees waive all rights to bring claims, typically including sexual harassment claims. Such agreements may need to carve out sexual harassment from any confidentially provision.

Many commentators have suggested that the IRS should provide clarification on the scope of the new law, but until then employers and employees must proceed with caution and weigh the consequences of including non-disclosure provisions in agreements covering sexual harassment claims.