You’ve Settled Your Employee’s Harassment Claim – Now, is it Deductible?

Employers who are faced with sexual harassment or sexual abuse claims by a current or former employee now have another problem to consider – are the settlement payment and related attorney’s fees incurred in settling the claim deductible?  Unfortunately, the answer to that question may now be no.

The enactment of the Tax Cuts and Jobs Act (the “Act”) on December 22, 2017 resulted in many significant changes in our tax laws.  One item of significance to employers is the inclusion of a new provision that restricts the ability of an employer to deduct certain settlements or payments relating to sexual harassment or sexual abuse claims.

Specifically, the Act added a new Internal Revenue Code (“IRC”) section, 162(q), which provides that “[n]o deduction shall be allowed . . . 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.” 

The impetus for the enactment of this new code section was of course the concern that confidentiality provisions tied to sexual harassment/sexual abuse settlements could potentially protect sexual predators and enable them to offend again.  However, confidentiality provisions are a common component in settlement agreements involving the settlement of employment-related claims including sexual harassment and can be of critical importance to employers. 

Given the broad scope of the statutory language, there are a number of uncertainties with respect to what deductions are permissible.  For example, neither the statute nor the accompanying legislative history includes a definition of the term “related to sexual harassment or sexual abuse.”  Does the statute preclude the deduction of the entire amount of a settlement in a case where sexual harassment is only one of many claims brought?  As we know, employment-related lawsuits very often include a claim for sexual harassment along with a variety of other claims.  Can a settlement be allocated between the various claims so that only the portion of the settlement (and related attorney’s fees) allocated to sexual harassment is nondeductible in cases where a nondisclosure provision is included in the settlement agreement?  Is a deduction allowed if a nondisclosure provision is included in the settlement agreement with the specification that it only applies to claims other than the sexual harassment/sexual abuse claim?

Since there are currently no regulations or other rulings interpreting this IRC section, there are unfortunately no answers to the above questions at this time.  As such, while it may be advisable to include an allocation between claims in a settlement agreement, until further guidance is issued, an employer wanting to ensure the deductibility of its settlement payment (and related attorney’s fees) in a sexual harassment or sexual abuse case will need to avoid including a nondisclosure provision in the settlement agreement.  Alternatively, if a nondisclosure provision is critical to an employer, the employer will need to take into account the fact that the settlement payment and related attorney’s fees will not be deductible in determining the amount for which it is willing to pay to settle the claim.

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