As a result of the recently passed Tax Cuts and Jobs Act of 2017 ("TCJA"), employers will no longer be allowed to deduct on their tax returns any "settlement or payment related to sexual harassment or sexual abuse
if such settlement or payment is subject to a nondisclosure agreement
." (Emphasis supplied). Further, any "attorney's fees related to such (confidential) settlement or payment" will also not be deductible. This change in the tax law became effective on December 22, 2017.
Employers who settle sexual harassment claims often include a confidentiality clause; previously, the business would deduct the settlement amount and attorneys' fees as business expenses. Now, the new rule would prohibit such deductions if the settlement agreement contains a confidentiality clause which forbids the employee from disclosing the settlement or payment.
Going forward, businesses must factor the new rule into their settlement strategy involving employee claims of sexual harassment or abuse. In those cases, employers will need to decide whether they want to:
- include a confidentiality clause as a part of the settlement and accept the "added cost to settle" resulting from the lost tax deduction for the settlement payment and any related legal fees (for example, fees paid to outside counsel to defend the case and the settlement negotiations); or
- Forego a confidentiality clause as a part of the settlement and take the tax deduction for the settlement payment and any related legal fees.
This decision will involve calculating the potential effects of public disclosure of an employee’s claims, as well as considering the amount of money involved. On this latter point, the cost of the lost deduction will be offset somewhat as a result of the TCJA's decrease in the corporate tax rate from 35 percent to 21 percent.
Some employers may not find the benefit of the tax deduction to be worth sacrificing confidentiality and potentially having to justify settlement payment deductions to tax auditors.
Beyond the foregoing basic overview, a number of questions exist as to the scope of this new rule. The Internal Revenue Service issued no relevant guidance yet on this issue, and it is likely that none will be forthcoming in the near future, given the IRS's higher priorities and limited staff. These unanswered questions include:
- Does the new law permit a non-disclosure agreement which is imposed on the employer by an employee who requests the settlement to be kept confidential to preserve their privacy?
- Can the specific allegations of the underlying claim be subject to a nondisclosure agreement? Because the law simply says that the "settlement or payment" cannot be subject to a nondisclosure agreement, would a disclosure limited simply to the fact that sexual harassment was alleged and that the matter was settled for a specified (disclosed) dollar amount still maintain the employer's ability to take the tax deduction?
- How does the new rule apply to an all-encompassing settlement of claims of sexual harassment accompanied by other claims, such as retaliation and gender discrimination? Does this render the entire settlement non-deductible? Can parties bifurcate the settlement into two separate documents, with one settlement being tax-deductible and the other one not? Will the IRS respect the parties’ allocation of settlement amounts with respect to the various claims?
- Could a crafty defense counsel get a plaintiff to dismiss the sexual harassment claim with prejudice and thereafter enter into a confidential settlement of the remaining (non-sexual harassment) claims and still deduct the costs of "settlement" and attorneys’ fees?
- Can a settlement agreement unrelated to a specific sexual harassment claim – but which includes a broad general release of claims that covers any potential sexual harassment claims – include a nondisclosure provision and still be tax deductible? (For example, separation agreements signed in connection with a layoff often have broad releases and include a nondisclosure provision).
- How broadly will the IRS interpret the rule that attorneys' fees that are "related to" a confidential sexual harassment settlement are also non-deductible? Would the cost of an investigation conducted by outside counsel related to an initial allegation of harassment be "related to" an ultimate settlement? What if outside counsel was retained only to conduct the investigation and played no further role once it concluded that investigation? Or is the "related to" provision only intended to cover payments made by the employer to the individual's attorney?
Many legal analysts have speculated that this new rule may make it more difficult for parties to settle sexual harassment and abuse allegations. This may be particularly true in cases where an employer believes it did nothing wrong but is nevertheless willing to settle the claim on a purely economic basis. Indeed, the law does not differentiate frivolous allegations from those with a strong basis in fact. Without a nondisclosure provision, will an employer be willing to settle a perceived "frivolous" claim of harassment? Would the same employer be willing to forego the tax deduction in order to get a commitment of confidentiality? Only time will tell.
Whatever employers decide to do pending resolution of all open questions, in the interim we recommend that businesses should seek experienced legal counsel in making these decisions. At a minimum, employers should update any standard separation agreements, severance agreements, and releases of claims accordingly.
Stokes Carmichael & Ernst LLP
("SCE") has represented businesses in employment law – as well as commercial law and collections, business law, and general civil litigation – for over 46 years. SCE provides sound legal advice at a reasonable cost and is experienced in representing employers in a myriad of issues. Both the author and the firm are rated by "AV Preeminent 5.0 out of 5
, the highest rating given by the legal industry’s premier peer-review rating system. This rating reflects "Preeminent" legal ability and "Very High" general ethical standards. Mr. Ernst has also been continually recognized as one of "Georgia’s Legal Elite," as a "Georgia Super Lawyer," and as a "Top Rated Lawyer
." If you have any employment law questions regarding your company, please contact Mike Ernst at 404.603.3441 or