A little-known provision in the Tax Cuts and Jobs Act should be of great interest to employers. In response to the #MeToo movement and the recent surge of sexual misconduct allegations, Congress included a provision in the Act that precludes employers from deducting (1) settlements or payments relating to sexual harassment or abuse if the settlement or payment is subject to a nondisclosure agreement or (2) attorneys’ fees relating to such a settlement or payment. The provision applies to amounts paid or incurred after December 22, 2017.
Previously, employers could deduct as ordinary and necessary business expenses all settlement payments arising out of a business matter as well as related attorneys’ fees. The new law will make sexual harassment settlements more expensive for employers who include confidentiality provisions in their settlement agreements. Employers will have to choose between deductibility and confidentiality.
The Internal Revenue Service (“IRS”) is expected to issue guidance to clarify some of the questions surrounding the new law. For example, it is not clear whether an employer can deduct payments relating to a confidential settlement agreement that contains a broad release of claims, including claims for sexual harassment, even if no actual sexual harassment claims were asserted in the underlying litigation. And, if a confidential settlement agreement settles litigation involving sexual harassment claims and other claims, can the settlement payments be apportioned among claims, allowing the employer to deduct a portion of the settlement payment?
Until the IRS weighs in, employers should tread carefully in this area and consider the potential added tax burden of settling sexual harassment claims. In some circumstances, employers may deem confidentiality to be worth the extra cost. One thing is clear – settling sexual harassment claims on a confidential basis just got more expensive.