Posted by Don Bell Law

Confidential Sexual Harassment Settlements No Longer Tax-Deductible

Confidential Sexual Harassment Settlements No Longer Tax-Deductible

There is a short provision on the new tax reform bill that was just enacted which might impact how employees settle sexual harassment claims. According to section 13307 of TCJA, there is no deduction allowed for sexual harassment payment provided there is a non-disclosure agreement. 

With this new law, the tax deduction is no longer allowed for attorney's fees regarding confidential sexual harassment payment.


How Confidentiality affects Deductibility 

With the new tax law, there is no more tax deduction for sexual harassment settlements provided an NDA is guiding the settlement. In essence, should the employer require the victim to keep the abuse and claim confidential, the claim, attorney fee, and payment cannot be taxed. In the absence of the NDA, however, the cost and associated attorney fees are tax-deductible.

With the elimination of the tax deduction for the purpose of confidential settlements and associated legal fees, parties and firms will have to compare confidentiality and tax deductibility in deciding whether to settle each claim or not.

  

Cases when Sexual Abuse is not the only Claim

This new tax reform, however, does not answer all concerns. One of these is the implication of tax deduction for payments meant to take care of other types of employment claims. There are many cases when sexual harassment victims also file other claims (retaliation, defamation, gender discrimination) against their employer. 

This provision has not made it clear what is supposed to be the sexual harassment-related payment. This is because it makes sense to argue that retaliation claims in response to any adverse action after filing a sexual abuse claim should be classified with the sexual harassment claim.

It is not very clear if confidential settlement payment in the same category with other employment claim types should be tax-deductible, mainly classified with sexual abuse settlement. Since there are discrepancies, employers might likely separate settlement agreements and harassment claims that are not sex-related. They do this to keep the compensation of other claims private and tax-deductible.  

At times, an attorney could advise their employer to classify settlement for a series of claims with a small allocation. For instance, $150, to settle sexual abuse claims, and the remainder will take care of other lawsuits filed by the victim.

We are projecting that companies and their lawyers might employ creative drafting of settlement to separate unrelated claims. They do this to uphold the confidentiality of harassment claims that are not sex-related.


Attorney’s Fee of the Victim: The Deductibility Question 

The question of whether the Deductibility concerns only the companies in charge of the settlement payment is pretty vital. There is also the concern if it affects the attorney's fee that the victim should pay. There is no deductibility for settlements under the NDA agreements with this new provision since it takes care of section 162 of the IRC. This is the part that necessitates deduction for ordinary and compulsory business expenses incurred in a tax year. 

Going by the IRC section 162, an individual is not permitted to take the deduction. However, from the provision, it is not clear if it only applies to the business's attorney fees. From this, we can deduce that it does not allow the sexual harassment victim to deduct the attorney fee to settle the claim. We can also conclude that the business deduction that will have taken care of the attorney fees is false.

This could shock victims that sign the NDA since they will have to pay taxes on their whole settlement. This also includes all fees paid to settle the attorney. The other implication is that victims might not want payments with NDA in a bid to shy away from the tax on the attorney's fee for the settlement.

We can also deduce that in response, employers might not be keen on paying the attorney fee for the victim since every price paid to the attorney cannot be classified nor deducted as a business expense.


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