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Davis Brown Employment and Labor Law Blog

Time's Up For Tax Breaks On Secret Settlements - February 21, 2018

#TimesUp and #metoo has dominated the news cycle for months. With the public spotlight on the Harvey Weinstein, Matt Lauer, and Larry Nassar scandals, some people fear confidential settlement agreements may perpetuate sexual harassment and abuse. Public attention around the #TimesUp movement has propelled new tax legislation - Section 13307, “Denial of Deduction for Settlements Subject to Nondisclosure Agreements Paid in Connection with Sexual Harassment or Sexual Abuse” - in the Tax Cuts and Jobs Act passed by Congress earlier this year. This new law is designed to eliminate tax benefits for secret settlements.

Attorneys’ Fees for Plaintiffs and Employers

In updating this section of the tax code, Congress intended to discourage the tide of secret settlements or non-disclosure provisions pertaining to sexual harassment claims.  Effective January 1, 2018, employers may no longer deduct attorney’s fees or settlement payments if a non-disclosure provision is used in a case “related to” sexual harassment or abuse. We’ll return to the ambiguity of the “related to” language later.

Unfortunately, this new law may have unintended tax consequences for both plaintiffs and defendants in sexual harassment cases. Despite Congress’s intention, the actual language of this law says “under this chapter,” which applies to both individuals and employers. Many believe it is extremely unlikely that this law was intended to negatively harm plaintiffs, but poor drafting has left litigants wondering how the IRS may apply this new law. Previously, plaintiffs could deduct their attorney’s fees from the taxes owed on settlement proceeds. But now, they may be taxed on the portion of the settlement they never receive, imposing a higher tax burden on plaintiffs in sexual harassment cases than those in any other employment discrimination case.

Most of the time, employers are not worried about a plaintiff’s tax implications from a settlement agreement, but the unintended consequences of this legislation may negatively affect employers too. Litigants--both plaintiffs and employers--wishing to resolve sexual harassment lawsuits outside of the limelight may find their tax burden higher as a result. This law may deter plaintiffs from agreeing to confidentiality and non-disclosure provisions. Alternatively, employers may value the ability to take advantage of a tax benefit but a plaintiff may insist on a confidential settlement where tax savings are no longer an option. Worse yet, this law may unintentionally increase the cost of settlement or otherwise impede settlement negotiations.  Without a tax clarification, you as the employer could end up paying more. 

Multiple Claims

As mentioned at the start, the language used in the law, “related to” creates additional ambiguity, especially as it relates to multiple claims. The law does not define sexual harassment or sexual abuse, or what “related to” means.

For example, if a plaintiff has alleged discrimination and retaliation, will separating settlement payments for each allegation allow the employer to take a tax deduction on the retaliation claim? Unfortunately, employers will have to wait and see what the IRS decides.  

What’s next?

Employers and plaintiffs must wait until the IRS clarifies the scope and application of this new law, which may not occur until 2019. In the interim, if employers are negotiating settlements, they should evaluate and compare the importance of tax savings and confidentiality. Employers should also review, update, and implement their policies and procedures to prevent sexual harassment claims in order to avoid the costly and uncertain effects of litigation and this new tax law.

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