The new Tax Cuts and Jobs Act (the “Act”) makes many changes to federal tax law, but one provision of the Act should be of interest to employers and claimants settling claims of sexual harassment and abuse.

In the wake of the Harvey Weinstein scandal, some have argued that the use of nondisclosure agreements in harassment and abuse cases may lead to continued abuse by perpetrators.  In an effort to discourage the use of nondisclosure agreements, New Jersey Senator Robert Menendez introduced a provision that penalizes perpetrators by taking away the tax incentive for their businesses to pay their legal fees and settlements in such cases.

New section 162(q) in the Tax Code provides as follows:

(q) Payments Related to Sexual Harassment and Sexual Abuse—No deduction shall be allowed under this chapter 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.

                        (emphasis added).

This provision has been widely criticized as hastily enacted and, as a result, overbroad and even unclear.  Many have noted the provision’s unintended adverse effects.

First, often the business’ reputation and the victim’s privacy are deemed to be more valuable than the tax deduction, so the provision may not in fact deter companies and victims from entering into nondisclosure agreements.  Moreover, it should be noted that the provision does not apply to the government (e.g., members of Congress) and tax-exempt entities (e.g., Catholic Church), because they are not “taxpayers.”

Another important criticism is that the provision says “under this chapter,” which applies to all income tax, both business and personal.  As a result, the provision may hurt the victim as well, who will be unable to deduct legal fees from the settlement amount received.  Currently, the tax law provides an above-the-line (dollar-for-dollar) deduction for legal fees in employment cases, resulting in tax to the claimants on net recoveries, not the gross settlement amount.

In addition, the reference to claims “related to” sexual harassment makes it difficult to know how to treat a settlement payment, and related legal fees, where numerous claims are asserted, only some of which relate to sexual harassment.  This provision will encourage the claimant and the employer to agree on an express allocation of some portion of the settlement amount to sexual harassment claims.

Finally, Section 13307(b) of the Act states that the new provision applies “to amounts paid or incurred after the date of the enactment.”  This means that it applies to settlements entered into before the enactment date, if part of the settlement has not yet been paid.  Thus, it could potentially force victims to seek renegotiation and/or revocation of existing nondisclosure agreements.

Nondisclosure agreements are a mainstay of sexual harassment settlements and often the key provision for which employers are bargaining, even if they deny the allegations, as there is significant value in keeping their reputation and eliminating “me too” suits.  Accordingly, it is unlikely that the new tax law provision will deter employers from requiring nondisclosure agreements, although it may affect the amounts for which these cases settle in order to account for the extra cost to all parties.

The new tax provision eliminating the deduction for payments related to sexual harassment and abuse cases raises many issues, some of which are not easily resolvable.  In addressing such claims and negotiating settlements, employers and claimants are well-advised to consider the impact of this new law and its far reaching implications.