New Tax Act Affects Settlements of Sexual Harassment Suits

by Jackson Walker
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Jackson Walker

The Tax Cuts and Jobs Act has a special provision that addresses the recent concerns growing out of Harvey Weinstein and other scandals related to sexual harassment and abuse. Specifically, the Tax Act addresses the concern that companies have used non-disclosure agreements to shield the reputations of prominent executives or other economically valuable employees, and that following such agreements, other employees have been subjected to similar conduct.

To address these concerns, in part, Congress limited the deductions that businesses may take for attorney’s fees or payments of sexual harassment settlements. Specifically, the new Act provides as follows:

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.

The law would clearly apply in a case alleging sexual harassment in which the Company or the accused employee obtains a non-disclosure agreement from the alleged victim of the conduct. The law would tend to deter such agreements by not allowing the Company to deduct the payment (or attorney’s fees related to the settlement or payment) as a “trade or business” deduction. (Notably, due to the reduction in the corporate income tax rate, the deterrence is not as much as it would have been under prior corporate tax rates.)

Some things are not clear, however. For example, often the victim of sexual harassment is equally interested in a confidential settlement. If the victim requests a “nondisclosure agreement” from the employer, and the employer agrees, does the employer potentially lose its deduction? Such a settlement or payment would appear to be, literally, a “settlement or payment [that] is subject to a nondisclosure agreement,” although it might be well argued that the intent of the provision is not to prohibit nondisclosure agreements protecting victims. For now, if employers wish to ensure deductibility, the better course would be to appear to make the non-disclosure agreement binding only on the employer, or, at the least, document carefully that non-disclosure was requested by the settling employee.

The new law will introduce different dynamics in a settlement. For example, the accused employee may be more interested in a nondisclosure provision than the Company, or vice versa. Companies might then insist that the executive contribute to the settlement to offset the loss of the deduction. Settlements may be harder to achieve, as the executive may insist on “clearing his name,” if there is no confidentiality agreement.

Another issue will be how the new Act affects severance agreements that release all claims, but where there has been no previous allegation made about sexual harassment. Should a carve out be made of the confidentiality provisions of such agreements? The law took effect immediately, so until the law is clarified, it may be prudent in those circumstances to carve out any allegations of sexual harassment from the nondisclosure agreement or to expressly disclaim any allegations of sexual harassment, to the extent deductibility is desired.

The provision is deceptively simple, and we will continue to monitor as regulations, interpretive statements or other guidance clarify this new provision.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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