The federal Tax Cuts and Jobs Act, which went into effect on December 22, 2017, included within it a quiet response to the #MeToo movement and growing issues surrounding workplace sexual harassment protection and resulting settlements. A relatively minor provision in the Act was inserted to try to discourage the use of confidential harassment settlements by employers by disqualifying those settlements from certain tax deductions.

Before the Act, companies were able to deduct the payment of settlements and attorney’s fees related to sexual harassment claims arising from business operations, as they were previously considered part of ordinary and necessary business expenses paid or incurred in carrying on trade. However, Internal Revenue Code Section 162(q) now reads: “No deduction shall be allowed under this chapter for – (1) any settlement or payment related to sexual harassment or sexual abuses if such settlement or payment is subject to a nondisclosure agreement, or (2) attorney fees related to such a settlement or payment.”

Several questions remain unanswered in the implementation of this new Code section.

1. Will this increase litigation of sexual harassment claims and discourage settlements?

Currently, only a small percentage of employment-related lawsuits go to trial. However, it has been speculated that the number of trials may well increase as settlements including a nondisclosure agreement can no longer be written off on their yearly taxes. Some commentators suggest that companies may make lower settlement offers as they know that they will not receive a tax benefit for the payment. Lower settlement offers may disincentivize claimants from settling. Employers will need to consider each claim on a case-by-case basis, balancing the importance of confidentiality and the tax deduction.

2. How does this effect sex discrimination and retaliation claims or settlements with multiple claims?

The Act does not define “sexual harassment” or “sexual abuse,” causing a gray area on whether or not sex discrimination is included. Retaliation claims are similarly not referenced, therefore leaving open the question of settlements with employees who claim retaliation after reporting sexual harassment or sexual abuse claims. Further, no clarity has been provided as to how the Act may apply to a multiple claim situation (i.e., wage and hour claim plus sexual harassment). It is unclear whether or not employers will need to apportion the parts of the settlement which are for sexual harassment or sexual abuse claims and then claim the rest as a business expense, or if a settlement which includes these claims and a nondisclosure agreement is entirely prohibited from being deducted.

3. Are pre-2017 settlements with payments going into 2018 deductible?

Settlements which include a confidentiality agreement and payment installments past December 22, 2017, but were entered into prior to the effective date of the Act are also left in the lurch following this provision.

It seems likely that we will see some guidance from the IRS on some of these issues over the course of the next year as businesses begin to navigate the impact of the Tax Cuts and Jobs Act. We may also see some minor corrective legislation as lawmakers are made aware of areas of confusion.

Employers who consider entering into releases or settlement agreements concerning sexual harassment claims should consult Martin Pringle’s employment law attorneys to determine how to best protect their companies’ interests.

Employers are always advised to first consult counsel regarding these questions and any others which may arise from the Tax Cuts and Jobs Act.