Why Confidential Settlements of Sexual Harassment Claims Just Got More Expensive

By:  Melanie Dunajeski

The #MeToo movement was front of mind with many lawmakers late last year when Congress passed the “Tax Cuts and Jobs Act”, and a tiny section of that Bill may make settlements of sexual harassment and sexual abuse claims more expensive—if either party wants to keep the settlement confidential. While the headliner of that Bill was reduction of corporate and personal income tax rates, tucked among the add-ons was new Internal Revenue Code Section 162(q) which provides “[n]o 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 non-disclosure agreement, or (2) attorney fees related to such a settlement or payment.”  Previously,  settlements—even confidential ones subject to non-disclosure agreements—had been treated by the tax code as deductible ordinary and necessary expenses incurred in the course of business.

This change has wide ranging ramifications to all of the parties involved in a sexual harassment or sexual abuse claim. For an employer seeking to make a confidential settlement, it just got more expensive.   For a person who is making a claim,  a private settlement may no longer be an option  AND payment to claimant’s attorneys may no longer be deductible by the claimant if a private settlement is made.

Further, this new section directly impacts every confidential agreement that an employer enters into with an employee that contains a broad-form release or waiver of claims including severance and separation agreements.  Even if no sexual harassment or sexual abuse is alleged, broad-form waivers and releases will require specific carve-out language and disclosures if payments made are to remain deductible. Employers should not rely on form agreements drafted before the passage of the tax act on December 22, 2017.

There is no doubt that this change will serve as a deterrent to confidential agreements, but it remains to be seen whether it will also have the unintended consequence of forcing more of this type of claim into litigation and ultimately trial.  It is expected that the IRS will issue some regulations or guidance to further explain the more ambiguous terms of the law, but until then, anyone entering into a confidential settlement agreement of an employment matter of any kind will be well served to consult with counsel.