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Post Weinstein Tax Provision - Private Settlements of Sexual Harassment Cases Are No Longer Deductible

Posted by Robin B. Kallor | Jan 25, 2018 | 0 Comments

In response to the tornado of sexual harassment allegations against prominent figures, there continues to be much discussion over whether confidential settlements of sexual harassment claims should be enforceable. It is not unusual for settlement agreements in employment cases (not solely those which resolve harassment claims) to contain confidentiality provisions to promote a quicker resolution before a jury determination and avoid the presumption of guilt, especially where cases often settle for business reasons to avoid the expense of a jury trial.  Moreover, confidentiality provisions serve to prevent plaintiffs' attorneys from informing potential plaintiffs about prior settlement amounts which could effectively set a floor for settlements against that same employer.  Confidentiality provisions encourage early resolution of these types of cases without the expense and uncertainty of litigation for both parties, and also allow employees, who experience emotional upset, to discretely put these matters behind them.  Critics of these confidentiality provisions contend that these provisions perpetuate sexual harassment claims by promoting a culture of silence that allows harassers and a harassing culture to continue.  Given the #metoo movement, we expect to see statutory changes, changes in administrative guidance and interpretation and changes in judicial interpretation. New York, New Jersey and Pennsylvania have already introduced bills to ban confidentiality provisions in settlement agreements in harassment cases.

The new tax bill, signed into law on December 22, 2017, contains a provision that will increase the after-tax cost for companies to settle “sexual harassment” or “sexual abuse claims if they wish to maintain a “nondisclosure agreement” of the details. The law will prohibit a business deduction for the amounts paid to settle such claims (including attorneys' fees) if the settlement agreement contains a nondisclosure agreement. The provision reads 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 settlement or payment.

The provision is very short, but creates more questions than it answers. While  government employers are seemingly not affected because they are not subject to federal income tax and therefore do not claim tax deductions for litigation settlements, the provision makes no distinction between deductions for employers and deductions for employees.  Therefore, employees who wish to gain the benefit of the deduction for their attorneys' fees may object to non-disclosure agreements in order to gain the tax advantage which, even under circumstances in which they may prefer the nondisclosure provision.  Additionally, the provision does not define the “payor.”  There is also no guidance as to what is meant by “related to sexual harassment or sexual abuse.”  Thus, where cases involve different types of claims, would allocation be permissible?  Would this expose the parties to litigation should the issue of the deduction be investigated by the IRS, thereby defeating the purpose of the confidentiality provision?   What if an employee is seeking confidentiality?  However, given the new rule, employers will be forced to choose between the deduction and confidentiality.

Regardless of the arguments against confidentiality provisions in settlement agreements, the unintended consequence of restricting their use will be an increase in jury trials which may not necessarily serve the interests of the employee, despite the intent of any legal restrictions or prohibitions on the use of such provisions.

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Robin B. Kallor



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