The Tax Cuts & Jobs Act of 2017 adds a new provision to the Code, section 162(q), that eliminates deductions for settlement payments related to sexual harassment or sexual abuse “if such settlement or payment is subject to a nondisclosure requirement.”
- The new provision also prohibits, in a separate subsection, deductions for attorney’s fees “related to such a settlement or payment.”
- Thus, if an employee asserts a claim of sexual harassment against of coworker or supervisor, and the employer enters into an agreement to settle the claim that includes a standard confidentiality provision, neither the amount of the settlement nor any amount of the settlement allocated to attorneys’ fees can be deducted as a business expense.
- The provision applies to payments made after December 22, 2017.
The new provision leaves several questions unresolved:
- It does not include a definition of the phrase “related to sexual harassment or sexual abuse,” which creates uncertainty about the scope of the new prohibition, especially as applied to settlement agreements covering multiple types of employment claims in addition to sexual harassment or abuse claims.
- It is also unclear, because of the structure of the new provision, whether the denial of a tax deduction for legal fees is independent from or contingent upon the presence of a nondisclosure clause.
- It is unclear how the term “nondisclosure agreement” will be interpreted; for example, whether it will reach nondisparagement clauses.
- Traditionally, plaintiff-employees have been permitted an above-the-line deduction for attorneys’ fees related to their employment claims. The new provision purports to disallow any deduction for any party to the settlement. The Act’s drafting history arguably supports a narrower interpretation, but it is hard to predict how IRS will interpret the plain language of the new provision.