Deduction Denied – The Two-Way Effect of a New Tax Provision for Payments Related to Sexual Harassment and Sexual Abuse

The year 2017 saw a significant amount of attention paid to allegations of sexual harassment in the workplace, and the recently passed U.S. tax bill attempts to address some of those issues.  But the bill itself is not without controversy.  One provision in the bill, for example, will make sexual harassment settlements non-deductible for employers in 2018.  The nature and extent of the application of this provision, however, remain unclear.

The text of § 13307 of the bill, popularly referred to as the Tax Cuts and Job Act, amends § 162 of the Internal Revenue Code (“Code”) by adding a subsection denying deductions for payments related to sexual harassment or sexual abuse.  The text in full is as follows:


(a) Denial Of Deduction.—Section 162 is amended by redesignating subsection (q) as subsection (r) and by inserting after subsection (p) the following new subsection:

“(q) Payments Related To Sexual Harassment And Sexual Abuse.—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.”.

(b) Effective Date.—The amendments made by this section shall apply to amounts paid or incurred after the date of the enactment of this Act.

There are multiple aspects of this provision requiring interpretation.

First, the scope of its application seems to be more expansive than the drafters intended.  By prohibiting deductions “under this chapter” the new subsection purports to apply to the entire Chapter 1 of the Code, i.e., both individuals and businesses.  Thus, not only is a defendant-employer prohibited from deducting payments made that relate to sexual harassment claims, but a plaintiff-employee is also prohibited from deducting the payments received.  A plaintiff who received settlement payments could previously deduct legal fees from their settlement, and their attorney would pay taxes on the money earned from the payment.  After the passage of this bill, a plaintiff seemingly will not be able to deduct any settlement payments from their income, including attorneys’ fees – even if the plaintiff never receives their attorney’s share of the payment.  This does not appear to have been the intent of Congress, as the predecessor of this provision, introduced in November 2017, was entitled the Settlement Tax Deductions are Over for Predators Act (STOP Act).  Although Congress may have intended to pass this provision to penalize predators and protect victims of sexual harassment or abuse, the two-way effect of this provision may make prospective plaintiffs less likely to file complaints containing sexual harassment allegations.

Second, the language of the bill makes it unclear how attorneys’ fees are affected in instances of payment not subject to a non-disclosure agreement (NDA).  Whereas the first clause explicitly only applies to payments subject to an NDA, the second clause, covering attorneys’ fees, does not contain the same language.  Instead, it references attorneys’ fees “related to such a settlement or payment” without clarifying whether “such” payments must be subject to an NDA.  The Conference Committee Report for this bill suggests that the attorneys’ fees portion of the provision only applies if there is an NDA: “Under the provision, no deduction is allowed for any settlement, payout, or attorney fees related to sexual harassment or sexual abuse if such payments are subject to a nondisclosure agreement.”  Under this reading, attorneys’ fees related to sexual harassment or sexual abuse payments that are not subject to an NDA, will be tax-deductible.  Unfortunately, there is ambiguity here that could have been eliminated with better legislative drafting.

Third, it is not clear what types of sexual harassment or sexual abuse allegations are sufficient to constitute “related to” for purposes of bringing a payment under this provision.  Given that the majority of lawsuits settle, even before specific causes of action are adjudicated, it is unlikely that a sexual harassment or abuse claim would first need to be proven to have merit.  If so, this would mean that, from the start of a claim, employers may be potentially faced with an all-or-nothing situation – either the settlement payment can be deducted because the plaintiff’s allegations did not include sexual harassment or abuse, or the deduction is prohibited, regardless of whether the claim had any merit.  Nor is there a requirement that the harassment or abuse be formally alleged in a court of law.  A severance agreement under which the employee threatened but then agrees to waive a sexual harassment claim could, therefore, conceivably fall under the application of this provision.  On the other hand, this could be a word of caution to plaintiff’s attorneys.  In the past, an attorney representing an employee may have utilized a “kitchen sink” strategy to filing the lawsuit, and lumped a sexual harassment claim along with claims for age, disability, racial, or other types of discrimination.  Plaintiff’s attorneys aware of the potential tax implications to their clients may be more judicious with alleging these types of claims in the future.

Fourth, “sexual harassment” and “sexual abuse” are themselves not defined in the bill.  Presumably, these terms encompass instances of “sexual assault” but other situations are less clear.  Take one hypothetical, in which an employee alleges discrimination based on their gender and sexual orientation, yet the facts of the case more closely track a claim for sexual harassment.  The question then becomes one of form versus substance, and whether discrimination claims can ever be characterized  as “sexual harassment” as well. A sufficiently creative attorney with an incentive will likely be able to craft an argument one way or the other.

In short, the scope and impact of this provision, and the bill itself, will likely be the subject of litigation in the years to come.  Defendants and plaintiffs alike should confer with their counsel to be aware of the effects, and possible effects, of this provision and others in the new tax bill.

References used:


© 2018 Ben Jakovljevic