A little-discussed provision in the Tax Cuts and Jobs Tax Act (“Act”) signed into law earlier this year by President Trump may increase the after-tax cost for companies to settle sexual harassment or sexual abuse claims. The Act will now disallow a business deduction for amounts paid to settle such claims, including attorneys’ fees, if the settlement contains a nondisclosure agreement.

Specifically, the Act adds Section 162(q) to the Internal Revenue Code, which simply provides that:

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.

Although the new language of Section 162(q) appears simple, the application of the new rule may make for difficult settlement negotiations or pose additional problems for employers and employees alike. For example, there is no exception in the Act to allow for deductions of settlement costs even if the employee making the claim wishes to include a nondisclosure agreement, rather than the employer. More perplexing, the law does not define “sexual harassment or sexual abuse,” leaving that definition up to employment and/or tax lawyers when fashioning settlement provisions or filing business tax returns. Finally, the law does not specify whether settlement payments or attorneys’ fees may be deducted when the settlement resolves allegations that include, but are not solely based on, sexual harassment or abuse claims.

Careful drafting of settlement agreements and structuring of payment plans may lessen the impact of this provision. However, until and unless the IRS issues further guidance on these issues in the form of rulings or regulations, the employer may not immediately know the tax implications of including nondisclosure language in a particular settlement agreement. Both employers and employees should therefore carefully consider the plain language of the Act and its possible effects when planning for legal settlements or tax purposes.

If you are concerned about the drafting or impact of potential sexual harassment settlements, or if you have any questions about how this new tax provision could affect your business operations, future settlement negotiations or tax filings, please do not hesitate to contact our Labor & Employment Law attorneys.