Rex P. Fennessey

Rex P. Fennessey Partner

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SEXUAL HARASSMENT AND THE NEW TAX BILL: What you might have missed

Despite seemingly exhaustive coverage of recent sexual harassment allegations and the Republican tax bill, there was little coverage of a small but important change in the tax laws that may have significant implications for settling sexual harassment claims in the workplace.

When multiple allegations of sexual harassment against film producer Harvey Weinstein garnered broad coverage last year, many asked why some of his accusers had not come forward earlier. In part, the answer involved settlements between Weinstein and his accusers that contained non-disclosure agreements. Although terms vary, these clauses generally state that the accuser will not further publicize or discuss the allegations that gave rise to the settlement; and often prevent disclosure of the settlement itself.  The consequences of violating a non-disclosure provision vary, but often involve forfeiting some or all of the money obtained by the accuser in the settlement.  To date, reports indicate that at least eight women who claimed that Weinstein had sexually harassed them entered into settlements containing non-disclosure agreements.

While non-disclosure agreements are neither new, nor unique to sexual harassment claims, many argued that such agreements “silenced” victims of sexual harassment.  During debate on the Republican tax bill last year, Senator Robert Menendez (D-N.J.) introduced what some have called a “Weinstein tax” that denies deductions for payments made under confidential sexual harassment or abuse settlements.  The version that ultimately became law – section 162(q) of the Internal Revenue Code – provides as follows:

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.

Prior to the tax bill’s passage, employers who reached settlements (including sexual harassment settlements) could deduct the cost of such settlements from their taxes as a “business expense,” regardless of whether the settlement contained non-disclosure agreements.  With the change to section 162(q), confidential sex harassment settlements and the attorney’s fees incurred in relations with such agreements will no longer be deductible as business expenses.

Whether this change in the tax code will ultimately result in fewer confidential sexual harassment settlements remains to be seen.  Also to be determined are the potential unintended consequences of the language used in the amendment.

The prospect of negative news or social media coverage and protracted litigation sometimes causes employers to make a business decision to settle sexual harassment claims even if they believe them to be unfounded.  For some employers, the inability to deduct such a settlement and the legal fees involved in reaching it may tip the scales against settling at all.  In that situation, accusers would be required to pursue a lawsuit in order to recover anything from the alleged harasser.  Such suits often take months or years to resolve, and require the accuser to recount the alleged harassment in detail in both deposition testimony and at trial.  Some sexual harassment victims may decide the emotional and financial cost and time required to pursue a lawsuit are not worth the mere possibility of some recovery in court.  The amendment’s focus on greater public awareness of sexual harassment allegations may therefore come at the expense of recovery by individual sexual harassment accusers.

Further, the underlying assumption that only employers desire non-disclosure agreements is not necessarily accurate.  Because of the personal and embarrassing nature of sexual harassment claims, victims often seek mutual non-disclosure in sexual harassment settlements where both the employee and the employer are prevented from discussing the allegations and the settlement.  For the reasons discussed above, the additional cost to employers of confidential settlements may make such mutual non-disclosure agreements more difficult to obtain.

Sexual harassment victims may also face another potential unintended consequence from the tax bill: the tax treatment of their own attorneys’ fees. When a sexual harassment accuser is represented by an attorney, settlement of their claims often involves payment of all or part of their attorneys’ fees.  The Supreme Court has ruled that payments to an accuser’s attorney in a discrimination or harassment settlement are counted as income to the client.  However, in 2004, Congress passed a law that essentially allows employees to deduct from the amount of the settlement their attorneys’ fees incurred in pursuing their claim when calculating their federal income taxes, leaving the employee to pay taxes on only the net they actually received in the settlement.

Although neither the IRS nor the Treasury Department have issued interpretive guidance, section 162(q) appears to change that result.  Under a plain reading of the new law, “no deduction” is allowed for “attorney’s fees related to” a sexual harassment settlement that contains a non-disclosure agreement.  In other words, an employee who confidentially settles a sexual harassment or abuse claim that involves an employer’s payment of their attorneys’ fees may now have to pay taxes on both the amount they receive and the amount their attorney(s) received.  The practical impact is that employees may have to choose between non-deductibility of part of the settlement amount and non-disclosure of the settlement.  Until there is further guidance from the IRS or Treasury Department, both employers and employees should carefully consider how such agreements are drafted.

The St. Louis employment attorneys at McMahon Berger have been representing employers across the country in labor and employment matters for over sixty years and are available to discuss these issues and others.  As always, the foregoing is for informational purposes only and does not constitute legal advice regarding any particular situation as every situation must be evaluated on its own facts. The choice of a lawyer is an important decision and should not be based solely on advertisements.

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