No tax deduction for sexual harassment payments subject to NDAs

Parts of the Tax Cuts and Jobs Act that took effect January 1, 2018, have amended Section 162 of the Internal Revenue Code to eliminate tax deductions for settlements, payouts and attorney’s fees “related to sexual harassment or sexual abuse if such payments are subject to a nondisclosure agreement” (NDA). Simply put, neither the payment to plaintiffs nor their attorney’s fees associated with the sexual harassment claim can be deducted if the payments are subject to an NDA.

Although the IRS has not issued guidelines interpreting Section 162(q), there are a number of updates employers should be mindful of now. First, this section applies to all employers.  Regardless of size or revenue, any employer making payments to resolve a sexual harassment claim that includes an NDA cannot deduct the payment as a business expense. 

Second, this provision merely applies to payments subject to an NDA. Accordingly, employers will have to weigh the relative importance of the deductibility of a payment to settle a harassment claim versus the importance of having the plaintiff(s) agree to maintain confidentiality. In other words, this change in the law means that an employer can no longer deduct a sexual harassment payment and keep such payments confidential.  

The IRS has yet to issue guidelines construing the scope and meaning of “related to sexual harassment or sexual abuse;” and, therefore, employers should be attentive when structuring and making payments to resolve sexual harassment claims if an NDA is involved. The provision also appears to limit deductibility to the employee (plaintiff) who agrees to sign an NDA: a plain reading of the statute prohibits a tax deduction for “any settlement, payment, or [attorney’s fees]” relating to a sexual harassment claim subject to a NDA.

To illustrate, although a plain reading of Section 162(q) provides that payments made to resolve a sexual harassment claim subject to an NDA are not tax-deductible, it is still unclear how this prohibition will be applied when:

• Resolving mixed claims alleging a sexual harassment count and other employment law claims (i.e., discrimination based on race);

• Dealing with severance agreements for an employee alleging sexual harassment or sexual abuse;

• Applying to NDAs that are intended to merely cover statements made by the parties about settlement negotiations;

• Applying Section 162(q) to claims that include sexual harassment allegations but are not the “origin of the plaintiff’s claim” (i.e., False Claims Act or whistleblower allegations).

Given the above, all employers should consult with legal counsel when making payments to resolve claims that have a sexual harassment component, as doing so may affect an employer’s tax burden and public reputation. Counsel can help employers consider the cost of resolving sexual harassment claims with or without an NDA, as well as weigh less tangible factors resulting from this change in the law, on a case-by-case basis.