New tax law creates unanswered questions on sexual harassment settlements

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A little-noticed change in the tax bill recently signed in to law will affect how employers resolve sexual harassment claims against them. Section 13307 of the tax bill amends the Internal Revenue Code to provide that no individual may deduct a “settlement or payment related to sexual harassment or sexual abuse if such settlement or payment is subject to a nondisclosure agreement.” It also prohibits the deduction of attorney’s fees related to any such payment.

It is not clear what will constitute a “nondisclosure agreement.” Most employment settlement agreements include some confidentiality provision, but they can be narrowly drafted to cover only the amount of the settlement payment or broadly drafted to encompass the underlying facts of the case. The latter may be what Congress had in mind when it drafted Section 13307, with the purpose of ensuring that sexual abusers are not quietly protected. However, until the Internal Revenue Service releases some guidance or otherwise clarifies how the new provision will be enforced, employers should assume that the IRS will consider any confidentiality provision a nondisclosure agreement.

The impact of this measure is that employers settling with an employee claiming sexual harassment or abuse will have to consider that a settlement agreement including confidentiality will increase the cost of the settlement by eliminating the tax deduction for it. Employers should take this into account at every stage of liability analysis and negotiation so they do not agree to a settlement without understanding its full cost.