In the wake of the #MeToo movement, a provision seeking to punish employers who engage in confidential settlement agreements for sexual harassment was added to the tax reform bill. The provision prohibits employers from deducting from their taxes the costs of confidential settlement agreements related to sexual harassment or abuse. The costs of non-confidential settlement agreements can still be deducted. However, sloppy drafting and unforeseen consequences may actually turn this provision into one which harms victims of sexual harassment.
The final version of this provision, which has been codified as 26 U.S.C. 162(q), was written so broadly that it prohibits sexual harassment claimants from deducting the costs of their own attorneys’ fees if they enter into a confidential settlement agreement. Previously, these claimants could subtract the costs of their attorneys’ fees from their gross income, therefore only paying tax on the settlement proceeds that they receive. However, section 162(q) prevents all parties to a sexual harassment settlement with a confidentiality provision from deducting the costs of attorneys’ fees, even the alleged victims of sexual harassment.
This could increase the tax bill for employees receiving settlements by several thousands of dollars. For example, an employee receiving a $100,000 settlement who has to pay his or her attorney 1/3 of the total settlement amount would incur an extra $8,333 worth of taxes if taxed at a marginal rate of 25%.
Additionally, the discouragement of confidentiality agreements might actually end up harming victims of sexual harassment. Many of these victims fear that publicly disclosing sexual harassment claims they made against their employer will harm their reputations and ability to obtain another job. After all, Gretchen Carlson, who brought the sexual harassment at Fox News to light, still has not returned to work as a TV anchor.
Obviously, Congress did not intend to punish victims of sexual harassment. Therefore, it is likely that the problems with section 162(q) will eventually be fixed. That will require Congress to pass a bill with these fixes, and it is anybody’s guess when that will happen. Until it does, both employers and employees should take these issues into consideration when settling a sexual harassment claim. Feel free to contact me for more information on this subject.
