Under the new US tax law, known as the Tax Cuts and Jobs Act (‘TCJA’), US taxpayers will lose, or have lost, a number of tax deductions. For employers, one they may not be aware of (or may not have had reason to hear about) relates to financial settlement of sexual harassment or sexual abuse claims by employees. Previously, employers generally could deduct amounts paid in settlement of sexual harassment or abuse claims, as well as legal fees paid with respect to these settlements or payments, from their Federal taxable income. Under the TCJA, this deduction will no longer be available if the settlement or payment is subject to a non-disclosure agreement.
This will have a major effect upon the economics of any settlement that an employer may enter into in cases involving claims of sexual harassment or abuse where a non-disclosure agreement forms part of the settlement. The actual cost of the settlement will increase by an amount equal to the tax on the (now non-deductible) settlement payment and related legal fees. In the case of a corporate employer, this could be as much as 21% (or more if the non-deductibility carries through to its income tax liability at state level, if any). For an employer subject to individual tax rates, such as a partnership, the cost could be much higher, as the individual rates are potentially much higher. However, the wording of the new provision is not the best, and there are several unanswered questions that need to be resolved by the Internal Revenue Service (the ‘IRS’) before the impact of the provision can be fully understood.
Some of those questions are:
This change became effective on 22 December 2017 (the date TCJA was enacted), and applies to any payment made after that date, specifically including payments made under pre-existing settlement agreements. This means that a settlement reached in November 2017 but paid on 30 December 2017, or any settlements paid in instalments for the past three years that are continuing past 22 December 2017 will no longer be tax deductible, if the conditions apply; that is, settlement of a sexual harassment or abuse claim that includes a non-disclosure requirement. This is subject to the resolution of any remaining uncertainties, as described above; hopefully we will have that resolution sooner rather than later, particularly for those employers whose 2017 tax deductions are being affected.