Taxes are due tomorrow. Among the less noticed features of the federal tax overhaul enacted late last year is a provision eliminating the deductibility of sexual harassment settlement payments and related attorney’s fees if the parties agree to keep the settlement secret.
Federal tax reform was the unexpected first legislative move to discourage secret sexual harassment payoffs. It won’t be the last.
Pending bills in state legislatures across the country — including in California — would prohibit employers from requiring employees to sign agreements blocking disclosure of alleged workplace sexual harassment. California law already bars confidential settlement of civil actions alleging elder abuse, childhood sexual exploitation, and any “act that may be prosecuted as a felony sex offense.” A California attorney who demands such an agreement in these contexts or counsels a client to sign one is subject to State Bar discipline.
Proponents of prohibiting nondisclosure clauses in sexual harassment settlements argue those clauses enable a culture of sexual harassment to fester within an organization because serial abs remain unexposed and a later potential acc, unaware of other claims, may feel she will not be believed. Such clauses also may deprive victims of the therapeutic value of openly sharing their experience with others.
Critics of stripping this choice from the parties contend that the unimpaired right to include nondisclosure agreements in sexual harassment settlements results in faster and higher settlements and respects the preference of the accused and, in many cases, the acc for the matter to remain private. Noted attorney and feminist Gloria Allred was quoted in The Los Angeles Times as opposing a ban on confidentiality clauses in sexual harassment settlements. The most important thing, said Allred, is the acc’s satisfaction with the settlement .
The new federal tax provision adds an exception to section 162 of the tax code which allows a business to deduct “all the ordinary and necessary expenses paid or incurred” in operating the business. New subsection 162(q) bars any deduction “under this chapter” for “any settlement or payment related to sexual harassment or sexual abuse if such settlement or payment is subject to a nondisclosure agreement” and for attorney’s fees related to such a settlement or payment.
Tax experts say the language of the provision – specifically the broadening phrase “under this chapter” — applies the deduction bar both to the businesses that pay settlements under an NDA and the accs who receive the payments. That means, according to experts, the recipient of such a secret settlement payment now must pay taxes on the full settlement – including the amount she turns over to her attorney – rather than excluding or deducting the amount paid in fees from her taxable income. That also means the fees paid to the acc’s attorney will be taxed twice, once as income to the acc and again as income to her attorney.
Sen. Robert Menendez, D-N.J., originally offered “conceptual language” for this provision that expressed his intent to direct the new provision only to businesses that pay such settlements. Sen. Menendez has called for a legislative fix to what he called the enacted provision’s “direct conflict with his stated legislative intent.” Sen. Menendez’s office did not answer emailed questions about the introduction of corrective legislation.
The Internal Revenue Service has not issued guidance about 162(q). Tax experts say one open question is whether the provision prohibits a deduction for settlement with an NDA even if sexual harassment is only one of several distinct claims of wrongdoing made and settled by the acc. Also uncertain is whether the non-deductibility of attorney’s fees applies only to fees incurred in negotiating and drafting the settlement or fees spent defending the claim up through settlement.
Even if the non-deductibility provision is limited to employers, or rendered irrelevant in states that later bar nondisclosure clauses, settling sexual harassment claims will effectively become more burdensome for employers. In the service of transparency, that increased burden on settlement may reduce payouts to accs. Maybe that is to the good, in a greatest-net-benefit-for-the-greatest-number kind of way. But federal and state lawmakers should consider that fully before proceeding further in this direction.
Dan Eaton is a partner with the San Diego law firm of Seltzer Caplan McMahon Vitek where his practice focuses on defending and advising employers. He also is an instructor at the San Diego State University Fowler College of Business where he teaches classes in business ethics and employment law. He may be reached at [email protected]. His Twitter handle is @DanEatonlaw.
