#MeToo Hits Employers Paying To Cover Up Misconduct

With limited exceptions, payments made by employers to settle lawsuits, and related attorneys’ fees, are generally deductible as ordinary and necessary business expenses. On December 22, 2017, the President signed reforms to the United States Tax Code.  Lost in the conversation about the changes to tax rates and various deductions is a provision, proposed by New Jersey Senator Robert Menendez, which may prevent employers from deducting payments made to settle claims for sexual harassment or sexual abuse and related legal fees.  Section 162(q) of the Internal Revenue Code now states that “[n]o deduction shall be allowed under this chapter for—(1) any settlement or payment related to sexual harassment or sexual abuse if such settlement or payment is subject to a nondisclosure agreement, or (2) attorney’s fees related to such a settlement or payment.”

When settling civil rights claims by employees, particularly accusations of sexual harassment or abuse, employers frequently will demand a non-disclosure agreement as part of a settlement, in order to protect the employer’s reputation. This new law is clearly designed to dissuade such agreements, and thus to prevent employers from keeping the underlying events secret or the offenders hidden

It is too early to determine what if any effect the new law will have on the frequency and structure of settlements. It should be noted that the new law does not prevent the use of confidentiality provisions in settlement provisions but it does make their use expensive by effectively increasing the cost of any settlement which includes non-disclosure provisions.

The new law also raises a number of issues and concerns which may create practical problems for employers. There is no requirement that litigation or a formal claim be initiated to trigger the new law.  Additionally, it is unclear whether a non-disclosure agreement limited to simply the amount of the settlement payment would trigger non-deductibility under the new law.  The new law also does not explicitly address common situations where an employer settles multiple claims including not just sexual harassment claims, but also claims which may be completely unrelated to the alleged sexual harassment (such as race discrimination claims).  What if the claims involved more than simply sexual harassment and the non-disclosure provision covered all of the other claims?  Alternatively, can the claims be structured so that there are multiple agreements or the parties agree that the harassment claims be dismissed?  Are the attorneys’ fees incurred in defending or settling the non-sexual harassment claims deductible?  These questions may need to await the issuance of guidance by the IRS.  Ironically, the new law does not impact the right to deduct the attorneys’ fees incurred in actually defending claims of sexual harassment (nor the payment of a judgment).  Thus, the tax consequences of any settlement will now need to be carefully evaluated.

For these reasons, if your business is faced with an allegation of sexual harassment or sexual abuse, or you have any questions regarding this aspect of the new tax law, you should contact a member of Archer & Greiner’s Labor and Employment Group in Haddonfield, N.J., at (856) 795-2121, in Philadelphia, Pa., at (215) 963-3300, or Hackensack, N.J., at (201) 342-6000.