A new tax law provision intended to discourage the use of “hush money” in sexual harassment settlements could hurt harassment claimants as well as employers.
The provision, codified as tax code Section 162(q), bars employers from deducting the costs of a settlement related to sexual harassment or abuse, including legal fees, if “such payment or settlement is subject to a nondisclosure agreement.”
But Congress in its haste to enact the Tax Cuts and Jobs Act wrote the provision so broadly that it also apparently bars harassment claimants from deducting their own attorneys’ fees if a settlement includes a nondisclosure pact. The result: Many workers who settle harassment claims will have to pay federal income tax on money they never see because it goes directly to their attorneys as part of the settlement.
And even though the goal was to make companies think twice about using nondisclosure agreements to keep alleged victims from divulging details about their claims, the new provision could also run counter to the interests of claimants who sometimes have their own reasons for wanting the details to remain under wraps.
Tax on Attorneys’ Fees?
Sex harassment claimants, like workers who settle other types of discrimination claims, previously could subtract their attorneys’ fees from gross income, leaving only their net settlement amount as potentially taxable income, said Anthony Infanti, a University of Pittsburgh tax law professor.
But Section 162(q) bars all parties to a sexual harassment settlement with a nondisclosure provision from deducting attorneys’ fees related to the claim.
That’s what happens when Congress enacts major tax legislation without adequate review, said Daniel Shaviro, a New York University tax law professor.
The legislation was “very much rushed” and “many stupid and absurd” provisions ended up in the enacted version, Shaviro said.
“It’s an example of sloppiness and carelessness,” he said in reference to Section 162(q).
Sen. Robert Menendez (D-N.J.), who sponsored the Senate proposal to deny tax deductions to employers that require nondisclosure pacts as the price for settling sexual harassment claims, expressed dismay with the final version of Section 162(q). Menendez has vowed to introduce a bill to correct the apparent error.
Settlement Dynamics Affected
In the meantime, employers and harassment claimants must grapple with the new tax rules when trying to settle harassment claims.
The circumstances of each harassment case probably will determine which side, if any, gains leverage in settlement negotiations when tax deductions are linked to the absence of a nondisclosure pact.
The conventional wisdom in the #MeToo era is that claimants always would oppose a confidentiality clause because they want to out the company or individual who abused them.
But “there are two sides of the coin,” said Michael Fleischer, a lawyer with Seyfarth Shaw in Boston who represents employers. A harassment claimant who wants to remain employed by the company or fears that publicity would damage her career prospects may be as interested in confidentiality as the employer, he said.
Meanwhile, it’s questionable how many employers would forego a nondisclosure agreement as part of a harassment settlement in order to keep their tax deductions.
A large employer might have greater resources to absorb the tax hit under Section 162(q) for a settlement including a nondisclosure pact, while a smaller employer might find it more critical to get the tax deduction, even if it means risking adverse publicity, Fleischer said.
The new law could make employers less willing to offer large sexual harassment settlements, said Avi Kumin, a lawyer with Katz Marshall & Banks in Washington who represents workers.
About “95 percent” of sex harassment settlements he sees include confidentiality provisions and nondisparagement clauses, he said. “It’s going to be a rare case” in which an employer will want to sacrifice those provisions just because of the new tax consequences, Kumin predicted.
“My concern is that on the margins, for employers, it makes settlement more expensive,” he said. Workers with harassment claims may see lower settlement offers on the table, or none at all, Kumin said.
What’s the Fix?
There could be ways to work around the new law. In cases alleging multiple bias and retaliation claims, the parties could agree to allocate a relatively small amount of the settlement to the sexual harassment claim.
Although the Internal Revenue Service might closely scrutinize such allocations, it’s worth a shot because under tax code Section 62(a)(20), claimants still can deduct their attorneys’ fees related to all other types of discrimination.
The IRS could choose “not to be very aggressive” in challenging the parties’ settlement allocations, said Shaviro of NYU.
The IRS also could issue guidance that removes the sting of new Section 162(q) for harassment claimants. But the new law pretty clearly applies to all taxpayers, including harassment claimants, so it could be difficult for the IRS to interpret the law otherwise, said Infanti of the University of Pittsburgh.
The IRS’s “hands are tied” by the broad language Congress used, he said.
Ultimately, a legislative fix through a technical corrections bill might be the only answer. In the interim, settlement negotiations in sexual harassment cases, already a fraught experience, just got a little tougher.
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