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The Removal of Tax Deductions for Sexual Harassment Settlements

Recent changes in the tax code have made sexual harassment charges more expensive than ever for businesses. A little-publicized tax change prohibits taking a deduction for sexual harassment settlements that involve nondisclosure agreements. This means that these settlements and related costs are above-the-line expenses and all the more important for businesses to avoid. 

What You Need to Know About Changes to The Tax Code

The Tax Cuts and Jobs Act of 2017 (TCJA) is a tax reform law that was passed in December of 2017. An often-overlooked section of this law prohibits taking tax deductions for settlements in sexual harassment cases that involve a nondisclosure agreement. 

Prior to this law, individuals could deduct legal expenses for sexual harassment cases, as long as those expenses were greater than 2% of the individual’s adjusted gross income. Similarly, employers could deduct sexual harassment awards and attorneys’ fees as “ordinary and necessary business expenses.” 

Section 162(q) of the TCJA prohibits such deductions when a nondisclosure agreement is involved. This tax section states: 

“No deduction shall be allowed under this chapter for—(1) any settlement or payment related to sexual harassment or sexual abuses if such settlement or payment is subject to a nondisclosure agreement, or (2) attorney fees related to such a settlement or payment.” 

Often known as the “Weinstein Tax,” the purpose of this section is to discourage the use of confidential harassment settlements and to prevent companies and individuals from being able to deduct either settlement fees or related legal fees. 

It’s worth noting that on its face, the section seems to state that plaintiffs are also prohibited from deducting legal fees for settlements received. However, the IRS addresses this issue in its “Frequently Asked Questions” section, stating that plaintiffs are entitled to deduct legal expenses. Similarly, the Joint Committee on Taxation has stated that beneficiaries of settlements are not subject to this rule; however, it also noted that Congress might need to issue a technical correction to “reflect this intent.” 

Implications of These Changes

One obvious result of this change is that sexual harassment cases become more expensive for businesses. Many businesses are not aware of this change, and it’s unclear how they will respond to it. One potential response is to reduce the number of nondisclosure agreements used in sexual harassment lawsuits. Another response is to reduce settlement offers, making these cases more affordable. Both responses could mean that fewer cases are resolved with settlements and that more cases will go to trial. 

Time will tell how individuals and businesses respond, but a clear takeaway for businesses should be that sexual harassment cases are becoming more expensive. For companies opting to use nondisclosure agreements in sexual harassment suits, the settlement and fees will be above-the-line expenses. And, even without this change, sexual harassment is expensive - it leads to lower productivity, employee turnover, and lawsuits. As always, the best course of action is to prevent sexual harassment proactively within your company. 

The Lynch Law Firm can help with the identification, investigation, and remediation of a culture that experienced a sexual harassment event. Give us a call if you have any questions about these changes or need help preventing or addressing issues of sexual harassment.