On December 22, 2017 President Trump signed into law the Tax Cuts and Jobs Act (officially Public Law no. 115-97, named “An Act to provide for reconciliation pursuant to titles II and V of the concurrent resolution on the budget for fiscal year 2018”). Recognized generally for changes to the individual income tax brackets, the corporate tax cuts, and the estate tax modification, a separate section, 13307, likely will have a significant impact on sexual harassment settlements.
Senator Bob Menendez (D- NJ) proposed the Weinstein tax exclusion (above) in direct response to the #MeToo movement after the sexual harassment revelations about Harvey Weinstein. The provision was added to the Tax Cuts and Jobs Act to restrict tax deductibility of sexual harassment settlements associated with nondisclosure agreements. Such agreements were reported in connection with Harvey Weinstein, Fox News, and other high profile cases.
Section 13307 modified the IRS Tax Code section 162 to eliminate the ability of businesses and defendants (and possibly plaintiffs) to deduct the costs associated with settlements of sexual harassment claims that are subject to nondisclosure agreements, including legal fees related to the settlements. Because most settlements related to sexual harassment have included confidentiality or nondisclosure language, the impact of this legislation will be significant for all parties involved, and will be reflected in advice from legal counsel. The provision applies to any payments made on or after December 22, 2017 and is not retroactive, except to the extent it affects payments left to be paid after December 22, 2017 on any prior settlement agreement.
The statutory language does not provide definitions for the terms “sexual harassment” or “sexual abuse.” The statutory language also does not clarify the meaning of “related to” for the purposes of settlement or legal fees. This ambiguity leaves several important open questions:
• An employment dispute that does not involve claims of sexual harassment but results in a nondisclosure agreement that includes broad releases may be problematic. If the scope of the releases includes sexual harassment claims, can that settlement be deducted by the business?
• What if a plaintiff has multiple claims, including but not limited to retaliation, gender discrimination, and a sexual harassment claim; what portions of a settlement payment will be deductible? Could effective contract drafting allocate most of the settlement consideration to the non-sexual harassment claims and thereby affect deductibility?
• In settling multiple claims, should counsel draft two separate agreements, one dealing only with the sexual harassment claim and the other agreement with all remaining claims, and allocating the larger portion of the settlement consideration to the nonsexual harassment claim, which is deductible?
• Does the statute exclude all legal fees associated with the claim from deduction, or just the portion of fees associated with the negotiation of the settlement and the drafting and execution of a settlement agreement?
Until more clarity is provided by administrative rules, legislative changes, or court opinions, lawyers will have an important role advising clients how to modify previous boilerplate nondisclosure settlement agreements Counsel also will be instrumental in structuring the negotiation of sexual harassment claims, as businesses and defendants weigh the potential benefit of keeping a sexual harassment claim confidential against the financial implication of losing the ability to deduct the settlement and legal fees.
The #MeToo movement has given a voice and a platform for sexual harassment victims. Because the number of sexual harassment claims, including class actions, is likely to increase, businesses will be motivated to increase their preventive efforts through education and training of their employees about sexual harassment. After the enactment of the Tax Cuts and Jobs Act, businesses and defendants also must be prepared to balance the cost of claims that can no longer be deducted against the value of confidentiality and settlement certainty.
The new tax provision is important, but also vague and subject to interpretation. In future issues, the Defense Litigation Insider will examine the effect of this legislation on the negotiation and drafting of settlement and nondisclosure agreements.