When U.S. President Donald Trump signed the Tax Cuts and Jobs Act into law last month, everyone was focused on the corporate tax cuts and — especially here in California — the reduction of the deductions for mortgage interest, state income taxes, and local property taxes.
But lurking in the new tax law was a provision that is already impacting employers across the country. Added by Senator Robert Menendez (D-NJ), the provision is now codified at Internal Revenue Code §162(q)(2) and provides:
“No 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.”
In other words, employers who settle workplace sexual harassment lawsuits using may no longer deduct the settlement payments or attorneys fee if they memorialize the settlement in a standard release agreement. Why? Because almost every standard release agreement contains a confidentiality/non-dislosure clause that prohibits the plaintiff from disclosing: (1) the fact that a settlement was reached, (2) the amount of the settlement payment, and (3) the facts and details underlying plaintiff’s claims.
The Impact on Employers
Now, as a result of the new tax law, American employers facing workplace sexual harassment suits have a choice to make. Either forego the standard non-disclosure agreement in order to get the tax deduction, or forego the tax deduction in order to get secrecy and confidentiality.
But some of us are arguing that there’s another option. A close read of the new law makes it clear that the settlement must be “related to sexual harassment or abuse” in order for the deduction to be lost. Given that most plaintiffs who allege workplace sexual harassment also raise other workplace claims as well, the language of the law appears to encourage employers to resolve disputes by making two separate settlement payments. One large (and deductible) settlement payment could be made for all of plaintiff’s claims other than the sexual harassment claim, and one smaller (and not deductible) settlement payment could be made for plaintiff’s sexual harassment claim. If documented carefully, and assuming the facts of the underlying lawsuit support such a division, this strategy could help offset some of the lost deduction.
The Impact on Employees
Interestingly, employers are not the only ones negatively impacted by this new law. Employees are also complaining. Under prior tax law, employees who brought and settled a sexual harassment suit could often deduct the attorneys’ fees that they incurred in connection with the lawsuit. This helped to lessen the blow when the plaintiff had to pay his/her attorneys 35% or 40% (0r more) of the settlement as legal fees. But the language of the new tax law almost certainly eliminates this deduction for employees when the employer opts to use a release agreement with a standard confidentiality/non-disclosure provision.
In addition, and not surprisingly, the new law is making it more difficult to settle pending sexual harassment cases. With employers facing the prospect of paying not only a settlement but also income tax on the settlement amount, some are choosing to go to trial instead. Even if the employer loses at trial, any amounts that the jury orders the employer to pay would remain deductible (because the employer is paying a court-ordered judgment, not crafting a settlement agreement and payment utilizing a confidentiality clause).
SB 820 — The California STAND Act
Finally, as is usually the case, California employers confront even more challenges. Why? Because a few weeks ago, as a result of the #MeToo movement, the California legislature began debating SB 820. This new law, if enacted, would apply to all public and private employers in California. It would prohibit settlement agreements that prohibit the plaintiff in a sexual harassment or gender discrimination case from talking about the facts underlying her claims. The settlement agreement could require the plaintiff not to reveal the amount that was paid to her/him in connection with the settlement, but it could not seek to prevent the plaintiff from telling his/her story and experiences that led up to the lawsuit. SB 820, which is formally known as the Stand Together Against Non-Disclosures (“STAND”) Act, is currently under consideration in the Senate Judiciary Committee.
You can read the full text of SB 820 here.