During the height of the #MeToo movement and in the wake of the Harvey Weinstein scandal, Congress enacted a sweeping tax reform bill containing a provision intended to penalize businesses who settle claims involving sexual harassment or sexual abuse if they include nondisclosure agreements as part of a settlement. As with many rushed pieces of legislation, legal commentators have more questions than answers about the practical effect of this tax amendment.

Congress passed the Tax Cuts and Jobs Act ("TCJA") effective December 22, 2017, as one of the most significant changes to the Tax Code since 1986.

The TCJA is a small, but significant, change to the deductibility of ordinary business expenses in relation to sexual harassment/abuse claims. Under the former version of Tax Code Section 162, businesses were able deduct such settlement payments and attorney's fees as "ordinary business expenses." Under the TCJA, Section 162(q) of the Tax Code now prevents the deduction of "(1) any settlement or payment related to sexual harassment or sexual abuse if such settlement is subject to a nondisclosure agreement, or (2) attorney's fees related to such a settlement or payment." Further, the nondeductibility applies not to just to the business, but also to the claimant. Unfortunately, Section 162(q) has caused more questions than answers. 

Who is Actually Being Punished?

Commentators have expressed concern Section 162(q) will effectively lower settlement payments offered to sexual harassment and sexual abuse claimants. Because settlement payments and attorney's fees can no longer be deducted, businesses may consider the tax ramifications in settling sexual harassment and sexual abuse claims during settlement negotiations. Such an outcome of "penalizing" a claimant would be the opposite of that intended by Congress.

Decrease in Popularity of the NDA or More Necessary Now Than Ever?

Because Section 162(q) disincentivizes nondisclosure agreements, businesses and claimants are now forced make the business decision to determine whether the necessity of obtaining a nondisclosure agreement is outweighed by the resulting tax ramifications. In balancing these competing interests, nondisclosure agreements may not be worth the tax ramifications, thereby reducing the popularity of including nondisclosure provisions in settlement agreements. On the other hand, the widespread notoriety of the #MeToo movement and the Harvey Weinstein scandal may reinforce the necessity of nondisclosure agreements in efforts for businesses to avoid becoming the next headline.

What Does "Related To" Mean?

"Related to" under the amended version of Section 162 provides little guidance on its scope. For a claim to fall within Section 162(q), it is unclear whether a claimant needs to specifically allege that he or she is the victim of sexual harassment or sexual abuse or a mere suggestion of sexual harassment or sexual abuse will suffice. Because the scope of the term "related to" is unclear, courts will be tasked with providing clarity to the scope of "related to" moving forward absent congressional intervention.

What Constitutes a Claim?

Section 162(q) applies to "claims" made by an alleged victim of sexual harassment or sexual abuse. While some may consider "claim" to only involve litigated claims of sexual harassment or sexual abuse, businesses should be aware the scope of Section 162(q) is not limited to litigation. Internal complaints of harassment and abuse made by employees may also constitute a claim. Similarly, Section 162(q) does not appear to have a limitation as to whether a claim of sexual harassment or sexual abuse is legitimate or not. Even after a complaint of sexual harassment and abuse has been investigated and found to be without merit, Section 162(q) may still apply. Therefore, it is important for all businesses to understand the term "claim" may apply in situations outside of an actual lawsuit.

Section 162(q)'s Effect on Multiple Claims?

Frequently, many claimants do not allege a single claim of sexual harassment or sexual abuse against a business. Often, claims of sexual harassment or sexual abuse are tied with allegations of various forms of discrimination and retaliation. In circumstances where multiple claims, including claims for sexual harassment or sexual abuse, are alleged against a business, the applicability of Section 162(q) to a global settlement of all claims remains unclear. In such circumstances, it may be difficult, if not impossible, for the business to apportion the payments and attorney's fees it incurred in settling each individual claim. Again, the responsibility for providing guidance on the scope of Section 162(q) will be left to courts unless Congress says otherwise.

As you can see, the new Section 162(q) has provided more questions than answers. However, with many laws, there may be effective tax or employment law strategies to reduce the effects of the Section 162(q) on businesses. With so many questions left to be answered, it is important to consult with an attorney when faced with a claim of sexual harassment or sexual abuse to see if Section 162(q) may have an effect.

The attorneys at Spilman Thomas & Battle will continue to monitor and provide updates on the TCJA and its effects on employment law moving forward. Please contact Spilman's Labor and Employment Law Practice Group if you have any questions regarding this article.