Mcle Self-study: Tax Reform Impacts the Tax Treatment of Sexual Harassment Settlements for Both Plaintiffs and Defendants

• Citation: Vol. 32 No. 3
• Publication year: 2018
• Author: By Stephen J. Turanchik

MCLE Self-Study: Tax Reform Impacts the Tax Treatment of Sexual Harassment Settlements for Both Plaintiffs and Defendants

Plus: Even More Uncertainty than the prior Law

By Stephen J. Turanchik¹

Stephen J. Turanchik is an attorney in the Tax practice of Paul Hastings and is based in the firm's Los Angeles office. Mr. Turanchik's practice focuses on tax controversy and litigation at the state and federal levels and tax advice on international reporting and the taxation of settlements. He is also a frequent lecturer on the taxation of settlements, virtual currency and international tax compliance and enforcement (not necessarily at the same time).

It has long been a tenet of U.S. income tax law that deductions are a matter of legislative grace.²

Taxpayers may deduct ordinary and necessary business expenses paid or incurred in carrying on any trade or business.³ Payment of a judgment or settlement of a suit or claim arising out of a business matter is generally deductible as a business expense. Until recently, this principle applied to payments in settlement of employment-related sexual abuse and harassment suits.

The enactment of the Tax Cuts and Jobs Act (TCJA) in December 2017 will significantly impact such deductions. Effective December 23, 2017, payments made or incurred after December 22, 2017 that relate to sexual harassment and abuse claims will no longer be deductible to the extent that they are: (i) payments of a settlement subject to a nondisclosure agreement; or (ii) payments of attorney's fees for such a settlement. Specifically, TCJA Section 13307 added new IRC § 162(q), which provides as follows:

Payments related to sexual harassment and sexual abuse. 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.

This change appears to be a response to the recent highly-publicized claims of sexual harassment and/or sexual abuse that were hidden from public view because of nondisclosure agreements.

Although such payments are no longer deductible, the additional cost to corporations will not be as significant. The new tax bill also reduced the corporate income tax rate to 21% from the previous 35%, which means a disallowed deduction of $100,000 would only be an additional cost to an employer of $21,000, as opposed to $35,000 under prior law.

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1. Scope of Disallowed Deduction

New IRC § 162(q) disallows a deduction for attorney's fees and payments or settlements "related...