Two sentences in the 2017 Tax Cuts and Jobs Act (TCJA) could have significant ramifications for healthcare employers when it comes to workplace sexual harassment and sexual abuse settlements.

The sentences, found in the TCJA’s new section 162(q) of the Internal Revenue Code, state: “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.”

Sexual harassment and abuse settlements are no longer tax deductible if a nondisclosure agreement (NDA) is included

The financial implications of this change, which applies to payments made after December 22, 2017, should give pause to employers considering a NDA as part of a sexual harassment and/or sexual abuse settlement, because of the limitation it imposes on a healthcare organization’s ability to deduct settlement payments and attorney fees when these payments are subject to an NDA.

Previously, employers were generally permitted to deduct the payment for a settlement or judgment involving allegations of workplace sexual harassment or sexual abuse, as well as the legal fees incurred. That is no longer the case if nondisclosure on the part of the employee is part of the settlement.

Sexual harassment and sexual abuse settlements that do not require an NDA are still deductible, along with legal fees, which means that organizations will have to carefully balance the desire for confidentiality with the higher overall cost of including an NDA when deciding how to settle a claim.

While section 162(q) is a new limitation rather than a new tax, it is important for healthcare employers to be aware of the potential tax cost for the company in addition to the actual settlement costs and legal fees for sexual harassment or sexual abuse.

There also is ambiguity as to legislative intent in many key areas in the provision. For example, did Congress intend to eliminate the ability for both the employer and the employee to deduct attorney fees if an NDA is involved, or just the employer? The statute’s wording is not clear in that regard.

What about multiple claims that include sexual harassment and/or sexual abuse? Is a retaliation claim that is alleged to have arisen over filing a complaint of sexual misconduct considered related or separate? What about an allegation of discrimination? It simply is not clear at this time whether settlements for other employment claims that are lumped in with sexual harassment or sexual abuse claims are tax deductible when an NDA is required.

Until Congress, the courts or the IRS provide guidance to these and other questions about the scope of this new provision, we at LBMC Healthcare suggest the following:

  1. Carefully evaluate the additional tax costs that will be incurred for a sexual harassment or sexual abuse settlement if an NDA is attached to it.
  2. If there are multiple claims and one component is sexual harassment or sexual abuse, attorneys, accountants and others who bill for their time should keep careful records and separate the amount of time spent on dealing with the sexual harassment or sexual abuse claim vs. time spent on other claims.
  3. Bifurcate agreements and payments for non-sexual misconduct claims with NDAs to give your company the best chance at keeping the settlement and attorney fees tax deductible.
  4. For settlements involving multiple claims, attempt to assign amounts to each claim, so that non-sexual harassment settlement amounts may still be deducted.
  5. Because employees who sign nondisclosure agreements may have to pay taxes on the settlement along with attorney’s fees, be prepared for the plaintiff’s attorney to demand that the anticipated tax liability be added to the victim’s total settlement.
  6. Get advice from attorneys and accountants who are knowledgeable on the implications of 162(q) before settling any claim. This is especially important as long as there are unknowns in the provision that could result in significant tax cost depending on how the claim is settled.

For more information, please contact your tax advisor or reach out to us at LBMC and we can get you in touch with one of our experts.

LBMC tax tips are provided as an informational and educational service for clients and friends of the firm. The communication is high-level and should not be considered as legal or tax advice to take any specific action. Individuals should consult with their personal tax or legal advisors before making any tax or legal-related decisions. In addition, the information and data presented are based on sources believed to be reliable, but we do not guarantee their accuracy or completeness. The information is current as of the date indicated and is subject to change without notice.