Section 13307 of the 2017 Tax Act (H.R. 1) (“the new tax law”), signed into law on December 22, 2017, significantly impacts settlements of sexual harassment claims by denying tax deductions for settlements subject to nondisclosure agreements paid in connection with sexual harassment or sexual abuse. Section 13307 eliminates the ability of an employer to take a tax deduction for its payment of a sexual harassment settlement, if the settlement is subject to a nondisclosure agreement. It also eliminates the ability of employers and employees to deduct their attorneys’ fees in connection with confidential settlements of sexual harassment claims. Section 13307 of the new tax law states that: “…No deduction shall be allowed…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.” Employers and human resources professionals should familiarize themselves with Section 13307 and its effect on sexual harassment settlements.

The purpose and policy behind Section 13307 is to discourage employers and sexual harassers from requiring employees and other victims of sexual harassment to agree to non-disclosure of the settlement and harassment as a condition of the payment. In view of the recent Me-too movement involving numerous persons coming forward with allegations of sexual harassment, the new law is designed to create a tax incentive for employers to not require confidentiality provisions in sexual harassment settlement agreements. Without confidentiality and nondisclosure requirements, employers and alleged sexual harassers could not pay off victims in order to conceal (and continue) their harassment and shield their conduct from scrutiny. One intended result would be to protect potential future victims from the harassers by exposing and preventing recurrence of their sexual harassment.

However, as a practical matter, this new tax law may have unintended adverse consequences for employers and employees. Employers generally may still insist on confidentiality provisions, despite the new tax law, to avoid the possibility of encouraging litigation or claims from other employees (who might otherwise “hear about” settlement payments in the absence of a non-disclosure agreement). Instead of its desired effect, Section 13307 may make it more challenging for victims of workplace sexual harassment to negotiate large settlements, as employers factor in the cost of the disallowed tax deductions. In addition, Section 13307 also disallows tax deductions for attorneys’ fees related to confidential settlements or payments in connection with sexual harassment. This may create a harsh result for employees, who were previously allowed to deduct the portion of a settlement allocated to their attorneys’ fees to avoid being taxed on their fees (which amounts to double taxation). Without the ability to deduct their fees, employees may seek larger settlements of sexual harassment claims, as employees factor in the higher taxes they may pay and the lower amounts they may net from a settlement. With employees potentially demanding larger settlements, and employers potentially offering smaller settlements, both to compensate for the adverse tax consequences of Section 13307, it may become more challenging for employment lawyers to negotiate settlements of sexual harassment cases.

There are also other pitfalls and new issues. Sexual harassment claims usually don’t come alone. They are often mixed with other types of employment law claims, such as retaliation, employment discrimination, and employment law tort claims. What if a settlement includes a sexual harassment claim along with several other employment law claims that are not covered by Section 13307’s disallowance of deductions? Unless Congress amends or repeals Section 13307, or employers abandon confidentiality clauses, employment lawyers and tax attorneys alike will have to work hard to develop best practices to deal with these new complexities.