Cheryl Wilke of Hinshaw & Culbertson. Cheryl Wilke of Hinshaw & Culbertson.

The daily press coverage disclosing alleged actions of high profile men accused of sexual harassment in the workplace, has resulted in a change to the tax treatment of settlements in claims of sexual harassment and discrimination.

Under a key provision of the new tax law: “No deduction shall be allowed under this chapter for any settlement or payment related to sexual harassment or sexual abuse if such settlement or payment is subject to a nondisclosure agreement, or attorney fees related to such settlement or payment.

Under the law as written, no taxpayer (neither the complaining party nor the employer) can claim the settlement amount or attorney fees paid in a sexual harassment case as tax deduction—and keep the settlement terms confidential.

This provision combines two previously unrelated aspects of harassment claims. First, companies have often sought the benefit of tax deductibility for settlement proceeds  and attorney fees arising from litigation of claims when available under the previous tax codes.  Second, the decision of the parties to a keep the settlement terms in sexual harassment or abuse cases confidential, which previously has not been a consideration as to the deductibility of the proceeds.

Employers will now be faced with a key decision: Is the benefit of keeping a settlement agreement confidential worth the financial impact of not claiming the settlement proceeds and associated legal fees as a deduction?

Obviously, the larger the amount of the settlement, the more financial impact companies face by waiving the deductibility of the proceeds. This was intentional and circles back to the claims made by many that the public should know that Harvey Weinstein, Bill O’Reilly, Kevin Spacey, and others had been accused of harassment and settled cases. Although in reality, the companies employing high profile individuals are likely willing to forego tax advantages in favor of perceived reputational integrity, the same may not be the case for most companies.

In addition, there is a specific statutory reference to “sexual abuse.” This appears to be directed toward entities like U.S. Gymnastics  and others who employ individuals accused of improper touching and assault committing crimes in the process and also generating civil claims by the victims.

Many will applaud the intention of the new provisions. Specifically, that companies should not be able to keep a settlement confidential and benefit from a tax deduction. However, the law does not address those situations where the employee or victim wants to keep the settlement confidential, but the company wants the tax deduction and does not care about the terms of the settlement being in the public forum. It is unclear how this will not have a chilling effect on some potential claims.

In addition, there are several questions regarding enforceability. Title VII does not have a “scale” of harassment claims. Race, religion, discrimination and national origin claims often have the same negative impact on an employee’s life and career as sexual harassment claims.  However, these claims are not subject to the new tax provisions. Employers can continue to negotiate settlement agreements with confidentiality terms and maintain the tax benefits for all discrimination claims—other than sexual harassment.

Additionally, many employers purchase Employer’s Professional Liability Insurance (EPLI) to provide insurance coverage for claims of harassment and discrimination. The carrier would be subject to the new law as they are a “taxpayer” as defined by the statute. However, because of the nature of insurance and limits on coverage, there are likely to be extensive issues regarding payment terms, taxation, deductibles and whether the tax cost of confidentiality is covered by the insurance policy.

Finally, government agencies are exempted from this provision. They are not taxpayers as defined by this statute. Therefore, to the extent any governmental entity resolves cases with employees, the right to assert confidentiality remains in place without change.

Overall, the goal of the statute is to force entities to make a financial commitment, which benefits the government not the accuser, to keep terms of a sexual harassment or abuse case confidential. Enforcement will be a key issue as the law and its implications are litigated in the future.

For the short term, employers need to be aware that there may be no tax  benefit to the settlement of a sexual harassment or abuse claim if they wish to maintain confidentiality of the nature and terms of the agreement. Employees need to consider, that if they wish to settle their claims and maintain confidentiality, employers may seek a lower payout to account for the lack of a tax savings.

Labor ​and employment attorney Cheryl Wilke is the partner in charge of the Fort Lauderdale office of Hinshaw & Culbertson.