Late last year, Congress adopted, and President Trump signed into law sweeping changes to our federal income tax laws. Several changes in the Internal Revenue Code have particular impact for those in the human resources and employment law fields. Those changes are summarized below; however, as always, this column does not substitute for the advice of legal counsel.
Sexual harassment claims – settlements may not be deductible
As we all are aware, high-profile allegations of sexual harassment and sexual misconduct dominated the public conversation throughout 2017. Much of the publicity centered on the settlement payments that had been made to the alleged victims of such misconduct, including “nondisclosure” provisions in such agreements — promises by the persons receiving those payments that they would not publicly discuss the matter any further.
Going forward, the new tax code limits the ability of a business to claim such payments as a deductible business expense.
The Code now provides that no deduction shall be allowed for: “any settlement or payment related to sexual harassment or sexual abuse if such settlement or payment is subject to a nondisclosure agreement.” In addition, the attorneys’ fees related to such a settlement or payment are also not deductible.
Accordingly, when resolving claims involving sexual harassment or sexual misconduct, businesses must take into consideration whether to include a nondisclosure provision in the settlement agreement, or whether to include such a provision and lose the business expense deduction. For example, some businesses may be showing a loss for the year, and accordingly would not benefit from a further deduction (although losses can be carried over to other years under certain conditions).
In addition, many lawsuits involve a variety of allegations. For example, a former employee might sue for wrongful discharge, retaliation, discrimination and sexual harassment. The new tax law impacts only claims for sexual harassment or sexual misconduct. Accordingly, if a settlement agreement specifically allocates an amount to resolve sexual harassment claims, and also identifies the amount paid to resolve other claims, the settlement dollars and attorneys’ fees attributed to the other claims could still be deductible.
It also may be possible to forego a nondisclosure provision, yet include stronger non-disparagement and non-admissions clauses in the agreement itself. In that case, the person receiving the settlement could discuss the settlement, and the amount of the settlement, but would be prohibited from making disparaging statements about the employer.
Finally, depending on the size of a business the amount of a settlement, the income tax consequences may not drive the decisions about whether to settle a case or to include nondisclosure language.
Penalties paid at the direction of the government
Another change in the tax law relates to the deductibility of penalties. Under the prior law, “penalties” paid to an individual because of litigation — for example “waiting time” penalties in California for failure to pay final wages on time, or punitive damages — were deductible. Any penalties paid directly to the government were not deductible. Under the new law, any penalty paid “at the direction of the government” — whether to the government itself, or to an individual — are not deductible.
Several questions remain unanswered regarding this new provision. For example, does a right-to-sue letter from the EEOC or a state labor agency, which later results in the payment of a penalty, mean an amount paid is “at the direction” of the government, such that there is no deduction? It is expected that the IRS will issue more guidance in the near future to flesh out the scope of this provision.
Lastly, note that moving expenses are no longer deductible, at least until 2026. Accordingly, moving expenses paid by an employer will be considered to be wages to the employee.
In the weeks and months ahead, it is understood that the IRS will be issuing new guidance and regulations regarding the impact of our new tax laws on workplace settlements and expenses. Central Valley employers should do their best to keep informed and develop business strategies which take into account the new legal-tax environment.
– Bruce Sarchet is an attorney with the firm of Littler Mendelson and represents employers in labor and employment law matters. You can contact him at [email protected].