A lesser-known amendment buried in the newly revised federal tax code related to tax deductions forbusinesses could very well have devastating, unintendedconsequences on victims of workplace sexual harassment and abuse.Specifically, §162(q), while originally intended to end abusiness's ability to deduct sexual misconduct settlements conditioned onnon-disclosure agreements (NDAs), states, in its present form, that “no deductionshall be allowed under this chapter for—(1) any settlement or payment related to sexualharassment or sexual abuse if such settlement or payment is subjectto a non-disclosure agreement, or (2) attorneys' fees related tosuch a settlement or payment.”

What this provision means

While §162 generally addresses tax deductions which a businessmay or may not take, many experts have interpreted §162(q) to apply to bothbusinesses and individual taxpayers based on its use ofthe modifier “under this chapter.” Based upon thisreading, victims of workplace sexual misconduct who settle theirclaims subject to an NDA would be prohibited from deducting theportion of their settlement allocated to attorney fees, but wouldhave to pay taxes on the entire amount of their recovery, and notjust the net amount they would ultimately receive.

Consequently, victims of workplace sexual misconduct would beworse off than their counterparts who were victims of other formsof invidious discrimination, such as race, age or disability, whocan generally deduct settlement portions attributed to attorneyfees. As a result of this uncertainty, Sen. Robert Menendez,D-N.J., who is credited with first introducing the idea thatbusinesses should not be allowed to take deductions for sexualharassment settlements conditioned on NDAs, has announced plans to introduce legislation clarifying that§162(q) is meant to apply only to businesses.

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Given the increasing influence of the #MeToo movement in recentelections, which is likely to be amplified in this criticalmid-term election year, one would think that members of Congress,despite being notoriously slow-moving, will act with urgency toclarify §162(q)'s intent, lest they be accused of furthervictimizing those who have already been subjected to workplacesexual misconduct.

Myriad questions

However, even assuming that Congress clears up the confusionconcerning §162(q)'s reach, there are still myriad unansweredquestions surrounding the practical impact §162(q) will have onemployment litigation, and how, if at all, the IRS will police thisnew rule.

For one, it is not uncommon for a plaintiff to accuse anemployer of sexual harassment in addition to other forms ofworkplace discrimination such as race, age or disability bias, oreven wage and hour law violations. Unfortunately, Congress hasprovided no guidance as to how settlements containing NDAs that aremeant to resolve all claims in a single case involving multipletheories of liability should be treated. Will an employer beallowed to deduct any portion of a settlement thatresolves an action in which sexual harassment is alleged, and ifso, how much?

Should the parties to a confidential settlement be able to weighthe relative strengths and weaknesses of each theory of liabilityalleged, and apportion a settlement accordingly for purposes ofmaking deductions subject to §162(q)?

Is there anything preventing an employer and employee fromentering into multiple agreements containing NDAs wherein the bulkof the payout is attributed to non-sexual harassment claims (thusallowing the employer to take a deduction), while a token amount isattributed to sexual harassment claims (thus rendering negligiblethe impact of §162(q))?

And in regards to attorney fees, could an employer deduct anyportion of attorney fees incurred where a payout conditioned on anNDA is meant to resolve multiple theories of liability, in additionto sexual misconduct?

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Unintended consequences for victims

Notwithstanding the countless unresolved questions about how§162(q) will be applied and enforced, the new rule may haveadditional unintended, negative consequences for victims ofworkplace sexual misconduct.

For instance, NDAs can act not only as a “shield” for employersguarding against so-called “copycat” claims, but also as a powerful“sword” wielded by an employee who can control whether or notexplosive, reputation-tarnishing allegations become public. Assuch, the notion that an accuser will enter into an NDA is often adriving force behind large settlements paid to victims of sexualmisconduct; taking away this weapon could actually drive down thesettlement value of such cases. Similarly, employers analyzingsettlements from a cost-benefit perspective may be unwilling tooffer as much to resolve workplace sexual misconduct allegationsknowing that such a payout will not be tax deductible if they wantan NDA.

Furthermore, employers who deem an NDA to be “off-the-table” maybe less inclined to resolve cases pre-litigation or at an earlystage of litigation, and may choose instead to “dig in their heels”and litigate a case to judgment in the hopes that they can cleartheir names. This arguably further penalizes victims of workplacesexual misconduct by causing them to have to relive traumaticexperiences over and over throughout the course of a lengthy andexpensive litigation, with no guarantee of success.

Of course, on the other hand, some employers who want an NDA maybe more inclined to resolve a case early on before their attorneyfees escalate given that §162(q) prohibits them from taking adeduction for attorney fees, which would certainly benefit victimsof workplace sexual misconduct (perhaps at the expense of defenseattorneys).

While Congress deserves some adulation for attempting to think“outside-the-box” and revise the tax code to punish employers whoengage in workplace sexual misconduct, there is much uncertaintyand confusion about the real-world, practical implications of§162(q). While only time will tell, it is quite possible that thiswell-intentioned amendment to the tax code ultimately backfires andleads to unintended, negative consequences to victims of workplacesexual misconduct.