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The use of the #MeToo hashtag recently hit the 19 million mark on Twitter. The movement underlying the hashtag has swept through many workplaces all across the globe. Even the United States Congress has taken note of the phenomenon and contributed in a surprising way—by disallowing tax deductions for sexual harassment settlements subject to non-disclosure agreements.

In many tax systems around the world, business expenses are deductible. In the United States, for example, Section 162(a) of the federal internal revenue code permits the deductibility of ordinary and necessary expenses incurred during the taxable year in carrying on any trade or business. As a result, business meals, travel, and other expenses have a long history of being deductible. Indeed, they are ordinary and necessary business expenses. Unfortunately, so too are sexual harassment settlements.

Problems with non-disclosure agreements

Sexual harassment settlements are themselves not inherently problematic when they aim to offer a remedy to victims. Certainly, employers should be addressing sexual misconduct claims in their work environments. What is often damaging, however, are the non-disclosure agreements to which many of these sexual harassment settlements are subject.

A major issue is that non-disclosure agreements help protect repeat sexual harassment offenders. After they sign a non-disclosure agreement, employees often cannot talk to coworkers about the incident. As a result, coworkers experiencing similar harassment cannot use their collective information to identify repeat offenders, who then go undetected for a long period of time. The privacy of settlement agreements also reduces the overall accuracy and availability of the statistics regarding settlement figures and the characteristics of sexual harassment claims.

Non-disclosure agreements not only limit the information available to fellow employees, but also to investigators. Specifically, such agreements may cause employees to withhold information from investigators pursuing sexual harassment claims. As a result, sexual harassers escape full investigation.

For example, the United States Equal Employment Opportunity Commission (EEOC) sought an injunction in the mid-1990s against non-disclosure agreements that were interfering with their investigation of sexual harassment. In that case, the Commission struggled to gather necessary information because employees were hindering the discovery process due to their perceived secrecy requirements. Thus, the Equal Employment Opportunity Commission sought a preliminary injunction preventing the employer from entering into or enforcing settlement agreements containing provisions that prohibited settling employees from assisting the Commission in its investigation of such charges. Nonetheless, many people continue to feel restrained from filing charges with the Equal Employment Opportunity Commission because of their non-disclosure agreements.

Non-disclosure agreements facilitate repeat sexual harassment offenders by cloaking their misdeeds with secrecy. As a result, employees cannot identify sexual harassment patterns and hesitate to cooperate with investigators. Congress has targeted these agreements with its most recent tax reform.

The 2017 Tax Cuts and Jobs Act change

The Tax Cuts and Jobs Act of 2017 (TCJA) in the United States introduced several additional business expenses that are no longer deductible. These provisions include Section 162(q), which concerns sexual harassment payments subject to a nondisclosure agreement:

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.

The simple language of this new tax provision has already raised some interpretive issues. For example, the provision lacks a definition of “sexual harassment” or “sexual abuse,” and lacks guidance on what constitutes a “nondisclosure agreement.”

Under the previous tax law, sexual harassment victims could deduct their attorney’s fees, but it is not clear that this survived the tax reform. The new tax provision does not differentiate between the attorney’s fees incurred by the employer from those of the employee. However, a clarification submitted by all fourteen Republican members of the Senate Finance Committee in a letter to Treasury Secretary Steven Mnuchin dated August 16, 2018 states that the deductibility of the employee’s attorney’s fees should not change.

A major step for #MeToo

Still, the language of Section 162(q) is clear enough to confirm that the 2017 tax reform introduced a new non-deductible business expense: deductions for sexual harassment payments if they are subject to a nondisclosure agreement. This is consistent with other limits on deductible expenses against public policy.

Deductions are a matter of legislative grace. Other business expenses that Congress has determined are against public policy and therefore are non-deductible include illegal bribes, kickbacks, and similar payments. Fines and penalties are also non-deductible. A deduction is also denied for certain lobbying and political expenditures. These and the new #Metoo provision demonstrate the use of the tax code as a public policy tool for regulating business.

What is the likely effect for sexual harassment settlements? Without a tax deduction, settlements are more expensive for employers who seek to keep them private. Thus, the question is whether employers will fight settlement or offer lower settlement amounts, or whether they will just not make them subject to a nondisclosure agreement. Employer response will probably not be uniform—some employers will waive confidentiality to receive a deduction for the settlement. Others, however, may still prefer confidentiality despite its added cost. Yet others may be more resistant to settling sexual harassment claims and more willing to fight such allegations.

It remains to be seen what the results of the U.S. nondeductibility provision are for sexual harassment in the workplace. However, it makes nondisclosure agreements less attractive to companies. This is a small step for the US tax code, but a major one for the #MeToo movement.

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