At the start of the New Year, it has been interesting finding out more about the massive tax legislation that Congress enacted in December. It has been interesting to see the various impacts that the legislation is having on a variety of companies. It has also been interesting to learn more of the details about what Congress actually enacted. For example, here’s a detail about the tax bill that I didn’t previously know about – apparently the tax legislation includes a provision specifying that employers can no longer include as a deduction on their tax returns amounts the employers pay in settlement and defense of sexual misconduct claims, if the settlement is subject to a nondisclosure agreement.


According to a January 18, 2018 post on the Norton Rose Fulbright Global Workplace Insider blog (here), the tax legislation specifies that employers may no longer deduct on their tax returns any “settlement or payment related to sexual harassment or sexual abuse if such settlement or payment is subject to a nondisclosure agreement” or any “attorney’s fees related to such a settlement or payment.” This new rule became effective on December 22, 2017, when the new law was enacted.


Confidentiality provisions are a common feature of sexual harassment or sexual abuse settlements. Employment practices defense counsel will explain that the inclusion of confidentiality provisions is often an important consideration for employment practices claim defendants who regard the claim against them to be frivolous but who want to settle the claim for financial or business reasons.


Part of the debate that has followed in the wake of the recent wave of sexual misconduct revelations has centered on the use of confidentiality provisions in these kinds of settlements. Among other things, critics of these confidentiality arrangements argue that the provisions could protect predators. These kinds of provisions, critics suggest, silence victims


While there have been proposals to try to ban the use of confidentiality provisions altogether for settlement of sexual misconduct allegations, the provision of the tax legislation doesn’t take this approach. Rather than instituting an outright ban on confidentiality provisions, the new legislation gives employers a choice when they go to settle these kinds of claims. Either they omit the confidentiality provision and keep the deduction, or they include the provision and lose the deduction – effectively increasing the cost of settling and defending the claim. As the blog post authors note, “the benefit of the tax deduction may not be worth sacrificing the confidentiality.”


It should be noted that while this provision could make it more expensive for employers to settle sexual  misconduct claims with confidentiality provisions, the extent of that extra cost is somewhat diminished by the tax legislation’s lower marginal tax rates. With the lower marginal rates in effect, the potential deductibility is worth less than it was under the prior higher rates.


The blog post authors also point out that the new statutory rule raises a number of questions. For example, it is often the case that other allegations accompany claims of sexual harassment or abuse, such as retaliation or gender discrimination. What happens to the tax-deductibility of amounts paid in settlement of these other claims, or to the associated defense expenses, if the settlement includes a confidentiality provision? What happens if confidentiality provision is included at the claimant’s insistence?


The authors also suggest that “some” have speculated that the new rule may make it difficult for parties to reach a settlement of sexual misconduct allegations “particularly in those cases where the employer believes it has done nothing wrong, but is willing to settle the claim as an economic matter.”


Without a nondisclosure provision, “will an employer be willing to settle what it considers to be a frivolous claim of harassment?” Would the same employer “be willing to forego the tax deduction in order to get a commitment of confidentiality? As the authors put it, “time and experience will bear out these answers.”


I suspect strongly that these questions are going to get quite a work out in the months ahead. The universal expectation in the management liability insurance industry is that there is going to be a major upsurge in the number of sexual harassment claims. The #MeToo movement is a powerful social force and the likelihood is not just that it will encourage more women to come forward but it will also encourage more women to try to hold the wrongdoers accountable. If the current social forces do indeed result in an increase in sexual harassment and sexual abuse claims, the defendants facing these claims will have to grapple with this confidentiality/ tax deductibility trade-off issue in trying to resolve the cases.


One factor that is relevant here that the authors do not discuss is the role that insurance frequently plays in the defense and settlement of these claims. Most employers carry employment practices insurance that specifically protects the company, its officers, directors, and employees from claims or employment practices misconduct. As I understand it, the tax bill’s provision relates only to employer’s rights to deduct settlement and defense costs incurred in connection with sexual misconduct claims. To my knowledge, the new provisions do not affect insurer’s rights to deduct settlement and defense costs in connection with the settlement of sexual misconduct claims where the settlement agreement contains a confidentiality clause.


While not all sexual harassment and sexual abuse claims are defended and settled with insurance funds, many are. At least if I am right that the new legislation does not affect insurers’ rights to continue to deduct amounts paid in defense and settlement of sexual misconduct claims, the legislative provision’s intended purpose – to try to provide a financial incentive for employers not to include confidentiality provisions in the sexual misconduct settlements – could be frustrated.


If readers out there have any additional insight on the potential impact of this provision of the tax legislation and how it might or might not operate if the relevant claim was defended or settled with insurance, I hope you will please add your observations using the blog’s comment feature.