By Leandra Lederman
The Tax Cuts and Job Act’s conference bill includes section 13307, titled “DENIAL OF DEDUCTION FOR SETTLEMENTS SUBJECT TO NONDISCLOSURE AGREEMENTS PAID IN CONNECTION WITH SEXUAL HARASSMENT OR SEXUAL ABUSE.” Fellow Surly blogger Sam Brunson blogged about an earlier version of this provision, which obviously reflects the recent, widely publicized revelations of sexual harassment and sexual assault that began with the Jody Kantor & Megan Twohey exposé of Harvey Weinstein in early October and was followed by a floodgate of allegations spanning a wide range of industries. Unfortunately, this tax provision, as drafted, is less than clear and could potentially have perverse—perhaps unintended—effects.
The provision seems intended as a policy-based provision rather than much of a revenue-raiser; it was one of very few things in the conference bill scored as raising less than $50 million over the entire 2018-2027 budget window. And, in the press release accompanying the predecessor of this provision, the Settlement Tax Deductions are Over for Predators Act (the STOP Act), which was introduced by Rep. Ken Buck (R-Colo.), Rep. Buck stated, “‘When we allow companies to deduct sexual assault and sexual harassment related settlements, we’re asking the American taxpayer to subsidize hush money payments that cover-up sexual misconduct.’”
But what exactly does the provision disallow? The principal language in the conference bill (the material other than the effective date and relettering) is a new subsection added to Code section 162 that reads:
“PAYMENTS RELATED TO SEXUAL HARASSMENT AND SEXUAL ABUSE.—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.”
Let’s start with what’s clear: The disallowance provision, although located in Code section 162 (on trade or business expenses), would apply to all of Chapter 1 of the Code, so it would also apply, for example, to activities for the production of income under Code section 212. The idea seems to be that if a payment that falls within this provision would otherwise be deductible under Code section 162 or another provision in Chapter 1 of the Code (which some may not be, under case law), it is disallowed.
But which payments fall within this provision? First of all, what is “sexual harassment or sexual abuse”? That is not defined in the bill. Also, the term “sexual assault” is not used. Is that encompassed in one or both of the terms used in the bill? The STOP Act used different terminology with more specifics: “offense under chapter 109A of title 18, United States Code, or . . . sexual harassment (including unwelcome sexual advances, requests for sexual favors, or other verbal or physical harassment of a sexual nature).” It may be that the term “sexual abuse” in the Tax Cuts and Jobs Act refers to conduct that falls within 18 USC § 2242, which is titled “Sexual Abuse”, but the bill does not say that. (And 18 U.S.C. § 2242 itself seems to apply in contexts such as “the special maritime and territorial jurisdiction of the United States or in a Federal prison.”)
Second, how are attorney’s fees treated in harassment cases not involving a non-disclosure agreement (NDA)? The tax bill’s provision disallows “any settlement or payment related to sexual harassment or sexual abuse if such settlement or payment is subject to a nondisclosure agreement.” (Harvey Weinstein reportedly used such NDAs, and the use of NDAs to hide settlements in sexual harassment and sexual assault cases has been a topic of media and legislative concern.) The tax bill also disallows “attorney’s fees related to such a settlement or payment.” What does the “such a settlement or payment” in the attorney’s fees sentence refer to? It seems largely to echo the “such settlement or payment” in the first sentence—that is, it seems to refer to “any settlement or payment related to sexual harassment or sexual abuse.” Thus, the provision at least arguably disallows an attorney’s fee payment related to sexual harassment or sexual abuse, regardless of whether that settlement or payment is subject to an NDA. However, that language is less than completely clear. And the Conference Committee Report (on p.279) suggests the opposite: that the entire provision, including the attorney’s-fees portion, only applies if there is an NDA; it states: “Under the provision, no deduction is allowed for any settlement, payout, or attorney fees related to sexual harassment or sexual abuse if such payments are subject to a nondisclosure agreement.” (emphasis added). The poorly drafted statutory language, coupled with the Conference Committee Report’s explanation, could leave payors open to arguing that attorneys’ fees relating to a sexual harassment or sexual abuse settlement or payment that is not subject to an NDA are deductible.
Third, and perhaps most troubling, the bill is unclear regarding whose attorney’s fees are disallowed, as Tony Infanti has noted in an op-ed in The Hill. Imagine that an employee experiences sexual harassment by a supervisor, and that rejecting the supervisor’s advances eliminates opportunities for promotion and results in lost income for the employee. The sexually harassed employee hires an attorney, sues, and ultimately receives a settlement that includes lost wages. Assume the employee cannot exclude any of the settlement under Code section 104(a)(2) because the settlement was not on account of physical injuries or physical sickness. Code section 212 should authorize a deduction for these attorney’s fees. Most 212 deductions are miscellaneous itemized deductions, which section 11045 of the bill eliminates (until that provision sunsets in 2025). However, attorneys’ fees paid by plaintiffs in this type of suit may be deductible above the line under Code section 62(a)(2), (e) (such as section 62(e)(17)). Assuming the employee’s attorney’s-fee deduction survives these and any other tax hurdles, can the employee deduct the attorney’s fees or does the new provision disallow them? There is still the issue of whether the attorney’s-fees disallowance requires there to be an NDA, but if we assume either that the settlement contains an NDA or that courts interpret the attorney’s-fees disallowance not to be limited to NDA contexts, the sexual harassment plaintiff here has a problem: The provision in the Tax Cuts and Jobs Act does not explicitly refer only to payors’ attorneys’ fees.
So, perversely, it is possible that this provision would disallow attorney’s fees deductions for successful plaintiffs in sexual harassment cases! This does not at all seem to be the intent of the provision. It is likely a result of the terribly rushed process driving this bill. It’s possible that some of these problems could be fixed in technical amendments, but, as guest blogger Victor Thuronyi recently stated about the Tax Cuts bill more generally, “the scope of technical corrections needed will likely exceed what is usual for other major tax bills.” That’s true of this sexual-harassment-payment disallowance provision, as well.
The Surly Subgroup 
It isnt clear to me— under the status quo before the tax bill, if a woman got a $100,000 award and paid her attorney $40,000 of it, and she earns, say, $50,000 in labor income besides that, how much taxable income does she have?
I gather the $100,000 is taxable income, because it’s not for bodily injury, but how would she deduct the attorney fees?
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In general, how the federal income taxation of your hypo works is that the $100K is gross income to the woman. The U.S. S. Ct.’s decision in Gilmore propbably precludes deducting the $40K as a business expense under IRC § 162. But the $40K is an expense for the production of income that should be deductible under IRC § 212(1). (Note that this is a broad section that is consistent with the normative income tax notion of taxing net proceeds, not gross receipts.) There are important issues that arise with this deduction, relating to whether it’s a miscellaneous itemized deduction that ends up being reduced or disallowed (you may recall the U.S. S. Ct. decision in Banks from a few years ago, which was followed by an amendment to IRC § 62), but that’s the basics of which Code section applies to authorize the deduction.
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It’s poorly drafted, I agree. This is a case where a public comment period with a website like the Federal Register for comments would be useful. For my regulation undergrad class, I have the students find a proposed regulation adn submit a public comment, and I tell them the best kind of comment is to improve the wording, because it will very possibly be adopted even coming from a student.
In fact, if Congress had even had a two-week public comment website, that could even improve on the twittering that tax profs did, by organizing it. Next tax bill season, remind me, and I’ll remind them to set one up. (Most comments are useless “I hate it” comments, of course, but those are easily screened out, and educated comments are truly helpful to drafters.)
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Interesting idea! This bill was intentionally pushed through quickly, though. It seemed more about politics than making sure the text of the provisions worked as intended.
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The idea of penalizing non-disclosure agreements is excellent. I think many such agreements should be unenforceable as against public policy anyway. What they do is allow the wrongdoer to pay the victim to keep quiet, beyond paying the actual damages. This has a strong negative externality, because the public would benefit from knowing how bad the wrongdoer is. Sexual harassment usually isn’t a one-time offense, so the information would be particularly useful in such cases. If signing a nondisclosure agreement makes the victim have to pay tax on 40% of the entire settlement (which includes the part that isn’t just quiet money), that raises the cost of paying for silence drastically.
The same should be done for university non-disclosure agreements when they fire tenured professors for bad reasons and then settle the inevitable lawsuits. In such cases, I wouldn’t be surprised if the hush money exceeded the damages money.
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The lack of deduction for attorney’s fees can easily be read to apply even where there is no NDA. But if it were limited to that context, it is one thing to disallow the wrongdoer’s attorney’s-fee deduction and another to disallow the victim’s. I understand that, in theory, the wrongdoer will pay more, to gross up the victim’s payment to reflect the lack of tax deduction, but I doubt that empirical evidence would show wrongdoers making victims whole for the tax due on money they don’t receive. Typically, the wrongdoer will have more power and higher-paid attorneys. I say that because these harassment situations have virtually all involved powerful and wealthy men and very junior/much less powerful victims. That’s not coincidence; harassers choose their victims. They choose victims unlikely to report.
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