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Global employment briefing: United States of America, January 2018

  • USA
  • Employment law


Employers should review their employee settlement agreements following tax bill change

On December 22 2017, President Trump signed a significant tax bill (originally named the Tax Cuts and Jobs Act but later renamed to comply with Senate rules) that includes provisions impacting settlement agreements with employees.

The new law includes a tax provision intended to address corporate settlements involving claims of sexual harassment and sexual abuse. U.S. Internal Revenue Code Section 162(q) now provides:

No deduction shall be allowed … 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.

This new limitation applies to any payments made on or after 22 December 2017. Existing agreements may be adversely affected if they contemplate payments extending beyond that date. The provision also denies deductions for any related attorney’s fees, whether paid to the company’s or the plaintiff’s counsel.

Employers should consider the implications for any employment-related settlement. The statutory language provides no definition for the terms “sexual harassment” or “sexual abuse,” nor does the language address whether any particular payment would be “related to” such claims within the meaning of the new provision.

Under Section 162 of the tax code, companies are permitted to deduct ordinary and necessary expenses of conducting business, with certain exceptions. Employers have relied on Section 162 deductions in making payments to employees under settlement agreements that release employment-related claims, as well as in deducting the costs of counsel defending such claims. Employers also use employment releases in any situation where an employee is being paid severance pay, such as reductions in force, redundancies, and negotiated separations.

It is common practice in employment-related settlement agreements to include both a broad release of claims as well as a confidentiality (nondisclosure) clause. The release typically applies to all claims the employee is permitted to release privately, including claims based on sex discrimination under Title VII of the Civil Rights Act (and similar state and local laws). Properly drafted, the release and confidentiality language in every settlement agreement would apply to claims of sexual harassment or sexual abuse whether or not the employee actually made such claims. The potential breadth of the new rule raises some concerns because application of the new rule seemingly does not require any obvious connection between the settlement and any particular underlying claim.

In light of Section 162(q), employers should review their standard employment settlement agreement templates, as well as agreements negotiated with individual employees, and any settlement agreements that were not fully paid prior to 22 December 2017. Depending on the circumstances of each individual case, employers may consider modifications to the breadth of the release, the breadth of the nondisclosure provisions, and/or to the addition of representations or new remedies.