Written on behalf of Feigenbaum Consulting
Last week, we blogged about the tax implications of Colin Kaepernick’s recent multi-million dollar settlement with the NFL. This week, we explore another aspect of legal settlement and tax: how settlements stemming from sexual harassment in the workplace (proliferating recently due to the massive #metoo movement) are being treated following recent tax reforms.
#metoo and the Growing Awareness of Problematic Workplace Behaviours
The #metoo movement exploded virally in October 2017, with millions of women sharing stories about their experiences with sexual harassment or sexual abuse, often in the workplace.
Over the course of a year, the hashtag was tweeted more than 18 million times, a number of prominent men in Hollywood and across other industries were publicly revealed to be predators, and legislation in various jurisdictions, including New York and California, was changed to make it easier to report abuse.
The Tax Cuts and Jobs Act and the “Weinstein Tax”: Implications for Employers
A surprising piece of legislation which addressed the issues identified by the #metoo movement was tax legislation, including the Tax Cuts and Jobs Act introduced by the Trump administration.
Included in the Tax Cuts and Jobs Act, legislation which we have commented on extensively, were provisions through which Congress intended to address the issue of sexual harassment in the workplace through eliminating the possibility of a tax write-off on sexual harassment settlements which are subject to a non-disclosure agreement.
Section 162(a) of the Internal Revenue Code permitted employers to deduct “ordinary and necessary expenses paid or incurred in carrying on a trade or business”. Prior to the tax reform, this would have included any expenses used in settling workplace disputes, including sexual harassment disputes that may have been settled through the use of non-disclosure agreements. Such expenses could include lawyer’s fees as well as any other legal fees which an employer racked up while addressing a sexual harassment complaint.
As of December 2017, employers can no longer deduct any settlement expenses stemming from sexual harassment or sexual abuse claims where a non-disclosure agreement forms part of the settlement. This has become colloquially known as the “Weinstein Tax” in the wake of the scandal that rocked Hollywood in 2017/2018.
This major change was intended to increase transparency, make it less appealing for employers to try to sweep problems under the rug, and decrease the chances that confidentiality and secrecy could lead to perpetrators repeating their problematic behaviour in the workplace.
The Tax Cuts and Jobs Act: Implications for Employees
When the new tax provisions were passed, there was initial confusion as to whether Congress intended an employee making a complaint to also lose the ability to deduct legal fees in a situation where a settlement agreement included a non-disclosure agreement.
The provision read on its face provides that no deductions were possible “under this chapter”, implying that the provision applied to all of Chapter 1 of the tax code (which was applicable to both corporations and individuals). This initially raised serious questions. Previously, an employee making a sexual harassment complaint and pursuing it through legal means could include any settlement amount received as taxable income and also deduct their lawyer fees from that amount. This meant that they would only be taxed on their net recovery following the deduction of lawyer’s fees (which were often significant).
Based on an initial reading of the revised tax provision, since an employee could not write off their lawyer fees from the, that employee would be taxed on the full amount of the settlement, even if a portion of that settlement was devoted to lawyer fees.
Many in the legal field raised concerns about this potentially unintended consequence of the tax reform.
Clarification by Republicans
In mid-2018, Republican members of the Senate Finance Committee wrote a letter to Treasury Secretary Steven Mnuchin indicating their intent to introduce a technical corrections bill which would make clear that legal fees incurred by recipients of settlement payments would not be prohibited from being written off.
We will continue to follow developments in this matter and will provide updates as they become available. In the meantime, if you have questions contact Feigenbaum Law.
With professional accounting designations from both Canada and the US, coupled with being admitted to the bar in the US and Canada, Mark Feigenbaum and his team are uniquely positioned to provide tax advice to clients on both sides of the border. Due to our vast knowledge of both U.S. and Canadian tax systems, professionals in both countries, such as lawyers, accountants, financial planners, agents, and business managers, frequently refer complicated tax matters to our firm. We have developed a reputation for finding creative solutions to seemingly unsolvable problems and for the exceptional quality of our work.