In response to the #MeToo movement, a number of state legislatures and Congress have enacted legislation to address their concerns regarding sex-based inequities in the workplace. One area of particular focus has been the use of non-disclosure provisions in settlement agreements that resolve allegations of sexual harassment, other forms of harassment, and discrimination. Critics of non-disclosure provisions argue that employers who have used these types of provisions may inadvertently promote a culture of silence around sexual harassment and sex-based discrimination in the workplace, thus enabling the individual perpetrators of harassment and discrimination to avoid accountability. On the other hand, many employers legitimately use non-disclosure provisions to protect the victims of harassment and discrimination, as well as to avoid negative publicity resulting from non-meritorious claims. Without the protection of a non-disclosure agreement, employers may more frequently elect to contest such non-meritorious claims of discrimination or harassment to avoid negative publicity emanating from a publicly disclosed settlement.

The federal government and several state governments have enacted legislation concerning non-disclosure provisions in settlement agreements, adopting varied approaches to the issue, in ways that affect an employer’s incentives and strategic options. In this article, we review the federal tax legislation concerning the deductibility of settlement payments for sexual harassment claims. Next, we review the varied legislative approaches that several states have taken to the issue of non-disclosure provisions in settlement agreements. Finally, we offer a number of practical considerations for employers in light of the current legal landscape.

Federal Tax Deductibility

In the 2017 Tax Cuts and Jobs Act, Congress amended federal tax law regarding the deductibility of costs associated with settlements and attorney fees concerning certain types of claims. 26 U.S.C. §162(q). Specifically, the tax law now states that, “no deduction shall be allowed under this chapter for any settlement or payment related to sexual harassment or sexual abuse if such settlement or payment is subject to a nondisclosure agreement …” 26 U.S.C. §162(q)(1) (emphasis added). The law also prohibits deduction of any “attorney’s fees related to such a settlement or payment.” 26 U.S.C. §162(q)(2). The IRS has yet to issue guidance on the reach of the “related to” language in this section. For example, does this language encompass a general release of claims, which may include a release of sexual harassment claims, even when the employee has never asserted any specific allegations of sexual harassment? Even if the prohibition applies only to instances in which the employee has made a specific claim of sexual harassment, employers face greater expense in resolving such claims if the settlement involves employee non-disclosure obligations than if the employer resolves such claims without such obligations.

Varying State Approaches

A number of states have passed legislation geared towards prohibiting the enforcement of non-disclosure provisions in settlement agreements that resolve allegations of sexual harassment, other forms of harassment, or discrimination. These states have taken different approaches towards the issue.

For example, New York enacted the first state-wide law in the nation concerning this subject, mandating that “for any claim or cause of action … the factual foundation for which involves sexual harassment … no employer … shall have the authority to include or agree to include in [a settlement agreement] any term or condition that would prevent the disclosure of the underlying facts and circumstances to the claim or action unless the condition of confidentiality is the plaintiff’s preference.” N.Y. Gen. Obligations Law 5-336 (emphasis added). Earlier this month, New York enacted additional legislation expanding this provision to cover all claims of “discrimination,” and not just “sexual harassment.” 2019 NY S.B. 6577/2019 NY A.B. 8421.