Federal Tax Reforms and Proposed State Laws Try to Address the Concerns Raised by the #MeToo Movement

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Since the beginning of the #MeToo movement in October 2017, Congress and state and local lawmakers have introduced a series of legislation aimed at eliminating sexual harassment and abuse in the workplace. In 2018 alone, over 125 bills have been introduced by states to eliminate workplace misconduct. We expect to see continuing efforts by Congress, states, and localities to offer legislative solutions.

On December 22, 2017, President Trump signed a sweeping tax bill (the "Tax Cuts and Jobs Act" or "Act") that overhauls much of the United States tax code and touches almost every section of the country's economy. Hidden within the more than 1,000 pages of the tax plan is a relatively small provision suddenly getting a lot of attention from employers and their counsel.

Section 13307 of the Act – titled "Denial of Deduction for Settlements Subject to Nondisclosure Agreements Paid in Connection with Sexual Harassment or Sexual Abuse" – was, as its name suggests – added in an effort to address corporate settlements involving claims of sexual harassment and abuse. Nicknamed "the Weinstein tax" or the "#MeToo tax" by some analysts, the amendment is already generating a lot of questions on the part of both employers and plaintiffs' attorneys.

Under old Internal Revenue Code Section 162, companies were permitted to deduct ordinary and necessary expenses of conducting business, with certain exceptions. Employers relied on this deduction to deduct settlement payments to employees and attorneys' fees and costs incurred in defending such claims. New Section 162(q) (effective December 22, 2017) now provides:
 
  • "Payments related to sexual harassment and sexual abuse – 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; or
    • attorney's fees related to such a settlement or payment."
The obvious intent of the provision, which will force negotiating parties to choose between non-deductibility of a settlement payment and nondisclosure of the settlement, strongly disincentivizes employers from including confidentiality provisions in certain settlement agreements.

New Section 162 also raises a number of more practical questions about its effect on standard settlement agreement language. Until now, for example, it has been normal practice in employment-related settlement agreements to include both a broad, general release of claims, as well as a confidentiality provision restricting the employee from discussing the terms and even the existence of the settlement agreement. Accordingly, the release and confidentiality provisions typically included in every employment-related settlement agreement will apply to claims of sexual harassment or abuse even if the employee has not raised any such claims.

Significantly, the Conference Report accompanying the statute did not include any helpful guidance regarding the meaning of "related to sexual harassment or sexual abuse." As a result, it is not at all clear how the provision should be applied in cases involving multiple claims by a plaintiff, including claims that may be "related to sexual harassment or sexual abuse." Likewise, it is not yet clear whether Congress intended for this limitation to apply whenever such allegations are made versus where an allegation of misconduct is supported or has been proven by factual evidence.

To date, there has been no further clarification from Congress, the Department of Treasury, or the IRS. Until these questions and concerns are addressed in Treasury or IRS interpretive guidance, employers should carefully consider the effect of the provision's plain text in their planning and involve legal counsel early when drafting settlements and other agreements. For example, if only some of a plaintiff/claimant's allegations concern sexual harassment or abuse, employers may want to work with their counsel to allocate settlement payments to claims other than sexual harassment or sexual abuse and possibly deduct portions of settlement payments (and related attorneys' fees) associated with those claims.

Additionally, New Section 162 contains what appears to be a significant typographical error. If the provision is read literally, it prohibits plaintiffs from deducting their attorneys' fees. According to those who introduced the amendment, this was not their intent. It is unclear if and when this error will be addressed.
 In 2010, Congress enacted the ‘Franken Amendment,' which bars certain federal defense contractors from entering into or enforcing mandatory pre-dispute arbitration agreements.
Although the impact of Section 162(q) is not yet known, some members of Congress have responded to the #MeToo movement in other ways. In December 2017, Congress introduced – with bipartisan support – the "End Forced Arbitration of Sexual Harassment Act." The legislation would prohibit an arbitration agreement from being enforced that precludes the litigation of sexual harassment or discrimination allegations brought under Title VII of the Civil Rights Act of 1964. This is not the first time Congress has addressed mandatory arbitration agreements. In 2010, Congress enacted the "Franken Amendment," which bars certain federal defense contractors from entering into or enforcing mandatory pre-dispute arbitration agreements.

Over the past several months, there has also been significant activity at the state level to address these concerns. Most recently, New York passed legislation that: (1) prohibits mandatory arbitration of sexual harassment complaints,1 (2) limits the use of nondisclosure provisions in sexual harassment settlements,2 and (3) requires employers to provide sexual harassment training annually. Additionally, the legislation states that mandatory arbitration will not apply "where inconsistent with federal law," apparently recognizing potential preemption issues that could arise under the Federal Arbitration Act (FAA).

Some states, like New York, have focused their legislative efforts on restricting the use of nondisclosure agreements. Washington State passed SB 5996 in March 2018, which states that "an employer may not require an employee, as a condition of employment, to sign a nondisclosure agreement, waiver, or other document that prevents the employee from disclosing sexual harassment or sexual assault occurring in the workplace."3 In April 2018, Arizona also passed HB 2020, which permits victims of sexual harassment to disregard a confidentiality provision if asked to do so in a court proceeding or by law enforcement.

Other states have passed broader legislation. For instance, Maryland passed the "Disclosing Sexual Harassment in the Workplace Act of 2018," effective October 1, 2018. This statute states that any provision in an employment contract, agreement, or policy will be void as a matter of public policy if it waives any procedural or substantive right or remedy. The law, however, includes the phrase "except as prohibited by federal law," suggesting – as New York's recently-passed legislation does – that the law's reach may be limited by the FAA.

There are also a number of states considering a variety of provisions targeting sexual harassment. Legislation proposed by a California state senator at the beginning of 2018 would prohibit anyone accused of sexual assault, harassment, or discrimination in the workplace from including confidentiality provisions in settlement agreements.4 California SB 820, which is co-sponsored by the Consumer Attorneys of California and the California Women's Law Center, would ban the inclusion of nondisclosure terms – unless requested by the alleged victim – in settlement agreements. Other California legislation pending includes a bill that would prohibit mandatory arbitration, and another that would require employers with five or more employees to provide two hours of sexual harassment prevention training.

Further legislation pending in other states includes Delaware, New Jersey, Massachusetts, and Vermont. Currently in committee is a Delaware bill that proposes sexual harassment training every two years for employers with 50 or more employees. Pending in New Jersey is legislation precluding arbitration agreements in employment contracts. More broadly is a bill pending in Massachusetts that would prevent the enforcement of mandatory arbitration agreements "relating to a claim of discrimination, non-payment of wages or benefits, retaliation, harassment or violation of public policy in employment." And in Vermont, a bill is awaiting the Governor's approval that would prohibit employers from preventing employees from reporting sexual harassment and from participating in an investigation.

Additionally, some localities have taken action of their own to protect employees in their jurisdictions. For example, New York City passed the "Stop Sexual Harassment in NYC Act" in early May. The law will require annual sexual harassment training for any city agency or private company with at least 15 employees beginning on April 1, 2019.

As illustrated above, efforts to discourage – or even prohibit – settlement agreement provisions or arbitration agreements limiting an employee's right to publicly disclose and/or pursue sexual misconduct claims are gaining momentum nationwide. Additionally, over the last year, an increasing number of public officials and prominent figures have been accused of sexual misconduct. Accordingly, employers are likely to continue to see more states and localities attempt to restrict the inclusion of confidentiality restrictions in settlements and the use of mandatory arbitration provisions in sexual harassment and abuse cases.

The author extends a special thanks to Emilie Adams and Nicollette Moser, who assisted with the preparation of this article.

1. The legislation applies to contracts executed on or after July 11, 2018.
2. An employee can still request a nondisclosure provision and has 21 days to consider the provision and can revoke the provision within seven days of signing.
3. Note that SB 5996 "does not prohibit a settlement agreement between an employee or former employee alleging sexual harassment from containing confidentiality provisions."
4. Interestingly, however, the law would allow a limited nondisclosure provision that prevents the parties from disclosing only the amount of the settlement.