IRS Clarifies Ambiguity in New Deduction Section Relating to Confidential Settlements in Sexual Harassment Cases

The IRS has addressed and clarified an ambiguity in a recently-enacted tax law that relates to deductions of attorney fees in sexual harassment cases, where a nondisclosure agreement is in play.

Section 162(q) of the Internal Revenue Code provides:

(q) 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.

After this statute was passed, some wondered whether this section – which clearly was meant to deprive a settling defendant of the deduction – also prohibited a settling plaintiff of the deduction as well.

Specifically, while 26 U.S.C. § 162 is titled “Trade or business expenses”, the language “under this chapter” technically reaches the above-the-line deduction allowed for attorney fees in discrimination cases, since the section codifying that deduction – 26 U.S.C. § 62(a)(20) – is part of “this chapter” (i.e., IRC Chapter 1).

The IRS, however, has clarified the issue in a FAQ:

Question:
Does section 162(q) preclude me from deducting my attorney’s fees related to the settlement of my sexual harassment claim if the settlement is subject to a nondisclosure agreement?

Answer:
No, recipients of settlements or payments related to sexual harassment or sexual abuse, whose settlement or payment is subject to a nondisclosure agreement, are not precluded by section 162(q) from deducting attorney’s fees related to the settlement or payment, if otherwise deductible. See Publication 525, Taxable and Nontaxable Income, for additional information on when all or a portion of attorney’s fees may be deductible.

It remains to be seen whether the statute itself will be corrected (e.g., by changing the language “under this chapter” to “under this section”).