Taxable settlement? The tax side of staying quiet

Your Guide to State, Local, Federal, Estate + International Taxation

settlement, tax, court, sexual harrassmentThe news headlines as of late have been filled with stories of individuals who are telling the world their stories of sexual harassment. The cast of accused encompasses a wide span of people. Hollywood, journalists and government officials are just a few of the many who have been called to account for their alleged behavior. What we are learning is that many of the individuals sharing their story now had received settlement payments – most of those being made under confidentiality agreements. As an accountant, I wondered how the settlement payments might be treated under the tax code.

Many claims are settled including confidentiality agreements. The confidentiality clause seeks to prohibit the parties to a settlement from disclosing the settlement terms and sometimes more. There is much debate to be had as to whether these agreements harm public policy. One could argue that a confidentiality agreement does nothing to prevent the accused from continuing the same alleged behavior. On the flip side, there is the view that a settlement with a confidentiality agreement saves the victim from the public scrutiny that surrounds the case.

Are these awards to “keep quiet” taxable? The answer under the tax code is yes. Consideration for confidentiality is taxable to the recipient. What if the agreement is silent as to the consideration paid for the confidentiality? One only needs to look to a case that involved Dennis Rodman and Eugene Amos to see how the Tax Court views such a situation.

Eugene Amos was a television camera man who during the course of a Chicago Bulls game in 1997 was kicked by Dennis Rodman. Mr. Amos suffered an injury and received medical treatment for a variety of ailments. Mr. Amos and Mr. Rodman eventually settled for a payment of $200,000 to Mr. Amos. The agreement was executed as a confidential settlement agreement and release. Damages received on account of physical injury or sicknesses are not taxable to the recipient. Mr. Amos filed his tax return and excluded the entire $200,000 from income as damages for physical injury. The IRS contended that a nominal amount of the settlement could be excluded and the rest of the settlement was to provide compensation to not defame, disclose the terms of the agreement, publicize facts relating to the incident and to assist in any criminal prosecution that could ensue. The payment, thus, was taxable as viewed by the Service. The Tax Court ultimately reached a decision that a portion, $120,000, was for physical injuries with the balance of the award subject to tax. When the agreement is silent as to the composition of the award, it may be left to the Court to determine the just and fair amount assigned as taxable and non-taxable compensation.

If the payment received is taxable to the recipient is it deductible by the payer? It may seem that alleged inappropriate behavior perpetrated on a co-worker would be personal and certainly not result in any type of tax deduction. Many of the harassment claims have arisen out of a working relationship between the parties. While it is reprehensible, if the harassment is within the scope of employment albeit not sanctioned, it can and generally is construed as a deductible business expense when the settlement payment is made.

Over the last 20 years, the Office of Compliance reported paying more than $17 million for 264 settlements. There is not published information to date that indicates the dollar amount of the payments that represented sexual harassment claims. This fund for settlements and awards comes from a special Treasury Department account that was established in 1995. I think you all know where the money to the Treasury Department comes from. If you’ve already filled in that blank with taxpayers, you’re correct. So in effect, it is the taxpayers that make it possible to provide a settlement award for a victim of sexual harassment.

The voices of the victims have intensified in their volume and the Senate has heard them. Currently, the Senate tax cut bill coming up for debate includes a provision to deny tax deductions for settlement payments in sexual harassment or abuse cases if there is a nondisclosure agreement. It is believed that this denial would encompass the legal fees associated with the payment as well. The provision has been called the “Harvey Weinstein” tax as it takes away the tax benefit of the deduction, thus in essence, amounting to a tax increase. The House bill does not include such a provision and until there is a final Senate bill the outcome of the proposal will be unknown.

Cheryl Dickerson, CPA