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If you’re approaching settlement in your client’s sexual harassment case, it’s important to know what will happen come tax season to both the settlement recovery AND your fee. With the right planning, you can avoid unwelcome surprises and lighten the immediate tax burden.

Before 2018, companies, plaintiffs, and their attorneys could take tax deductions on settlements in court cases involving sexual harassment, because they counted as business expenses. But the “Harvey Weinstein tax” included in the new tax bill means those deductions are now denied in confidential sexual harassment or abuse settlements.

So, in a sexual harassment or abuse case with a non-disclosure agreement involved:

Plaintiffs cannot receive a tax deduction on the settlement. Moreover, plaintiffs will be taxed on the full settlement recovery, so they will be taxed on 100% of the award money before their lawyer even takes his or her contingency fee. So, a plaintiff won’t net 100% once the fee is deducted, yet they will still be taxed on that amount.

Most legal settlement agreements have some type of confidentiality or nondisclosure provision, thus making them subject to this new inclusion. However, the IRS might read the new law as a denial of a tax deduction for legal fees related to sexual harassment or abuse, even without a nondisclosure agreement. That interpretation would hurt plaintiffs.

Attorneys cannot receive a tax deduction on legal fees.

Defendants cannot receive a tax deduction on the payment to settle the case. They are now required to pay the settlement, the legal fees, and then the taxes on top of all these payments.

How Can You Lessen the Tax Blow?

At Milestone, we advise attorneys to establish a qualified settlement fund (QSF) in these kinds of cases. A QSF will buy you and your client extra time to determine the tax expectations and whether the settlement should be spread over a handful of tax years in the form of periodic payments. Doing so can spread the tax burden over time, lower  one’s tax bracket, and offer other benefits to both attorney and plaintiff alike.

We welcome you to give our firm a call for advice on your planning options to avoid a major tax hit after you conclude your sexual abuse or harassment case.

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