Will Changes to the 'Weinstein Tax' Prevent Double Taxation of Sexual Harassment Settlements?

The Tax Cuts and Jobs Act of 2017 is noted for eliminating the personal exemption, tweaking child credits and deductions, lowering individual income tax brackets, and steeply cutting the corporate income tax rate.

But one provision contained within this sweeping piece of legislation, dubbed the "Weinstein Tax," is designed to prevent people accused of sexual harassment from writing off their legal fees and settlements as business expenses. This provision was added after the New York Times and other media outlets reported that disgraced movie mogul Harvey Weinstein had paid (and written off) settlements of anywhere from $80,000 to $150,000 to at least eight victims over the years. 

Unfortunately, as written, the Weinstein Tax also prohibits plaintiffs from deducting their legal fees. Because most firms take these types of cases on a contingency-fee basis, plaintiffs may be required to pay taxes on 100 percent of the cash value of a sexual harassment settlement even if they only netted 60 or 70 percent of these funds. The law firm must also pay taxes on the contingency fee it receives, which means that some of these funds are taxed twice. 

This practice isn't unprecedented—in fact, since 2005, the U.S. Supreme Court has held that plaintiffs are responsible for paying taxes on the full amount of legal settlement or judgment they receive. But the federal Tax Code provided plaintiffs with an above-the-line deduction for any legal fees paid, and because the attorney is responsible for paying income taxes on the fees they receive, any settlement would receive full tax treatment.

For sexual harassment plaintiffs, the TCJA eliminated this deduction. A bill designed to reinstate it has been pending before a Senate committee since May 2018, and several Senators recently sent a letter to the U.S. Treasury Secretary and the Commissioner of the IRS indicating their desire to reinstate the contingency fee deduction. But until this fix is passed, many plaintiffs (and those considering filing lawsuits) are understandably concerned about the tax consequences of settlement. 

One workaround some experts have advocated is to allocate nothing (or a token amount like $1) to the settlement of sexual harassment allegations in a lawsuit that brings other charges. For example, if a complaint alleges sexual harassment and defamation, 100 percent of any settlement can be allocated to the defamation claims (which are still subject to the full fee deduction), with nothing provided to the harassment claims, even if both parties intend for the settlement to cover all claims.