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How does the IRS treat sexual harassment settlements?

On Behalf of | Aug 27, 2019 | Internal Revenue Service

No one should have to put up with sexual harassment. Massachusetts residents who experience this unseemly treatment have the right to lodge a complaint with their employers. In some cases, victims receive financial settlements in exchange for not pursuing the matter any further. What they need to take into consideration is how the IRS treats these types of settlements in order to plan for the tax ramifications.

Under the new tax laws, the victim pays taxes on the gross amount of the settlement regardless of whether he or she pays attorney’s fees from it. Then, the attorney pays taxes on the amount of fees received. This change to the tax law, called the Weinstein Tax, intended to keep companies from deducting their settlement payments and legal fees in sexual harassment cases requiring a confidentiality agreement, which is a requirement in most of these claims.

Presumably, the victim having to pay taxes on the entire amount of the settlement instead of subtracting the amount for attorney’s fees was an unintended consequence of this provision. Some senators want to stop this practice, but have yet to pass any law fixing the problem. In the meantime, those receiving such settlements need to remain aware of the tax liabilities they incur.

Sometimes, these cases involve more than just one type of claim. They often involve issues such as retaliation, discrimination and, sometimes, wrongful termination. If only a portion of the claim is allocated to sexual harassment, it may be possible to avoid a larger tax burden. Massachusetts residents need to know that the IRS does not have to honor such an allocation, but they tend to. It may help if victims who receive settlements for sexual harassment claims take the time to fully understand the tax implications prior to signing any agreement.


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