The new tax reforms that became law late last year could have a significant effect on individuals and businesses when it comes to whether attorney’s fees are deductible from federal income taxes. In fact, plaintiffs could find themselves paying taxes for money they never received.
For example, if a plaintiff recovers $100,000 but signed a 40 percent contingency fee with his attorney, the plaintiff will have to pay taxes, not on the net recovery of $60,000, but on the gross recovery of $100,000. Of that money, $40,000 went to the attorney, not the plaintiff, but the plaintiff pays taxes on it anyway.
The kinds of lawsuits in which attorney’s fees are not deductible include cases of invasion of privacy, defamation, divorce and family law proceedings, wrongful arrest or imprisonment, bad faith insurance, and professional malpractice.
Significantly, the cases in which attorney’s fees are not deductible by the plaintiff specifically include sexual harassment and sexual abuse cases if there is a non-disclosure agreement.
Some have called the sexual harassment and sexual abuse provision of the law the “Weinstein tax,” named for entertainment mogul Harvey Weinstein, who was charged with multiple cases of sexual harassment in 2017. Since, historically, sexual harassment and sexual abuse cases almost always have nondisclosure provisions if they are settled, the law will include most of them.
This, of course, will discourage the use of nondisclosure provisions. However, part of the benefit of those cases — for the defendant, but also, in many cases, for the plaintiff — are the nondisclosure provisions. Also, the amounts paid in settlement of these cases by employers are not considered deductible to the employer.
What kinds of cases are considered to be sexual harassment and sexual abuse cases is not yet clear, since the new law does not define them. It is also unclear what might happen in terms of deductibility of attorney’s fees if a case involves both sexual harassment and sexual abuse cases and some other claims. For example, if a case involves allegations of sexual harassment and employment discrimination claims, it is not clear how the new tax reform will be implemented.
Three areas remain largely unaffected by the new law: personal injury lawsuits, in which recovery for injury or sickness is not taxable; lawsuits by employees against their employers; certain whistleblower and discrimination claims; and lawsuits that are directly related to the plaintiff’s trade or business in which the attorney’s fees may be deducted as a business expense.
Not allowing a claimant to deduct attorney’s fees can seriously affect the economics of a case. Before settling any lawsuit, the parties should try to get answers on whether the amounts received in settlement are taxable, the amounts paid by the defendant are deductible as expenses, and the attorney’s fees paid by the plaintiff are deductible.
