On December 22, 2017, President Donald Trump signed sweeping tax reform legislation. The controversial tax bill includes many changes that directly affect the employment relationship. These range from sexual harassment settlements and paid family and medical leave to reimbursed employee expenses and retirement plans.
Although I am neither a tax lawyer, nor an accountant, I offer a synopsis of these changes here.
Tax Deductions for Sexual Harassment Settlements
In response to the ongoing #MeToo movement, Senator Bob Menendez (D-NJ) introduced a new provision to the Internal Revenue Code’s section on tax deductions for ordinary trade or business expenses. The provision prohibits deductions for:
- any settlement or payment related to sexual harassment or sexual abuse if such settlement or payment is subject to a nondisclosure agreement; or
- attorney’s fees related to such a settlement or payment.
The tax reform bill doesn’t expand on the meanings of the terms used in this new provision. That leaves its application open for debate, at least until the IRS issues guidance and begins to apply the restriction to actual returns.
Clearly, this new tax code provision will affect settlements of employment claims. This may include both cases of an asserted claim involving sexual harassment or sexual abuse and those where the employer seeks a general release to cover all employment-related claims. In the latter scenario, the employee may not have specifically alleged sexual harassment/abuse. But a broad release would typically reference Title VII and similar state laws that could encompass sexual harassment claims. Employers (and employees) will need to weigh the trade-off between release coverage, confidentiality, and tax deductibility.
Employer Credit for Paid Family & Medical Leave
Employers can now claim a tax credit starting at 12.5% of wages paid to qualifying employees on family and medical leave. Wages paid must be at least 50% of the employee’s normal wages. The credit increases by 0.25% for each full percentage point by which the employer’s wage payment exceeds 50% of the employee’s normal wages, up to a maximum 25% credit.
To be eligible to take the credit, the employer must provide all qualifying full-time employees at least two weeks of paid family and medical leave each year under a written policy. The employer must also provide part-time employees leave on a pro-rata basis.
Qualifying employees are only those who have been employed for one year or more and whose wages do not exceed $72,000 (in 2018, indexed for inflation).
The credit is limited to 12 weeks of paid leave per employee in a tax year. It is only in place for 2018 and 2019 and does not apply to paid leave mandated by state or local law.
Certain Reimbursed Expenses No Longer Excluded from Employee Income
The 2017 tax reform bill repeals certain exclusions from employees’ taxable income. One such exclusion previously applied for certain moving expenses reimbursed by their employer. Another permitted employees to exclude up to $20 per month of qualified bicycle commuting expenses reimbursed by their employer. Under the new tax law, neither of these exclusions apply between January 1, 2018 and December 31, 2025. Subject to future Congressional action, these exclusions are scheduled to return in 2026.
The reforms also indefinitely eliminated employer deductions for certain transportation benefits provided to employees. Specifically, these deductions applied to up to $255 per month for employee mass transit commuting and parking and up to $20 per month in bicycle costs.
There are also changes to tax treatment of qualified equity grants to employees, employee achievement awards, and length of service award plans.
Retirement Plans
The tax changes also affect employer-sponsored defined contribution plans. It gives employees more time to roll over loan balances to an IRA following plan termination or separation from employment. Under the old rules, employees had 60 days to avoid having the loan treated as a distribution. They now have until the due date for filing that year’s tax return.
Other earlier drafts included additional changes that were ultimately dropped. These included reducing the age for beginning in-service distributions from defined benefit and state and local governmental plans to 59 1/2 and changing rules regarding hardship distributions.
Health Care
The new tax bill eliminates the penalty connected to the Affordable Care Act’s individual mandate as of 2019. The penalty still applies to individuals who haven’t maintained sufficient health insurance coverage in 2017 and 2018.
It also reduces the threshold for claiming itemized deductions for qualified medical expenses from 10% to 7.5% of income in 2017 and 2018. The 10% threshold returns in 2019.
Response to Employment-Related Tax Reform Issues
Most of these issues do not require employers to take action (other than paying taxes differently). However, because they will affect taxation of both the employing organization and the employees, questions are likely to arise. Proactive employers should consider the tax impacts and plan accordingly.
Businesses should seek further guidance from appropriate professionals in considering their approach in response to these developments. Often that will mean accounting or tax law professionals. But it will also include attorneys involved in settling disputes with employees, especially (but not only) those involving sexual harassment allegations. An experienced employment lawyer can also assist in preparing a credit-qualifying paid family and medical leave policy.
The IRS indicates that it will provide updates and resources about the new tax reforms here.
