On December 22, 2017, President Trump signed into law the “Tax Cuts and Jobs Act” (TCJA), otherwise known as the new tax law. Since that time, most of the focus on the TCJA has been understandably devoted to how the new law affects tax rates and deductions for individuals and companies. However, the TCJA also includes several significant changes about which employers should be aware. These changes include the elimination of a tax deduction related to nondisclosure agreements in sexual harassment settlements, a tax credit for providing paid family and medical leave, and changes to employee income tax withholding tables, together with a pending revision of Form W-4. Employers of every size will be affected by these changes, and should strongly consider discussing the implications of the TCJA on their business with experienced employment and tax counsel.
Loss of Deduction for Nondisclosure Agreements
One of the most significant changes for employers in the TCJA is the loss of the federal income tax deduction for amounts paid to settle claims of sexual harassment or abuse (as well as attorneys’ fees paid in such settlements), if the settlement or payment is subject to a nondisclosure agreement. When settling such claims, businesses have routinely insisted that a claimant execute a nondisclosure agreement in exchange for receiving settlement payments. The TCJA will make employers think twice before continuing this practice, as the payment to resolve such sexual harassment or abuse claims will no longer be deductible as a business expense if the settlement is conditioned on such a nondisclosure agreement. This change, therefore, penalizes employers and likely will effectively drive up the cost of settling sexual harassment or abuse claims to a significant degree if employers choose to continue to include nondisclosure obligations in settlement agreements.
This change became effective as of December 22, 2017, so employers should be aware that a settlement reached last year providing for settlement payments to be made in early 2018, for instance, is subject to the non-deductibility rule.
The new law also leaves several questions unanswered with regard to this tax penalty. For instance, the TCJA does not provide any clarity on how this provision will work when sexual harassment or abuse claims are mixed with other claims, or whether settlement amounts can be allocated to other specific claims to avoid non-deductibility. Likewise, the TCJA does not define “sexual harassment” or “sexual abuse.” While the Internal Revenue Service might incorporate the Equal Employment Opportunity Commission’s definitions of harassment and abuse, it remains possible that the IRS could instead draft its own definitions. The text of the TCJA also does not indicate whether a nondisclosure provision in an agreement constitutes a “nondisclosure agreement” for purposes of the law. Moreover, the IRS has not indicated how soon it may resolve any of this confusion, or even if it intends to do so.
Tax Subsidy for Wages Paid During FMLA Leave
The Family and Medical Leave Act (FMLA) generally requires employers with more than 50 employees to provide eligible employees with up to 12 weeks of job-protected leave per year for specific family or medical-related reasons. The FMLA does not dictate that this leave be paid leave, but some employers allow or require employees to take accrued paid leave such as vacation or PTO concurrent with FMLA leave. After exhausting such paid leave, the balance of the FMLA leave is then unpaid.
The TCJA seeks to encourage employers to provide paid FMLA leave to eligible employees by providing tax credits to employers for wages paid by the employer to such employees. According to the new law, qualifying employers may claim a credit of 12.5% of the amount of wages paid to a qualifying employee taking FMLA leave. To receive such a tax credit, the wages paid to such an employee must be 50% of the employee’s normal wages. For each percentage point by which the wages paid exceed 50% of the employee’s normal wages, the tax credit increases by 0.25%, up to a maximum tax credit of 25% if the employee is paid 100% of their normal wages during an FMLA leave.
Employers may only apply for the tax credit for employees who have been with the employer for more than a year and who earned less than $72,000 in 2017. This wage cap will be adjusted for inflation going forward. The tax credit will expire after two years, on December 31, 2019, but may be extended or otherwise addressed by Congress before then.
Employers must have written policies detailing various requirements set forth in the TCJA to be eligible for the new tax credit. For instance, employers must provide at least two weeks of paid leave for full-time employees, as well as a prorated amount for part-time employees. Significantly, this two weeks of paid leave cannot be provided as medical or sick leave, vacation, or PTO – it must be a separate entitlement. It is important to note that most employers’ current vacation or PTO policies likely will not qualify for the tax credit.
It is likely that additional regulations explaining the tax credit provision will be published. However, employers should begin evaluating right away whether they can and want to take advantage of this tax credit in 2018 and 2019. If so, employers should review their current policies with experienced employment counsel to determine if the policies meet the guidelines specified in the TCJA. Paid leave provisions can and should be reassessed and redrafted to ensure that employers desiring to do so can benefit from this new tax credit.
New Withholding Tables
In connection with the new law, the IRS recently updated income tax withholding tables for 2018. The updated tables include the new rates for employers to use during the 2018 tax year. The new withholding tables reflect the increase in the standard deduction, repeal of personal exemptions, and changes in tax rates and brackets. The IRS has instructed employers to begin using the new tables as soon as possible, but no later than February 15, 2018. Until then, employers should continue using the 2017 tables.
The IRS indicated earlier this month that it is in the process of revising the current Form W-4 – which indicates the amount of federal income tax to withhold from employees’ paychecks – although it has not yet indicated a release date for the new form. Until that time, the new withholding tables are designed to work with the current Form W-4 completed by employees and filed with employers. Once the IRS issues a revised W-4 (likely before tax year 2019) many employees may need to submit revised W-4s to their employers. This could create an administrative headache for employers, who might be required to process a large number of revised W-4s at the same time. It is presently unknown whether employers will be required to obtain revised W-4s from all employees or only some of them, or whether employees themselves will be responsible for determining whether they need or want to submit a revised W-4.
Payroll withholding can be complicated, and employers will certainly need tax guidance on these issues. Nevertheless, employers should begin preparing for the significant tasks that may be associated with the new withholding tables and revisions to Form W-4. Such tasks include managing the interplay between the new withholding tables and the current W-4, communicating with employees about adjustments to withholding, meeting deadlines for employees to submit revised W-4s, and implementing such changes in the employer’s payroll system.
Now is the time to consider how the TCJA will affect your business and your employees. Calfee will continue to update you on regulations and guidance on these issues. If you would like to discuss or have questions about the employment-related implications of the new tax law, please contact a member of Calfee’s Labor and Employment or Tax practice groups.