Section 162(q): Can One Confidentiality Clause Wipe Out Your Deduction?

Settling a lawsuit that arises from your business is normally a deductible expense. The payment, the legal fees, all of it generally lands on the return as an ordinary and necessary business expense. But since late 2017, there is one category of settlement where a single clause in the agreement can eliminate the deduction entirely: sexual harassment or sexual abuse claims settled with a nondisclosure agreement.

The general rule

Judgments and settlements paid in connection with a trade or business are deductible under Section 162, and so are the attorney's fees to get there. That has been the baseline for decades, and for most employment claims, it still is.

What Section 162(q) changed

The Tax Cuts and Jobs Act added Section 162(q), effective for amounts paid or incurred after December 22, 2017. It denies a deduction for:

1. Any settlement or payment related to sexual harassment or sexual abuse, if the settlement or payment is subject to a nondisclosure agreement, and
2. Attorney's fees related to that settlement or payment

Note the trigger. It isn't the nature of the claim alone; it's the claim plus the NDA. And "NDA" is a broad concept here. Whether your agreement calls it a confidentiality agreement, a confidential disclosure agreement, or a secrecy provision buried in paragraph 14, the label doesn't matter.

Example: BigBox Corp. settles a sexual harassment claim in 2026 for $500,000 and pays $150,000 in legal fees. The settlement agreement includes a standard confidentiality clause. Under Section 162(q), the entire $650,000 is nondeductible. At a 21% corporate rate, that confidentiality clause just cost BigBox roughly $136,500 in cash taxes. Strike the NDA, and the full amount is back on the table as a deduction.

What about the person receiving the settlement?

Here's where the statute got ahead of itself. Read literally, Section 162(q)(2) denies a deduction for attorney's fees "related to" the settlement, which would seem to catch the plaintiff's fees too. That was never the intent. The Joint Committee on Taxation said the recipient's fees are not subject to the rule, and the IRS confirmed it in a published FAQ: recipients are not precluded by Section 162(q) from deducting attorney's fees related to the settlement, if otherwise deductible. So the above-the-line deduction for fees in unlawful discrimination claims survives the NDA. Just be aware the fix lives in an FAQ and legislative history, not the statute itself.

The gray areas

So, just carve the NDA out and move on, right? Usually, yes, but "related to" is doing a lot of unguided work in this statute, and the open questions are real:

1. Mixed settlements. One agreement settling five employment claims, only one of which involves harassment. Does the NDA taint the entire payment? The statute doesn't say.
2. Severance to the accused. An employer pays severance to the alleged perpetrator under a confidentiality provision. The plain language appears to deny that deduction too.
3. One-sided NDAs. The employee requests confidentiality that binds only the employer, say, about the termination and work history. Read literally, the deduction is still gone.

Eight-plus years in, we're still waiting on regulations. Until then, allocation language and NDA scoping in the settlement agreement itself are your best tools.

Bottom line

If a settlement touches a harassment or abuse claim, the tax cost of confidentiality needs to be on the table before anyone signs. Get the tax advisor into the conversation while the agreement is still a draft, not after.

This post is general information, not tax advice for your specific situation.