Former President Donald Trump is facing trial in New York over charges related to hush money paid to Stormy Daniels. While hush money may seem dirty or illegal, many businesses pay it on occasion. The charges against Trump claim he falsified business records to conceal damaging information during his 2016 election campaign. However, the case also brings important tax rules into play for businesses, as nearly every kind of payment has tax consequences for both the recipient and the one who paid the money.
Hush money is considered income by the IRS, and recipients are required to report it on their taxes. This applies to almost all lawsuit settlements, with few exceptions for compensatory personal physical injury damages. Plaintiffs must provide evidence of physical sickness to avoid taxation on their settlements, and the exact wording of the settlement can greatly impact how much they get to keep after legal fees. In some cases, plaintiffs are taxed on 100% of the money, even if legal fees are deducted.
Businesses often settle legal claims to keep them quiet and avoid bad publicity, with nearly every settlement agreement requiring confidentiality. These settlements are usually tax deductible for businesses, except for cases involving hush money for sexual harassment or abuse. Individual defendants generally cannot claim a write-off for hush money payments unless they can prove it relates to their business activities. Since the tax law changed in 2018, businesses and individuals can no longer write off confidential legal settlements for sexual harassment or abuse if confidentiality is required.
Some companies settle without requiring confidentiality to get around the new tax rules, while others are willing to forgo a tax deduction to keep settlements quiet. However, some companies split the money into parts to try to still claim a deduction, separating the portion allocated to sexual harassment from other claims in the settlement. Legal fees can also be a problem for plaintiffs, as they face IRS taxes on their settlements and struggle to deduct their legal fees under the new tax law. Overall, hush money payments and legal settlements continue to raise legal and tax implications for businesses and individuals.
