By Abou B. Amara, Jr. and Karla M. Gluek

Imagine being sexually harassed at work, standing up for yourself and reaching a financial settlement with your employer—and then the government steps in and taxes you on that settlement. Seems unfair, right? Well, for decades, this was the reality for countless sexual harassment victims. Under Minnesota state law, at least, that is no longer the case.

Last year, the Minnesota Legislature amended1 the law to exempt sexual harassment settlements from state tax by expanding upon the narrow tax exemptions in place under federal law. Under the federal tax code,2 sexual harassment settlements are subject to federal taxation unless the victim’s settlement arose “on account of personal physical injuries or physical sickness.”3 At first glance, this legal phrase of art presents as broad language that seems to ensure victims of workplace sexual harassment would not pay federal taxes on settlements. But in reality, “personal physical injuries or physical sickness” has consistently been construed narrowly by the courts, thereby denying many sexual harassment victims this important federal tax exemption. 

One example is found in Shelton v. IRS Commissioner.4 In that case, a female employee was subjected to persistent sexual harassment by her supervisor and several other members of her employer’s management team. The harassment was so severe that the female employee sought medical assistance and began to take antidepressants and other medication to deal with its effects. Subsequently, the Equal Employment Opportunity Commission entered into a consent decree with the employer that forced the employer to pay $10 million into a settlement fund to be distributed to an entire class of employees subjected to a sexually hostile and abusive work environment. The female employee at issue received $123,500 from the fund.

Because the female employee experienced physical effects from the harassment she suffered, she believed that she was entitled to claim the “personal physical injuries or physical sickness” federal tax exemption, and therefore did not report the $123,500 settlement proceeds in her federal income tax filings. Shortly after filing, the IRS brought action against her before the United States Tax Court, alleging that the settlement proceeds were, in fact, taxable. Despite concluding that the female employee suffered “physically” in a general sense, the tax court reasoned that “[f]or the damages to be excluded [from taxation], the underlying cause of action must be based in tort or tort-type rights, and the proceeds must be damages received on account of personal physical injury or sickness.” Because the female employee’s “settlement proceeds were for emotional pain, suffering, inconvenience, mental anguish, loss of enjoyment of life, and nonpecuniary losses,” the court reasoned, the settlement proceeds did not arise from a “physical injury.” Accordingly, the tax court held that the woman’s sexual harassment was “not excludable from income” under the federal tax code, and the court identified a tax payment deficiency of $46,395 in federal taxes on the proceeds—more than one-third of the amount she received.5 

Another example lies in the case of Devine v. IRS Commissioner.6 In Devine, a female military aircraft technician employed by the Washington D.C. Air National Guard faced several years of sexual harassment from senior noncommissioned officers with the D.C. National Guard. The technician told authorities that one of the officers who sexually harassed her told her that “he did not want women working in his unit” and insisted that she could not receive a promotion “because she was pregnant.”

Subsequently, the technician filed a complaint within the military—alleging, among other things, that one senior officer made multiple “romantic advances” toward her and said to other military unit members that he wanted to have sexual relations with her. She also alleged that another senior officer “came up behind” her and “violently threw himself” into her, forcing her to “hug him.” She added that the officer’s violent thrust to hug her “was forceful enough that it actually hurt.” 

After some litigation, the technician accepted a $225,000 settlement offer from the National Guard. Like the female employee in Shelton, she also did not report the settlement proceeds she received as income, based on her belief that the settlement funds were exempt under 26 U.S.C. §104(a)(2). Subsequently, the IRS brought action against her. Upon review, the tax court noted it had “great sympathy” for the technician as she “endured great indignities in her workplace” but could not provide her with the settlement tax exemption because “Congress has limited [the settlement tax exemption]… to damages received on account of personal physical injuries or physical sickness” and the “emotional distress” she suffered did not qualify. As such, the court identified a tax payment deficiency of $65,401 in federal taxes, along with a $13,070 tax penalty.7 

As the U.S. Tax Court’s holdings in Shelton and Devine illustrate, under the federal tax code, unless a victim of sexual harassment is subjected to an extremely violent form of sexual harassment, leading to injuries akin to ones caused by physical violence, the federal tax code provides no refuge. Until last year, Minnesota’s state tax code dovetailed with federal law: Had the victims of sexual assault in Shelton or Devine lived in the North Star State, their settlements would have been taxed by both the federal government and state government, often resulting in the victims receiving only a small fraction of the total settlement amount.

Prior to the 2023 amendment to the Minnesota Tax code, for example, one Minnesota employee who settled her sexual harassment claims with her employer ended up only receiving about 11 percent of the total settlement amount after paying federal and state taxes and her legal fees.8 

This reality is one our Legislature no longer was willing to contribute to. Moving forward, Minnesotans victimized by workplace sexual harassment who stand up for themselves and reach a financial settlement with their employer will at least know that where state tax law is concerned, Minnesota is going to help them keep more of their money.  

ABOU B. AMARA, JR. and KARLA M. GLUEK are colleagues at Gustafson Gluek PLLC, a national complex litigation law firm that specializes in, among other things, impact litigation and providing critical support for #MeToo victims. Just weeks after the new Minnesota law exempting sexual harassment settlements from state taxation took effect, Gustafson Gluek PLLC successfully facilitated one of the first settlements under the new law.


1 See Minn. Stat. §290.0132, subd. 35 (2023).

2 See 26 U.S.C. §104(a)(2); see also I.R.C. §104(a)(2)

3 See 26 U.S.C. §104(a)(2); see also I.R.C. §104(a)(2)

4 97 T.C.M. 1592 (T.C. 2009), 2009 WL 1456477.

5 97 T.C.M. 1592 (T.C. 2009), 2009 WL 1456477 at *3. 

6 113 T.C.M. 1496 (T.C. 2017), 2017 WL 2558814.

7 Id. at *5-6.

8New Minnesota Law Exempts Sexual Harassment and Abuse Settlements From State Income Taxes,” Caroline Cummings, WCCO News (7/5/2023), https://www.cbsnews.com/minnesota/news/sexual-harassment-settlements-now-exempt-from-minnesota-taxes/ (accessed 3/10/2024).