Thank you for sharing!

Your article was successfully shared with the contacts you provided.
Tony Mauro is Supreme Court correspondent for American Lawyer Media. When a client wins a damage award in court, the portion of the award that goes to the lawyer as a contingent fee is taxable income for the lawyer. But a long-simmering issue, now before the Supreme Court in a trio of cases, is whether the client should also pay taxes on that contingent fee money. At the Court’s private conference on March 26, the justices will consider Freeman v. Commissioner of Internal Revenue, No. 03-660; Commissioner of Internal Revenue v. Banks, No. 03-892; and Commissioner of Internal Revenue v. Banaitis, No. 03-907, among dozens of other cases. The Court is expected to announce as soon as March 29 whether it will add these or other cases to its docket for review next fall. In nearly a dozen instances in recent years, the high court has denied review in cases raising the issue of a client’s tax liability for contingent fees. But in those cases, the taxpayer lost in the courts below, and the Supreme Court heeded the solicitor general’s advice not to review the taxpayers’ appeals, as it usually does. What makes this batch of cases different – and possibly more attractive to the Court – is that the government has begun losing on this issue below. Now it is the government that is urging the high court to step in. “That always increases the chances of the Court granting review,” says Russell Young, a Chicago tax partner in Mayer, Brown, Rowe & Maw who represents Joseph Banks II in the lead case before the Court. Banks, an education consultant for the state of California, sued the state after being terminated in 1986. He claimed discrimination and state law torts of slander and infliction of emotional distress. Soon after his trial began, the state settled his claims for $464,000, of which $150,000 went to his lawyer as part of a contingency fee arrangement. Banks did not report any of the settlement money as income. When the IRS issued a notice of deficiency, Banks appealed to the Tax Court, which sided with the government. But Banks, after moving to Michigan, appealed to the Sixth U.S. Circuit Court of Appeals. The Sixth Circuit reversed, determining that when the contingency fee arrangement was signed, the money was an “intangible, contingent expectancy” and that taxing the client for it would result in “double taxation.” Judge Eric Clay wrote the opinion. In his petition, Solicitor General Theodore Olson asks the high court to reverse the Sixth Circuit, which he says goes against rulings in the Fourth, Seventh, Ninth, and 10th circuits: “Resolution by this Court of the widespread and irreconcilable conflict among the courts of appeals is needed to eliminate the disparate treatment of similarly situated taxpayers that now exists.” The government contends that the award money a client gets should be taxable no matter where some of it goes later. “The taxpayer cannot avoid tax on the income he has earned by the simple artifice of having it paid, for his benefit, to someone else,” the brief states. Olson also noted that contingent fee arrangements are common, so the issue is likely to arise frequently. Mayer, Brown’s Young says the tax issue comes up most often in employment cases, but not in personal injury lawsuits, because damage awards resulting from “personal injury or sickness” are specifically excluded from taxation. Young also says that while in some instances clients can claim the contingent fee portion of their awards as a deduction, they cannot do so at all if they are subject to the alternative minimum tax. Bills pending before Congress aimed at benefiting the victims of employment discrimination would end their obligation to pay taxes on the portion of their damage awards that go toward lawyer fees. The other two contingent fee cases before the Court also involve employment claims. In the Banaitis case, the Ninth Circuit ruled that because of Oregon law giving lawyers a property interest in their contingent fees, plaintiff Sigitas Banaitis did not have to report as taxable income the $3.8 million contingent fee that he paid his lawyer out of an $8.7 million damage award against Mitsubishi Bank. In the Freeman case, petitioner Jack Freeman challenges another Ninth Circuit ruling, this one unpublished, that sided with the government and ordered him to pay taxes on the $199,642 paid to his lawyer out of a $300,000 award he won for wrongful discharge. The government asks the Court to delay ruling on both the Freeman and Banaitis cases pending its decision in the Banks case.

This content has been archived. It is available through our partners, LexisNexis® and Bloomberg Law.

To view this content, please continue to their sites.

Not a Lexis Advance® Subscriber?
Subscribe Now

Not a Bloomberg Law Subscriber?
Subscribe Now

Why am I seeing this?

LexisNexis® and Bloomberg Law are third party online distributors of the broad collection of current and archived versions of ALM's legal news publications. LexisNexis® and Bloomberg Law customers are able to access and use ALM's content, including content from the National Law Journal, The American Lawyer, Legaltech News, The New York Law Journal, and Corporate Counsel, as well as other sources of legal information.

For questions call 1-877-256-2472 or contact us at [email protected]

Reprints & Licensing
Mentioned in a Law.com story?

License our industry-leading legal content to extend your thought leadership and build your brand.


ALM Legal Publication Newsletters

Sign Up Today and Never Miss Another Story.

As part of your digital membership, you can sign up for an unlimited number of a wide range of complimentary newsletters. Visit your My Account page to make your selections. Get the timely legal news and critical analysis you cannot afford to miss. Tailored just for you. In your inbox. Every day.

Copyright © 2021 ALM Media Properties, LLC. All Rights Reserved.