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When a client wins a damage award in court, the portion of the award that goes to the lawyer as a contingentcy fee is taxable income for the lawyer. But a long-simmering issue, now before the U.S. Supreme Court in a trio of cases, is whether the client should also pay taxes on that contingentcy fee money. At the court’s private conference today, the justices will consider F reeman v. Commissioner of Internal Revenue, Commissioner of Internal Revenue v. Banks, and Commissioner of Internal Revenue v. Banaitis, among dozens of other cases. The court is expected to announce as soon as today 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 contingentcy 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,” said 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 6th U.S. Circuit Court of Appeals. The 6th 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.” In his petition, Solicitor General Theodore Olson asks the high court to reverse the 6th Circuit, which he says goes against rulings in the 4th, 7th, 9th 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 contingentcy fee arrangements are common, so the issue is likely to arise frequently. Young said 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 said that while in some instances clients can claim the contingentcy 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 two other contingentcy fee cases before the court also involve employment claims. In the Banaitis case, the 9th Circuit ruled that because of Oregon law giving lawyers a property interest in their contingentcy fees, plaintiff Sigitas Banaitis did not have to report as taxable income the $3.8 million contingentcy 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 9th 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. OTHER CASES UP FOR REVIEW April 2: Newdunn Associates LLP v. Army Corps of Engineers, No. 03-637 (and 03-701). Whether Clean Water Act jurisdiction over “navigable waters” extends to wetlands that are not adjacent to open waters, but whose rainwater runoff sometimes reaches distant navigable waters. Halliburton Energy Services Inc. v. BJ Services Co., No. 03-1025. Whether a jury determination of patent indefiniteness deserves deference in patent claim interpretations. Owner-Operator Independent Drivers Association Inc. v. New Prime Inc., No. 03-1044. Standards for class certification in class actions. St. Vincent Medical Center v. Service Employees International Union, No. 03-1083. Whether a labor union may require private arbitration of objections to a National Labor Relations Board-conducted representation election when the NLRB has already certified the outcome. This article originally appeared in Legal Times , a publication of American Lawyer Media.

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