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They may be employees of Target, but that doesn’t mean they can discount their tax returns. The 9th Circuit U.S. Court of Appeals ruled that taxpayers lucky enough to win punitive damages still have to pay taxes on the percentage used to pay their attorneys. The petitioners in Benci-Woodward v. Commissioner of Internal Revenue, 00 C.D.O.S. 5934, had won a suit in a California court against their former employer, Dayton Hudson Inc., now known as Target Corporation, which owns Target stores. The suit arose from a Target investigation into its employees, which resulted in employee allegations of false imprisonment, defamation and intentional infliction of emotional distress, among other things. The plaintiffs won, and under a contingency agreement, paid the attorneys from their award of compensatory and punitive damages. Then came April 15. At first, the plaintiffs didn’t report any of the punitive damages as gross income. Then, they argued that only the portion left over after paying the lawyers should be reported as income. That landed them in federal tax court, where they lost. They appealed to the 9th Circuit. A three-judge panel was unimpressed. Consistent with several other opinions, Judge M. Margaret McKeown ruled that because an attorney’s contingency agreement does not confer ownership of any recovery, the plaintiffs are on the hook for any applicable taxes. In particular, McKeown’s curt opinion pointed to the 9th Circuit’s ruling last month in Coady v. Commission of Internal Revenue, 00 C.D.O.S. 4709, which arose from an Alaska wrongful termination suit and decided essentially the same issue. “Although Coady involved an analysis of an attorney lien under Alaska law, the result is the same under California law,” McKeown wrote.

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