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The 7th Circuit has held, in an issue of first impression in the circuit, that contingent attorney fees are part of a client’s taxable income. Eldon Kenseth launched a successful age bias suit against his former employer, and the firm representing him deducted 40 percent of the award pursuant to a contingency agreement. The U.S. Tax Court ruled that the entire award, including the $91,800 deducted by the law firm as its fee, was part of Kenseth’s gross income. On appeal, the 7th Circuit affirmed. ( Kenseth v Commissioner of Internal Revenue, 7thCir, 81 EPD �40,768) The court noted a split among the circuits on the issue, but stated that “with all due respect to those who disagree, we think the Tax Court’s resolution of the issue is clearly correct.” Taxable income, the court said, is gross income minus allowable deductions. Had the employee paid the firm on an hourly basis, the fee would have been a deduction from, rather than a reduction of, his gross income. Furthermore, although the firm had a lien on the fee, the lien was not proprietary — ownership of a security interest is not ownership of the security. The court noted that while the fee was a deductible expense under the federal income tax, it was not deductible from gross income in computing the alternative minimum tax. Kenseth argued that his position would eliminate this inequity. However, the court said there was no reason that attorney fees should be distinguished from other miscellaneous deductions disallowed by the alternative minimum tax. Accordingly, the 7th Circuit affirmed the judgment of the Tax Court. � 2001, CCH INCORPORATED. All Rights Reserved.

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