Legal Memorandum: Adjusted Gross Income

Issue: Is it possible to avoid double taxation of an attorney’s contingency fee?

Area of Law: Litigation & Procedure, Tax Law
Keywords: Taxable income; Contingent fee; Double taxation
Jurisdiction: Federal
Cited Cases: 340 F.3d 1074; 543 U.S. 426
Cited Statutes: 42 U. S. C. §§ 1981, 1983, and 2000(e); American Jobs Creation Act of 2004, 18 Stat. 1418; Section 703 of the Act amended the Tax Code, subsection 62(a)(19); 302 of the Civil Rights Act of 1991
Date: 03/01/2006

The Supreme Court recently held that if a litigant’s recovery constitutes income, his or her taxable income generally includes that part of the recovery paid to the attorney as a contingent fee, Comm’r v. Banks, 543 U.S. 426 (2005).  In Banks, the Court noted that if the American Jobs Creation Act of 2004 Act had been “in force for the transactions now under review, these cases likely would not have arisen. The Act is not retroactive, however, so while it may cover future taxpayers in respondents’ position, it does not pertain here.”  Id. at 433.

The Banks Court decided two similar discrimination cases, one involving Banks and one involving Banaitis v. Comm’r, 340 F.3d 1074, 1080 (9th Cir.2003).  Banks settled a federal employment discrimination suit against a California state agency, and Banaitis settled an Oregon state case against his former employer.  Neither included contingent fees paid to their attorneys as gross income on their federal income tax returns.  In Banks’ case, the Sixth Circuit Court of Appeals held that the amount Banks paid to his attorney was not includable as gross income.  In Banaitis’ case, the Court of Appeals for the Ninth Circuit held that the contingent-fee portion of his settlement was not includable as gross income.  The Supreme Court granted certiorari to resolve the conflict.

The Court reasoned that the Tax Code defines "gross income" broadly to include all economic gains, unless otherwise exempted.  A taxpayer may not […]

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