Legal Memorandum: Double Taxation of Attorneys Fees

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

  The U.S. Supreme Court case of Commissioner v. Schleier, 515 U.S. 323 (1995), established the current law regarding whether amounts received to settle a discrimination claim are taxable income.  Generally, a “settlement constitutes gross income unless it is expressly excepted by another provision in the Tax Code.” Id. at 329.  In Schleier, the Court held that the amounts the plaintiff received in settlement of a claim brought under the Age Discrimination in Employment Act were not an exclusion to gross income under I.R.C. § 104(a)(2), which excludes damages received “on account of personal injuries or sickness.”  The Court reasoned that a taxpayer may exclude a recovery under § 104(a)(2) only if he or she meets two independent requirements: (1) the underlying cause of action is “based upon tort or tort type rights”; and (2) the damages were received “on account of personal injuries or sickness.”  The Court held that no part of Schleier’s settlement was excludable under § 104(a)(2) because recovery for back wages is not “on account of” any personal injury, and no personal injury affected the amount of back wages recovered.  Moreover, because Congress intended the Act’s liquidated damages to be punitive, they are not compensatory, so they cannot be described as being “on account of personal injuries.”   The Court also found that Schleier’s recovery and claim were not based on a “tort or tort type right” because the statute lacked the availability of compensatory damages.  Thus, Schleier’s claim failed to meet either of the two required elements for […]