Mediation Message No. 20

TAX RELIEF IN DISCRIMINATION CASES

This message is intended primarily for those attorneys who practice in the area of employment law where last month’s legislative change reducing the tax consequences on the successful plaintiff for discrimination judgments or settlements should have a salutary effect on the settlement of such claims.

Before the American Jobs Creation Act (Act) became law last October 22, it was the position of the IRS that successful plaintiffs in discrimination cases owed taxes on the gross settlement or award in such matters, which included the costs of the case and the fees paid to their counsel. At the same time, their attorneys also paid taxes on the fees collected, which resulted in a form of double taxation. Section 703 of the Act changed all that.

Section 703, entitled “Civil Rights Tax Relief”, provides that plaintiffs in discrimination cases, retroactive to the 2003 tax year, are entitled to above-the-line deductions for both the costs of litigation and the attorneys’ fees paid to their counsel. Discrimination suits are very broadly defined and include, but are not limited to, the Civil Rights Acts of 1964 and 1991; the Age Discrimination Employment Act of 1967; the Family and Medical Leave Act of 1993; the Americans with Disability Act of 1990; any federal whistleblower laws prohibiting retaliation against employees for asserting their rights and any federal, state or local provision providing for the enforcement of civil rights or regulating any aspect of the employment relationship.

A limitation on these deductions is that they may not exceed “the amount includable in the taxpayer’s gross income for the taxable year on account of a judgment or settlement (whether by suit or agreement and whether as lump sum or periodic payments) resulting from such claim.”

This favorable change as to the tax consequences of successful discrimination claims should provide an additional incentive to plaintiffs to resolve their cases at mediation when they know that their net recovery will now be greater than it would have been before the enactment of tax relief. At the same time, attorneys should also benefit because the Act provides one less reason for them to reduce their fees to appease the client who previously may have complained about having to pay taxes on those fees.

Copyright, Michael D. Marcus November 2004

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