Posts Tagged ‘tax relief in discrimination cases’

Mediation Message No. 23

TAX RELIEF IN DISCRIMINATION CASES, PART II

Mediation message no. 20 discussed the implications of the American Jobs Creation Act of 2004 (Act) on the tax consequences in discrimination judgments and settlements. Commissioner of Internal Revenue v. Banks (2005) 2005 U.S. Lexis 1370, 73 U.S.L.W. 4117 provides finality to the pre-Act split of authority on the same subject.

The “Civil Rights Tax Relief” section of the Act 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. Prior to this legislation, the IRS took the position that successful plaintiffs in such cases owed taxes on the gross settlement or award, which included the costs of the case and the fees paid to their counsel. The federal circuits had been divided as to whether the fee and costs portion of any discrimination recovery was income to the plaintiffs.

Banks rejects the argument that arrangements between claimants and attorneys are like joint ventures or partnerships since the value of the legal claims are speculative if not worthless and ultimate recovery includes not only the claimants’ legal injuries but also the attorneys’ efforts and expertise, without which claimants would not prevail. Instead, the Supreme Court held that the anticipatory assignment doctrine, which provides that “[a] taxpayer cannot exclude an economic gain from gross income by assigning the gain in advance to another party,” extends to attorney-client contingency agreements even though “the precise dollar value of the assigned income is (not) known in advance.” Banks also finds that the attorney-client relationship, for tax purposes, is not a business partnership or joint venture. Rather, “The relationship between client and attorney, regardless of the variations in particular compensation agreements or the amount of skill and effort the attorney contributes, is a quintessential principal-agent relationship.”

Because Bank’s attorney did not receive any fees pursuant to a federal prevailing party statute, Banks refused to discuss whether such fees are also subject to the anticipatory assignment principle. Nonetheless, the Court’s discussion of the subject appears to indicate its preference, should the issue ever come before it, that only attorneys should be taxed for such fees.

Copyright, Michael D. Marcus February 2005