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SUPREMES TO HEAR CASE ON TAXATION OF CONTINGENT ATTORNEY FEES IN INCOME
March 30, 2004
The U.S. Supreme Court announced yesterday that it will hear two cases on the taxation of legal judgments and settlements with contingent attorney fees. The Court will hear appeals of a Ninth Circuit Case holding that the gross amount of an award, including contingent legal fees, is taxable. It will also hear a conflicting Sixth Circuit case holding that only the net amount - after fees - is taxable.
WHY IT MATTERS
You may be thinking "aren't attorney fees deductible?" Well, yes and no. They are deductible as an itemized deduction for regular tax, to the extent they exceed 2% of adjusted gross income when combined with other "miscellaneous" deductions. For alternative minimum tax, they aren't deductible at all.
The lack of an AMT deduction for attorney fees has led to perverse results. In some cases the taxes on a settlement have exceeded the amount received by the plaintiff after attorney fees. If the Supreme Court decides that contingent fees aren't includible in income in the first place, the AMT problem disappears.
This problem doesn't apply to all legal settlements. For example, legal fees involving an settlement for impairment of a capital asset may offset the recovery.
Links:
Banaitis v. Comm (CA-9, 2003)
John W. Banks II v. Comm. (CA-6, 2003)
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Comments
I received a settlement for back wages and was unsure of how to file.
Several of my coworkers, who also received settlements, opted to cite the Banaitis case and exclude the attorney fees from their income, even though we are CA employees.
The case as it stands appears to hinge on OR attorney fee lien law, so I opted to bite the bullet and pay the additional taxes. I am hoping that if the Supreme Court rules in the Taxpayer's favor I can file an ammended return and recover the tax paid.
My coworkers were encouraging me to file as they did - did I do the right thing by taking the AMT hit?
Posted by: CJ | April 22, 2004 7:53 PM
Did you do the right thing? A lot depends on what the Supreme Court decides and the specifics of your case. You probably should contact your tax advisor about filing a refund claim to protect your rights in case the court rules favorably for you.
If the Court rules unfavorably, you definitely did the right thing, and your coworkers may suddenly face the unhappy need to come up with some cash. If the statute of limitations is still open and the Court rules favorably, you end up no worse off than they did once you get your refund, with interest.
Posted by: Joe Kristan | April 23, 2004 6:28 AM