Supreme Court Agrees With IRS on Contingent Attorney Fee Cases

Basically, when someone gets a settlement from a lawsuit, the part that goes to their lawyer as a fee is considered income for the person who sued. This means they have to pay taxes on that money. This was decided by the Supreme Court in two cases where people had sued their former employers and got big settlements, but then tried to exclude the part that went to their lawyers from their taxes. Mr. Banaitis didn’t include the money he paid to his lawyer in his income for taxes. The tax office said he should have. A court decided that under Oregon law, Mr. Banaitis’ lawyer had a right to the money, so Mr. Banaitis didn’t have to include it in his income. If the money paid to a lawyer is seen as a miscellaneous deduction, it can only be deducted if it’s more than 2% of your income and it might not be deductible for some people. There’s an exception for lawyer fees paid for cases of discrimination, but it’s limited. A Supreme Court decision says that the money paid to a lawyer as part of a contingent fee must be included in your income for taxes even though it doesn’t seem like it’s meant to avoid paying taxes. The Supreme Court said that when someone assigns income they don’t have yet, they still have to pay taxes on it. The taxpayers argued that the assigning income rule shouldn’t apply because the value of the legal claim was uncertain and the attorney did a lot of work on the case. But the Supreme Court said that the rule still applies, and the attorney and client relationship is like a boss and employee, not business partners. State laws also can’t change this. The Supreme Court didn’t consider some arguments about how attorney fees should be treated for taxes. They said the arguments were new and might not work anyway. But a taxpayer could still try to exclude attorney fees from their income and make these arguments. It’s important for the taxpayer to tell the IRS about this on their tax return to avoid getting in trouble. Also, when Mr. Banks settled his case, his attorney fees were based on their private agreement, not on any court order. So the argument about fee-shifting laws didn’t apply to his situation. The Supreme Court has decided that contingent attorney fees are taxable income for the taxpayer. However, there are still potential arguments that a taxpayer can make, especially if the claim is under a statute that authorizes fee awards to prevailing plaintiffs’ attorneys. Before finalizing a settlement, it would be advisable for the plaintiff’s tax advisor to estimate the after-tax settlement proceeds available to the plaintiff and to advise the plaintiff of this amount. If the tax advisor fails to perform this analysis, the plaintiff may have an unhappy surprise the following April. D. Michael O’Leary is a tax lawyer in Tampa.

Source: https://www.floridabar.org/the-florida-bar-journal/supreme-court-agrees-with-irs-on-contingent-attorney-fee-cases/