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High Court OKs Double Tax on Some Contingent Fees
In a pair of cases with potential pocketbook impact on lawyers and their clients, the Supreme Court ruled on January 24th that the contingent fee portion of lawsuit settlements and awards is taxable to the client, even if the money goes directly to the attorney. But initial reaction to the 8-0 decision was more muted than expected because a law passed by Congress last fall limits the ruling's implications, and the decision won't doom the contingent fee system, which fuels a broad range of private litigation.
While the cases ' Commissioner of Internal Revenue v. Banks and Commissioner of Internal Revenue v. Banaitis ' were pending last fall, Congress passed a provision allowing taxpayers who win awards in employment, whistleblower, and civil rights litigation not to count attorney fees and court costs as taxable income. [See the November 2004 edition of A&FP for coverage and background on that legislation.] Congress already allows this for lawyer fees in personal injury cases. In addition, Justice Anthony Kennedy, in his opinion for the Court, explicitly said he was not ruling on the tax implications of other federal laws that provide attorney fees, some of which exceed the award the plaintiff receives.
But in other types of commercial litigation under federal and state law, experts forecast more costly settlements in light of the rulings because winning plaintiffs may insist that the extra tax they have to pay be tacked onto the settlement. “Congress pre-empted the worst possible impact of [January 24th's] rulings,” said Jennifer Brown, legal director of Legal Momentum (formerly the NOW Legal Defense and Education Fund), which worried that a ruling against the taxpayer would discourage public interest litigation. “But we are still concerned about other cases in which the contingency fee offers the only means of access to the courts for people of ordinary means.”
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