Supreme Court decides contingent fee cases.

• Author: O'Driscoll, David

A recent Supreme Court decision held that, when law suit judgment or settlement is taxable, the litigant must include in income the portion paid to the attorney as a contingent fee. However, the Court did not address cases involving court-awarded attorneys' fees.

In one of the reviewed cases, Banks, 345 F3d 373 (2003), the Sixth Circuit had held the contingent fee portion of a litigation recovery is not included in the plaintiff's gross income. It reasoned that the contingent fee agreement was not an anticipatory assignment of the plaintiff's income, because the litigation recovery was not already earned, vested or even relatively certain to be paid when the contingent fee contract was made.

In the other case, Banaitis, 340 F3d 1074 (2003), the Ninth Circuit had held that the portion of the recovery paid to the attorney as a contingent fee is excluded from the plaintiff's gross income only if state law gives the plaintiff's attorney a special property interest in the fee. Six circuits had held that the entire litigation recovery (including the portion paid to an attorney as a contingent fee) is income to the plaintiff, with little emphasis on state law; other circuits have been explicit that the fee portion of the recovery is always income to the plaintiff.

Facts

In Banks, Ysued his former employer for employment discrimination under 42 USC Sections 1981 and 1983, Title VII of the Civil Rights Act of 1964 and Cal. Govt. Code Ann. [section]12965. He retained an attorney on a contingent fee basis. After trial commenced, the parties settled for $464,000. Y paid $150,000 of this amount to his attorney under the fee agreement.

In Benaitis, X retained an attorney on a contingent fee basis in a state court case against his former employer for willfully interfering with his employment contract, attempting to induce X to breach fiduciary duties to customers and discharging him when he refused. The jury awarded compensatory and punitive damages; the parties settled and in following the formula set forth in the contingent fee contract, the defendants paid an additional $3,864,012 directly to X's attorney.

Anticipatory Assignment of Income

The rationale for the so-called anticipatory assignment of income doctrine is the principle that gains should be taxed "to those who earn them"; see Lucas v. Earl, 281 US 111 (1930). The doctrine is meant to prevent taxpayers from avoiding taxation through "arrangements and contracts however skillfully devised to...