Vol. 28, No. 2 #2 (April 2005). Contingent Fees in Anti-Discrimination Cases - The Bad News for Winners.

• Author: Commissioner of Internal Revenue v. John W. Banks, II; Commissioner of Internal Revenue v. Sigitas J. Banaitis, 125 S.Ct. 826 (Jan. 24, 2005)

Wyoming Bar Journal

2005.

Vol. 28, No. 2 #2 (April 2005).

Contingent Fees in Anti-Discrimination Cases - The Bad News for Winners

WYOMING LAWYER April 2005/Vol. XXVIII, No. 2 Contingent Fees in Anti-Discrimination Cases - The Bad News for Winners Commissioner of Internal Revenue v. John W. Banks, II; Commissioner of Internal Revenue v. Sigitas J. Banaitis, 125 S.Ct. 826 (Jan. 24, 2005)

By Scott W. Meier Explain this to your client: You have good news and bad news. First, the good news; you have won your anti-discrimination case. The jury has returned a verdict awarding you damages and the judge has entered judgment in your favor.

Now the bad news; despite your victory, you may walk away with nothing and still owe the IRS money.

Three principal federal anti-discrimination statutes - Title VII of the Civil Rights Act of 1964 ("Title VII"),(fn1) the Age Discrimination in Employment Act ("ADEA" ),(fn2) and the Americans with Disabilities Act ("ADA")(fn3) - generally confer broad equitable powers on the courts to devise remedies making the victims of discrimination whole in economic terms. The Internal Revenue Code ("IRC"), however, sometimes operates to frustrate this make-whole objective by taxing a discrimination award more heavily than if the plaintiff earned the award as income during the normal course of business. This excess taxation can lead to adverse consequences.

In 1996, Congress amended IRC 104 making awards for nonphysical injuries taxable. As such, a discrimination plaintiff may suffer adverse tax consequences in two distinct ways. First, the IRC may subject amounts recovered to compensate for back pay and front pay losses to higher income tax rates than if the plaintiff had earned such amounts as wages in due course. This increase in tax rates is typically due to the fact the plaintiff's recovery is in a lump sum; as a result, part of the recovery may be subject to marginal rates higher than the plaintiff's typical marginal rate. Second, an employment discrimination recovery could trigger the Alternative Minimum Tax ("AMT").(fn4)

The IRS' position is that the plaintiff must report as income the entire award, including attorney fees under a contingent agreement or fee award. Although the taxpayer must include the entire award in computing gross income, the taxpayer is entitled to deduct the attorney fees as a miscellaneous itemized deduction. Such deductions...