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U.S. Supreme Court Rules Attorneys' Fees Are Income and Reportable on Claimant's Federal Tax Return

By Bruce H. Schwartz
  • January 24, 2005

In a unanimous decision, the U. S. Supreme Court has ruled that attorneys fees paid out of a judgment or settlement under a contingent fee agreement are includible in a claimant's gross income for federal tax purposes. Both cases under consideration by the Court involved claims arising out of the employment relationship. The ruling ends a conflict among the federal appeals courts over whether the position taken by the Internal Revenue Service regarding the tax treatment of such contingency fees was correct.

Commissioner of Internal Revenue v. Banks, consolidated with Commission of Internal Revenue v. Banaitis, 543 U.S. ____ (Docket Nos. 03-892 & 03-907, January 24, 2005).

Federal appeals courts in the 5th, 6th and 11th circuits had ruled that the contingency fees portion of judgments and settlements was not includable in the recipient's gross income. The federal appeals court in the 9th circuit had applied state law giving a plaintiff's attorney a special property interest in such fee arrangements. These rulings were in disagreement with the position of the federal appeals courts in the 1st, 2nd, 3rd, 4th, 7th, 10th and Federal Circuits, as well as the U.S. Tax Court and IRS, on whether attorney contingency fees were includible in claimants' gross income.

As a result of the Supreme Court's ruling on January 24, 2005, the attorneys' fees portion of any settlement or judgment is taxable income to the recipient whether the fees have been paid directly to the claimant or directly to the attorney, and whether the fees are pursuant to a contingent fee or other agreement. The amount of the fees is reportable on IRS form 1099-MISC to be issued to the claimant. If the fees are paid directly to the attorney, a separate form 1099-MISC must be issued to the attorney, in addition to the one issued to the claimant.

The American Jobs Creation Act of 2004 created a new provision in the Tax Code, effective October 22, 2004, that allows the claimant to deduct 100% of the fees payment on his or her federal income tax return. This provision is not retroactive and did not apply to the cases decided by the Supreme Court.

©2005 Jackson Lewis P.C. This material is provided for informational purposes only. It is not intended to constitute legal advice nor does it create a client-lawyer relationship between Jackson Lewis and any recipient. Recipients should consult with counsel before taking any actions based on the information contained within this material. This material may be considered attorney advertising in some jurisdictions. Prior results do not guarantee a similar outcome.

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