Double Taxation in Settlement of Employment Cases Statutorily Eliminated

Posted 10:22 PM by Michael Fox

Employment practitioners are well aware of the tax consequences of settlement of employment cases which often provide obstacles to resolution. One of the hottest issues is whether or not in a settlement involving attorneys fees, the plaintiff should be taxed on the total settlement amount including attorneys fees, or only on the portion that he or she netted. If taxed on both, it resulted in double taxation as plaintiff's counsel also was taxed. Making it particularly troublesome was the impact of the Alternative Minimum Tax, which in extreme cases could mean that an employee could owe more in taxes than they actually received.

The circuit courts were divided, with the 5th Circuit for example not requiring double taxation, but others doing so. The Supreme Court had taken a pair of cases to decide the issue this term. See Commissioner of Internal Revenue v. Banks and Commissioner of Internal Revenue v. Banaitis which are set for oral argument on November 1.

The impact of those cases will now have interest only to the parties involved as one of the many provisions of the huge corporate tax bill, the American Jobs Creation Act of 2004, is a provision that eliminates that problem in any case involving discrimination. See §703 of the Conference Report Civil Rights Tax Relief (p. 343) [pdf]. For a more complete explanation see the Statement of the Conference Managers explaining the background and the amendment beginning on p. 252 of the Statement of the Conference Managers. [pdf].

Although only maintaining the status quo in the 5th Circuit, it removes the uncertainty raised by the pending Supreme Court action and for those circuits which allowed the double taxation, it is a major step forward.

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