Jottings By An Employer's Lawyer

Monday, January 24, 2005

It Could Have Been A Big Deal, But New Tax Law Relieves the Pain In the Future

The importance of the section of the Jobs Creation Act which dealt with how contingency fees are reported and dealt with in employment cases came to full fruition today. This morning a unanimous (minus Justice Rehnquist) Supreme Court held that in cases before the effective date of the Act, the entire amount of a settlement, including the portion to be paid to the attorney under a contingency fee agreement is included in the gross income of the plaintiff for the year of the payment. While the plaintiff is entitled to a deduction it often does not remove the pain because of the alternative minimum tax. Commissioner of Internal Revenue v. Banks (1/24/05) [pdf]. Here is my earlier comment with a link to the applicable section of the new tax law which would have provided aid and comfort to Mr. Banks if only it had come in time, or been made retroactive.

Here's the Supreme Court's take on the going forward aspect of this decision:
[A]fter these cases arose Congress enacted the American Jobs Creation Act of 2004, 118 Stat. 1418. Section 703 of the Act amended the Code by adding ยง62(a)(19). Id., at 1546. The amendment allows a tax-payer, in computing adjusted gross income, to deduct "attorney fees and court costs paid by, or on behalf of, the taxpayer in connection with any action involving a claim of unlawful discrimination." Ibid. ... These deductions are permissible even when the AMT applies. Had the Act been in force for the transactions now under review, these cases likely would not have arisen. The Act is not retroactive, however, so while it may cover future taxpayers in respondents' position, it does not pertain here.
My emphasis added.

The case got to the Supreme Court in the first place because of a split in the circuits. Which means that if the IRS decides to go after tax revenue from past settlements, today's decision could have real consequences for those plaintiffs whose claims were settled prior to the effective date of the new Act (October 22, 2004), particularly in circuits which had previously held that the attorney fee portion of the settlement was not gross income.

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