|
Clients Must Pay Taxes On Lawyers' Contingency Fees By Tony Mauro WASHINGTON 覧 In a pair of cases with potential pocketbook impact on lawyers and their clients, the U.S. Supreme Court ruled yesterday that the contingent fee portion of lawsuit settlements and awards is taxable to the client, even if the money goes directly to the attorney. The initial reaction to the 8-0 decision was more muted than expected because a law passed by Congress last fall limits the ruling's implications. The decision will not doom the contingent fee system, which fuels a broad range of private litigation. While the cases 覧 Commissioner of Internal Revenue v. Banks and Commissioner of Internal Revenue v. Banaitis 覧 were pending last fall, Congress passed a provision allowing taxpayers who win awards in employment, whistleblower and civil rights litigation not to count attorney fees and court costs as taxable income. Congress already allows this for lawyer fees in personal injury cases. In addition, Justice Anthony Kennedy, in his opinion for the Court, explicitly said he was not ruling on the tax implications of other federal laws that provide attorney's fees, some of which exceed the award the plaintiff receives. But in other types of commercial litigation under federal and state law, experts forecast more costly settlements in light of yesterday's ruling because winning plaintiffs may insist that the extra tax they have to pay be tacked onto the settlement. "Congress preempted the worst possible impact of today's rulings," said Jennifer Brown, legal director of Legal Momentum, formerly the NOW Legal Defense and Education Fund, which worried that a ruling against the taxpayer would discourage public interest litigation. "But we are still concerned about other cases in which the contingency fee offers the only means of access to the courts for people of ordinary means." Jeffrey White, a lawyer for the Association of Trial Lawyers of America, said, "Now, in some cases, when both sides sit down to discuss settlement, you'll have to evaluate the tax consequences on the individual plaintiff and maybe hire a tax consultant. It will get a lot more complicated."
Supreme Court Reviews Taxes on Contingency Fees Lawyers' Fees No Longer Face Double Tax Under New Law By Tony Mauro WASHINGTON 覧 Amidst all the corporate tax benefits enacted by the Senate on Monday, one little-noticed provision may turn out to be a boon for civil rights plaintiffs, public interest groups, whistleblowers and even trial lawyers. The American Jobs Creation Act of 2004, which now heads to President George W. Bush for signature, contains a section ending the "double taxation" of lawyer contingent fees in several types of litigation. The Internal Revenue Service has favored double taxation for years, and its policy is the subject of two cases set for argument at the U.S. Supreme Court Nov. 1. Until now, the IRS required a victorious civil rights or other plaintiff who won, for example, a damage award of $100,000 to pay taxes on the entire amount, even though a contingent fee of $30,000 went to the plaintiff's attorney, and even though the attorney would pay taxes on that $30,000. The government's theory was that the entire award went to the client and should be taxed to the client, no matter where a chunk of the award ended up. This double taxation has been challenged in court, with mixed success, as a powerful disincentive for public interest and civil rights litigation. A bill to fix the problem, the Civil Rights Tax Relief Act, has languished in Congress for nearly five years without success until this week. "I am proud to say today we are putting a permanent provision in law that will protect people who risk their health and safety to help the government identify and prosecute fraud, and others who fight to protect their civil rights," said Representative Deborah Pryce, R-Ohio, an original co-sponsor of the bill four years ago. Senator Susan Collins, R-Maine, also pushed for the law. The National Employment Lawyers Association, one of a coalition of groups that fought for the bill, was also celebrating this week. "We are thrilled that Congress saw the wisdom of relieving individuals from having to pay taxes on fees that are paid to their attorneys, where the attorneys are already taxed on those same fees," said Bruce Fredrickson, vice president of public policy. Mr. Fredrickson said the bill was supported by groups ranging from AARP to the National Whistleblower Center and the U.S. Chamber of Commerce. Even though they are on the other side of affected litigation, businesses did not like the double taxation policy because it would jack up the cost of settling suits to compensate for the extra tax payments. "This tax issue complicated nearly every employment discrimination settlement we dealt with," said Mr. Fredrickson. The fact that groups across the political spectrum sought the change, he added, was a big factor in the legislation's success. The old tax policy began to show signs of weakness when appeals courts began siding with taxpayers who challenged it. The IRS, in turn, sought to defend the policy in a pair of cases now before the Supreme Court: Commissioner of Internal Revenue v. Banks and Commissioner of Internal Revenue v. Banaitis. Both won awards in employment disputes and challenged tax bills based on the full amount. The fact that Congress has now overturned the disputed policy has thrown those cases into uncertainty, though they do not become entirely moot. Jerome Libin of Sutherland Asbill & Brennan in Washington, D.C., who wrote a brief in the Supreme Court cases on behalf of several civil rights groups, said his understanding of the new provision is that it is prospective and that it may only cover contingent fees in litigation under specific laws listed in the legislation. "There is still a broader issue of other kinds of litigation," Mr. Libin said. Since Banks and Banaitis involve two taxpayers among the hundreds who have been levied the disputed tax in the past, their cases might still be alive. "There are lots of people in that position who might not be affected by a prospective law," said University of Washington School of Law professor Eric Schnapper, lawyer for Sigitas Banaitis, who challenged his tax bill on an $8.7 million settlement he won in an employment dispute, even though $3.8 million went to his attorneys. Mr. Schnapper said it was too soon to assess the full impact of the congressional enactment on the pending Supreme Court cases. It is also possible that in light of the new preferences expressed by Congress, the IRS would drop its pursuit of taxes under the old policy, Mr. Libin said, "though that is doubtful." Mr. Libin said the old policy was especially harmful because the alternative minimum tax does not allow taxpayers to deduct attorney's fees from income. In cases where attorney's fees exceeded the damage awards 覧 such as in public interest litigation where relief is injunctive or awards are minimal 覧 a client could be forced to pay more in taxes than he or she won in the award. "Congress cannot have intended the tax laws to produce a result that would clash so directly with its intentions in the civil rights area," Mr. Libin wrote in his brief before the Court. Among the groups joining the brief were the Lawyers' Committee for Civil Rights Under Law, the Bazelon Center for Mental Health Law, and the National Association for the Advancement of Colored People. |
|
A Feast
|
