Contingent attorney's fees.

In David Raymond, 2d Cir., 1/13/04, a case of first impression for the Second Circuit, the court reversed a Vermont district court and held that an individual who settled a wrongful termination suit could not exclude from income the portion of the settlement paid directly to his attorneys under a contingency fee arrangement; instead, these amounts had to be included in income and deducted as miscellaneous itemized deductions subject to the 2%-of-acljusted-gross-income floor. Because the taxpayer was subject to the alternative minimum tax, the fees were completely nondeductible.

There is a huge conflict among the circuits on whether a directly paid contingency fee is income to the plaintiff. Courts addressing the issue have generally recognized that state law determines the nature of the legal interests in property, while Federal law determines the tax consequences of the receipt or disposition of property. The Second Circuit now agrees with the First, Third, Fourth, Seventh, Tenth and Federal Circuits and the Tax Court in taxing plaintiffs on contingent fees paid to their attorneys. The Fifth, Sixth and Eleventh Circuits, however, have permitted clients to escape tax on contingent attorney fees. The Ninth Circuit has reached different results depending on state law. For a discussion of Raymond, see "Tax Trends" p. 181, this issue.