Contingent attorney fees.Taxpayers often hire an attorney on a contingent fee Payment to an attorney for legal services that depends, or is contingent, upon there being some recovery or award in the case. The payment is then a percentage of the amount recovered—such as 25 percent if the matter is settled, or 30 percent if it proceeds to trial. basis. If the recovery is taxable, the attorney fee is deductible. Because of the interaction between regular tax and alternative minimum tax rules, however, these taxpayers can owe significant amounts--sometimes exceeding their entire receipt. In such situations they have argued that the correct amount of their taxable income Under the federal tax law, gross income reduced by adjustments and allowable deductions. It is the income against which tax rates are applied to compute an individual or entity's tax liability. The essence of taxable income is the accrual of some gain, profit, or benefit to a taxpayer. is the net proceeds Net Proceeds The amount received after all costs are deducted from the sale of a piece of property or security. Notes: In the case of an investor selling a security, net proceeds represent the proceeds from the sale minus any trading costs (i.e. commissions). (recovery minus contingent legal fees). The courts of appeals have split over the answer. The Supreme Court agreed to hear the issue and delivered a short but significant opinion. The Supreme Court decision covered two consolidated cases. In the first, John Banks II was fired from his position as educational consultant to the California Department of Education The California Department of Education is a California agency that oversees public education. The Department oversees funding, testing, and holds local educational agencies accountable for student achievement. . He sued for employment discrimination, hiring an attorney on a contingent fee basis. He did not include any of the $464,000 settlement in income on his tax return. The IRS An abbreviation for the Internal Revenue Service, a federal agency charged with the responsibility of administering and enforcing internal revenue laws. issued a deficiency notice based on the full amount, and the Tax Court upheld the deficiency. The appellate court A court having jurisdiction to review decisions of a trial-level or other lower court. An unsuccessful party in a lawsuit must file an appeal with an appellate court in order to have the decision reviewed. held that the correct amount of included income was the settlement minus the $150,000 attorney fee. In the second case Sigitas J. Banaitis left his job as vice-president and loan officer at the Bank of California The Bank of California was founded in San Francisco, California on July 5, 1864 by William Chapman Ralston. It was the first commercial bank in the Western United States, the second-richest bank in the nation, and considered instrumental in developing the American Old West. . He hired an attorney on a contingent fee basis to sue the bank and its successor, Mitsubishi Bank, for willful interference with the employment contract, attempting to induce him to breach his fiduciary responsibility and firing him for refusing. Banaitis was awarded compensatory and punitive damages. He settled for a payment of $4.9 million, which he included in income, plus $3.9 million to be paid directly to his attorney, which he did not. The IRS determined that the amount paid to the attorney should have been included in income. The Tax Court agreed, but the appellate court reversed based mainly on state law. Result. For the IRS. The Supreme Court opinion began with two clarify |
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