Contingent Attorney Fees
Schnee, Edward J., Journal of Accountancy
Taxpayers often hire an attorney on a contingent fee 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 is the net proceeds (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. 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 issued a deficiency notice based on the full amount, and the Tax Court upheld the deficiency. …