Commissioner v. Banks
The Supreme Court ruled that when a person wins money in a lawsuit, the portion paid to their lawyer under a contingent-fee agreement still counts as the client's taxable income, not just the money the client actually keeps.
The decision resolves a split among the federal appeals courts and means plaintiffs generally cannot avoid taxes on the lawyer's cut of a settlement or judgment, even though Congress later created a narrow deduction for certain discrimination claims.
“[T]he contingent-fee lawyer [is not] a joint owner of his client’s claim in the legal sense any more than the commission salesman is a joint owner of his employer’s accounts receivable.”
Explaining why a contingent-fee lawyer is an agent, not a business partner, of the client.
How it got here: The Tax Court ruled for the IRS in both cases; the Sixth and Ninth Circuits reversed in the taxpayers' favor, and the Commissioner asked the Supreme Court to resolve the resulting circuit split.
The Case in Depth
What happened
Two people who won employment-related lawsuits — John Banks, fired from a California education job, and Sigitas Banaitis, fired from a bank job — each hired a lawyer on a contingent-fee basis and won settlements or damages. Each paid a large share of the recovery directly to his attorney and did not report that share as taxable income, prompting IRS deficiency notices.
The question before the Court
When someone wins a lawsuit and pays part of the winnings to their lawyer under a contingent-fee deal, does that lawyer's share still count as the client's taxable income?
The Court's answer
Yes — the Court ruled that when a lawsuit recovery counts as income, the portion paid to the plaintiff's lawyer as a contingent fee is still part of the plaintiff's taxable income, not a tax-free pass-through to the lawyer. The Court reasoned that the plaintiff, not the lawyer, controls the lawsuit itself — deciding whether to settle or go to trial — so the plaintiff is the one who "earns" the income under longstanding tax principles, even though the lawyer's skill helped produce the result.
The Court rejected arguments that the lawyer and client form a kind of partnership sharing ownership of the claim; instead, the lawyer is legally just the client's agent. This rule applies even in states that give lawyers special legal protections over their fees, and it applies to both a private settlement (Banks) and a jury verdict followed by settlement (Banaitis).
Curious how the Court got there? See the step-by-step legal reasoning →
Why it matters
People who win lawsuits and use contingent-fee lawyers may owe income tax on the full recovery, including the lawyer's share, even though they never keep that money. This can be especially costly for plaintiffs hit by the Alternative Minimum Tax, which does not allow deductions for legal fees, though a later federal law softened this for many discrimination claims.
What changes now
The Court reversed the rulings favoring both taxpayers and sent both cases back to the lower courts for further proceedings consistent with this rule. Because a 2004 federal law now lets many discrimination plaintiffs deduct attorney's fees when computing income even under the Alternative Minimum Tax, the harshest effects of this decision are reduced going forward for future claims involving unlawful discrimination, though the new law was not retroactive and did not apply to Banks or Banaitis themselves.
What this does not decide
The Court did not decide whether its rule applies when a court — rather than a private contract — awards attorney's fees directly under a fee-shifting statute, since Banks' fee was set entirely by private contract. It also left open several alternative tax theories raised for the first time on appeal, including partnership and capital-expense theories.
How the Court got there
The legal reasoning, step by step
- The Court applied the 'anticipatory assignment of income' doctrine, a long-standing tax rule holding that a person cannot avoid taxes on income by arranging in advance for someone else to receive it — income is taxed to whoever earned it.
- Because a person who assigns income away often no longer holds the income itself at the moment of payment, the key question becomes who controls the underlying asset that generates the income — here, the lawsuit itself.
- The Court found that the client, not the lawyer, controls the lawsuit throughout the case: the client decides whether to settle or go to trial, even though the lawyer makes tactical choices along the way.
- The Court rejected the argument that a contingent-fee deal creates a partnership between client and lawyer, explaining that the lawyer is instead the client's agent, legally bound to act only for the client's benefit, similar to a salesman working on commission for an employer.
- Because the lawyer is an agent whose fee is generated through the client's own legal claim, the Court concluded the full recovery — including the lawyer's contingent fee — counts as income to the client, regardless of how much skill or effort the lawyer contributed or what any state law says about the lawyer's interest in the fee.
Doctrinal impact
Cases affected by this decision
Reaffirms Lucas v. Earl (281 U. S. 111)
The Court relied on this case's rule that income is taxed to the person who earns it, not whoever receives it later.
Reaffirms Helvering v. Horst (311 U. S. 112)
The Court extended this case's logic about controlling an income-generating asset to contingent-fee lawsuit recoveries.