Commissioner v. Banks
Headline: Tax ruling says plaintiffs must include the portion of a settlement or judgment paid to their lawyer under a contingent-fee agreement as the plaintiff’s taxable income, raising tax bills for many litigants.
Holding: The Court held that when a litigant’s recovery is taxable income, the portion paid to an attorney under a contingent-fee agreement must be included in the plaintiff’s gross income.
- Requires plaintiffs to report contingent-fee portions of recoveries as taxable income.
- Can increase tax bills for plaintiffs who pay large contingency fees.
- Limits the benefit of claiming fees as non-taxable unless other law provides relief.
Summary
Background
These consolidated cases arise from two lawsuits where plaintiffs recovered money and paid lawyers under contingent-fee agreements. In Banks, the plaintiff settled for $464,000 and paid $150,000 to his lawyer but did not report the full amount as income; the Tax Court taxed the full recovery and the Sixth Circuit partially reversed. In Banaitis, the plaintiff received $4,864,547 while $3,864,012 was paid directly to his lawyer; the Ninth Circuit reversed the Tax Court based on state-law liens for attorneys.
Reasoning
The Court addressed whether the portion of a recovery paid to an attorney is income to the plaintiff. It applied the long-standing rule that income is taxed to the person who controls the income-producing asset — here, the cause of action. The Court found the client retains dominion over the claim and treats a contingent-fee lawyer as an agent, not a partner, so the full recovery is income to the plaintiff even if part is diverted to the lawyer. The Court rejected arguments that uncertainty of value or the lawyer’s effort makes the fee a non-taxable transfer. It reversed the Sixth and Ninth Circuits and remanded for further proceedings.
Real world impact
The decision means plaintiffs who receive taxable settlements or judgments must include the full recovery in gross income, including the portion paid to their contingent-fee attorneys. The opinion notes ordinary deductions may be limited by the Alternative Minimum Tax, and that a later Congressional change allows certain discrimination claimants to deduct attorney fees for future cases but does not apply retroactively. The Court did not decide some related questions, such as court-awarded statutory fees or relator suits, because those issues were not presented here.
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