Commissioner V. Banks - Background

Background

In the first case, John W. Banks, II was fired from his job with the California Department of Education. He retained an attorney on a contingent-fee basis and filed a civil suit against his employer alleging employment discrimination against his employer. Banks settled the case for $464,000 and paid $150,000 to his lawyer. The Internal Revenue Service (IRS) contended that the entire amount was income to Banks, a position upheld by the United States Tax Court. The United States Court of Appeals for the Sixth Circuit ruled in favor of Banks, holding the lawyer's share could be excluded from the taxpayer's gross income. The Court of Appeals reasoned the contingent-fee arrangement “is more like a partial assignment of income-producing property than an assignment of income.” Under this theory, Banks and his attorney were in effect partners in a joint venture who shared a recovery, and who should each be taxed only on his separate part.

In the second case, Sigitas J. Banaitis, a vice president of the Bank of California, retained an attorney on a contingent-fee basis and sued the bank and its successor in ownership, the Mitsubishi Bank, for interference with his employment agreement and wrongful discharge. The parties settled the case. The defendants paid $4.9 million to Banaitis and $3.9 million to his attorney, following the formula set forth in the contingent-fee contract. The IRS viewed the entire amount as gross income to Banaitis. This view was rejected by the United States Court of Appeals for the Ninth Circuit, which reasoned that because the state law granted attorneys a superior lien in the contingent-fee portion of any recovery, that part of Banaitis’ settlement was not includable as gross income.

Both cases were then heard by the United States Supreme Court.