Commissioner V. Banks - Subsequent Developments

Subsequent Developments

Successful plaintiffs may face an unintended and unfair tax result because of this ruling. Gross proceeds from settlement or litigation are considered income and the related legal fees are deductible only as an itemized deduction. Some or all of the deduction benefit may be lost because of the 2% limitation on miscellaneous itemized deductions or the loss of the deduction for legal fees for purposes of calculating the Alternative Minimum Tax (AMT) with larger awards. Double taxation of the attorney fees may result because the amount for attorney fees is income to the plaintiff and the attorney who is eventually paid. Some plaintiffs may be put in a worse financial situation after winning a case if the attorney fees far exceeded plaintiff’s actual damages.

The impact of this decision may have little impact on future tax disputes involving substantially the same facts. After these cases arose, the Internal Revenue Code Section 62(a)(20), enacted as part of the American Jobs Creation Act of 2004, expressly permits a taxpayer to subtract from his or her gross income, in arriving at adjusted gross income, the “attorneys fees and court costs paid by, or on behalf of, the taxpayer in connection with any action involving a claim of unlawful discrimination” as defined by the Act. The Act was not retroactive and only applied to attorney fees paid after the date of enactment with respect to any settlement or judgment occurring after its enactment. This provision eliminates the double taxation of attorney fees on plaintiff discrimination awards by changing the deduction for attorney fees from itemized deduction to an above the line deduction.

Commissioner v. Banks is still precedent for those contingent fee arrangements not eligible for an above the line deduction, which include claims for defamation, invasion of privacy, and tortious interference with contract.